Discover how to avoid the hidden costs of lease accounting errors. Learn strategies for accurate reporting and compliance.
Lease accounting errors are rarely dramatic. They do not announce themselves, they do not break anything visibly, and they are usually discovered months or years after they were made, by an auditor asking a question that nobody can answer without rebuilding a spreadsheet from scratch.
That is precisely what makes them expensive. An error caught in the period it occurs costs an hour. The same error caught three years later has propagated through twelve sets of accounts, affected covenant calculations, and requires a restatement conversation nobody wants to have.
This article covers the errors we see most often under AASB 16, why each one happens, what it actually costs, and what prevents it.
The most common error is not a miscalculation. It is a lease that finance never knew about.
The pattern is consistent. Property leases go through one person, vehicle leases through fleet or operations, equipment leases through whoever needed the equipment, and photocopier and IT arrangements through administration. Only some of those routes end at finance.
The cost is completeness. Understated right of use assets and lease liabilities affect the balance sheet, the gearing ratios lenders look at, and the disclosure that is supposed to represent the full obligation.
The prevention is procedural rather than technical. Somebody has to own lease identification, there has to be a route from anybody signing an agreement to finance, and there should be a periodic completeness sweep against the contract register, the fleet list and the accounts payable ledger, which is where a lease nobody told you about eventually shows up as a recurring payment.
The lease term under AASB 16 is not the non cancellable period. It is the non cancellable period plus any extension option the entity is reasonably certain to exercise, and minus any termination option it is reasonably certain to exercise.
Reasonably certain is a high threshold and it is a judgement, which means it has to be assessed rather than assumed. A five year lease with a five year option might be a five year lease or a ten year one, and the difference roughly doubles the recognised amounts.
The error usually goes one of two ways. Either every option is ignored, which understates the liability, or every option is included, which overstates it. Both are wrong for the same reason, which is that no assessment was made.
The assessment should consider the economics rather than the intention. Leasehold improvements with remaining useful life, the cost of relocating, whether the site is genuinely substitutable, and whether the option rent is below market are the factors that make exercise reasonably certain.
The discount rate drives the measurement more than any other input and it is frequently chosen rather than derived.
Where the rate implicit in the lease cannot be determined, which is most of the time, you use the incremental borrowing rate. That means the rate you would pay to borrow, over a similar term, with similar security, for an asset of similar value, in a similar economic environment.
The common failure is using a single corporate borrowing rate for every lease regardless of term. A two year lease and a fifteen year lease should not carry the same rate, because the term structure of interest rates is real.
The other common failure is having no documentation. Auditors will ask how the rate was derived, and an answer that amounts to it seemed reasonable creates a finding. Write down the basis, the reference points used, and the adjustments made.
This is where technical errors concentrate, because the treatment depends on the nature of the change and the categories are easy to conflate.
A change in the consideration arising from something already in the original terms, such as a CPI linked escalation or a rent review mechanism, is a remeasurement of the liability with a corresponding adjustment to the asset, using the original discount rate where the change is not driven by interest rates.
A change in the assessment of an option is a remeasurement using a revised discount rate.
A change that adds a right of use not in the original contract, priced at a standalone rate, is a separate lease.
A change that alters the scope or consideration in any other way is a modification, remeasured using a revised rate at the effective date, with any decrease in scope also recognising a gain or loss on partial derecognition.
Getting these wrong is common and it is the error most likely to compound, because the wrong treatment persists in every subsequent period.
Leases with CPI linked or fixed percentage escalations require the liability to be remeasured when the change takes effect, and this is regularly missed.
The reason is timing. The escalation applies on an anniversary that has nothing to do with your reporting calendar, the payment simply increases, and unless somebody is watching for it the accounting continues on the old schedule while the cash goes out at the new amount.
The symptom is a lease liability that does not unwind to zero at the end of the term, which is a useful check and one most organisations never perform.
The prevention is a diary of escalation dates maintained alongside the lease register, reviewed each period, with the remeasurement performed as part of the close rather than when somebody notices.
The short term and low value exemptions are useful and they are conditional, and both conditions get stretched.
Short term means a term of twelve months or less at commencement, assessed including options the entity is reasonably certain to exercise, and excluding any lease with a purchase option. A twelve month lease that everybody expects to roll is not short term. The election is made by class of underlying asset and must be applied consistently.
Low value is assessed on the value of the underlying asset when new, not on its value to you and not on the total payments. It is applied lease by lease. And it is not available where the asset is subleased.
The error is usually convenience driven. A lease is awkward to model, so it becomes low value. That works until an auditor asks for the basis of the assessment.
Many lease agreements bundle services with the right of use. A property lease may include cleaning, security or maintenance. A vehicle lease may include servicing and registration.
The default treatment is to separate them, allocating the consideration on the basis of relative standalone prices, with only the lease component recognised on balance sheet.
There is a practical expedient allowing an entity to elect, by class of underlying asset, not to separate, which puts the whole payment into the lease. That is simpler and it inflates the asset and liability, so it is a decision with consequences rather than a shortcut.
The error is failing to make the decision at all, which usually means the whole payment goes in by default without the election being documented, and the inconsistency across leases becomes visible during audit.
Separate from the technical accounting, a whole class of error comes from the tooling.
Formula references break when rows are inserted, and a schedule that was correct becomes subtly wrong in a way that does not produce an obvious error.
Hardcoded values get entered to make something reconcile, and then nobody remembers why the cell is a number rather than a formula.
Versions proliferate, and establishing which file produced the numbers in a given set of accounts becomes genuinely difficult.
And rounding accumulates. Small differences per period, across many leases and many periods, produce a balance that does not clear at the end of the term and cannot be explained.
Where the schedules live outside the ledger, someone posts a journal each period, and that handoff is its own source of error.
A period gets missed, or posted twice, or posted to the wrong entity in a multi entity group.
The journal is posted from a superseded version of the schedule.
Or the schedule is updated after the journal was posted, and the two are never brought back into line.
The check that catches all of these is a reconciliation between the lease register total and the general ledger balance, performed every period rather than annually. It takes minutes when everything is right and it is the only thing that reliably detects when something is not.
Groups have failure modes that single entity businesses do not.
Leases get recorded in the wrong entity, usually because the paying entity and the entity using the asset differ and nobody decided which one should carry it.
Intercompany leases get recognised on both sides without elimination on consolidation, which double counts.
Foreign currency leases get translated at the wrong rate, or the liability is translated at closing while the asset is treated as non monetary and held at historic rate, and the distinction is missed.
And the discount rate is applied at group level when the relevant borrowing rate is the individual lessee entity's, which for a group with entities of different credit standing is materially wrong.
The costs are more concrete than the risk of restatement, which is the one usually cited.
Audit effort is the most immediate. Every error found means more testing, and more testing means higher fees and a longer audit, every year.
Covenant calculations are affected where they reference gearing, EBITDA or interest cover, all of which AASB 16 touches. A misstated lease liability can create a technical breach or conceal a real one.
Management decisions are affected where lease cost feeds into project, site or division profitability, which for property intensive businesses is most of them.
And remediation is expensive. Rebuilding several years of schedules, reconciling the differences and explaining them takes weeks of senior time and produces nothing new.
A small number of controls catch most of what goes wrong.
A single lease register that is the acknowledged source of truth, with a named owner, and a documented route by which every new lease reaches it.
A periodic reconciliation between that register and the general ledger, performed every period without exception.
A schedule of escalation dates, option decision dates and expiry dates, reviewed monthly so that remeasurements happen on time rather than in arrears.
Documented policy positions on discount rate derivation, exemption elections and component separation, so the answer to an audit question is a document rather than a recollection.
And a completeness sweep at least annually against contracts, accounts payable and the asset registers.
Most of the spreadsheet specific errors disappear when the calculation lives in a system rather than a workbook, and that is a large proportion of what goes wrong.
Where the lease records sit inside the accounting platform, the journals post directly, so the reconciliation is structural rather than a task. The remeasurement logic is applied consistently rather than rebuilt each time. The audit trail exists by default. And the schedules cannot silently diverge from the ledger because they are the same data.
What a system does not do is make the judgements. Lease term, discount rate, option assessment and component separation remain accounting decisions, and a system will apply whatever you tell it consistently, including a wrong answer.
So the value is in eliminating the mechanical errors, which frees attention for the judgemental ones, which is where it should have been all along. Our piece on NetLease in NetSuite covers what that looks like in practice.
If you suspect your lease accounting has drifted, a focused review answers the question faster than a full rebuild.
Start with completeness, comparing the register against contracts, the fleet list and recurring payments in accounts payable. Missing leases are the highest impact finding.
Then check that every liability unwinds to zero at the end of its term, which detects missed escalations and remeasurements without needing to examine each one.
Then reconcile the register total to the ledger for the current period and for the same period last year, since a difference that has grown tells you when the problem started.
Then sample the leases that have changed, because modifications are where the technical errors live and unchanged leases rarely go wrong after the first period.
Not every error found requires the same response, and the assessment is one of materiality rather than perfectionism.
Errors affecting the current period are corrected in the current period, straightforwardly.
Errors affecting prior periods require a materiality assessment, both individually and in aggregate, and the aggregate is the part that is often skipped. Several individually immaterial errors pointing the same direction may be material together.
Where a prior period error is material, prior period restatement is required, and that is a conversation to have with your auditor early rather than late.
Where it is not material, correct it prospectively and document the assessment, because being able to show that you considered it is what distinguishes a controlled process from an uncontrolled one.
The errors above are common, they are avoidable, and almost all of them come from either a process gap or a tooling limitation rather than from a lack of technical knowledge.
The highest value action for most businesses is the completeness sweep, because a missing lease is the error nobody detects and the one with the largest effect.
The second is the periodic reconciliation between register and ledger, because it catches nearly everything else early enough to be cheap.
Our pieces on AASB 16 explained and choosing lease accounting software take this further, and using lease data strategically covers what the same records are worth beyond compliance.
If you would like a review of your lease accounting, get in touch.
