A guide to lease audits
For companies handling a large number of leases that are either very complex or have high churn, lease audits are a necessary but resource-intensive process.
Whether a company acts as a landlord, a tenant, or both, it can be challenging to stay on top of the details of hundreds or even thousands of lease contracts and ensure that revenue or payables are correct. Inaccuracies in billing or payables can add up significantly over time, leading to lost revenue if mistakes are not identified quickly. Incorrect lease details can also cause IFRS/FASB compliance issues for companies if their balance sheets do not reflect their lease commitments accurately.
For many companies, lease audits can be a time consuming and expensive manual job, meaning this important process might not happen as often as it should. However, AI powered lease abstraction software is revolutionising the process, making lease audits faster and less painful.
What is a lease audit?
A lease or contract audit is the process of reviewing terms to confirm that the amount being billed or paid to a tenant is correct. Lease audits are commonly carried out for complex leases which run over a long period of time or simple leases that may have high churn.
Which industries have to carry out lease audits?
Any industry which leases property or equipment over a long period of time with complex conditions will typically need to carry out lease audits.
Commercial real estate or retail leases are a good example of this. Commercial leases are often lengthy documents (often 150+ pages) designed to run over periods of ten years or more, with clauses such as rent review addendums, break clauses or other clauses which could vary the amount the lessee pays over time.
Telecommunication leases also tend to require regular lease audits, because of the volume of leases being issued as a result of a high level of churn. A telecoms company might assign over 150 new leases for space on towers per year, making keeping track of leases a challenging job. Telecoms firms often have an additional layer of complexity to manage, because they often lease the land for their towers, or lease space on towers from other owners.
Retail tenants with a high number of stores or offices may also need to carry out lease audits, to help them keep track of the rent payable across multiple high street or shopping mall locations and reconcile this against the rent costs they’re declaring in their accounts.
What is the regulation associated with lease audits?
Many publicly-listed and larger private companies worldwide are required to report financial information according to International Financial Reporting Standards (IFRS). IFRS 16 sets out the reporting standards for leases, and is designed to make companies’ financial statements more transparent. In the US, which uses its own GAAP accounting principles instead of IFRS, there’s a similar requirement called ASC 842.
IFRS 16 and ASC 842 make it easier to compare the financial performance of companies who lease their assets (operating leases) with those who borrow money to buy them (finance leases), by requiring that these are reported in a consistent manner on a company’s balance sheet.
IFRS 16 and ASC 842 have implications for the data companies maintain on their leases, making regular lease audits vital to ensure that financial data is accurate and that your company’s lease commitments are reflected accurately and in compliance with IFRS 16.
When does a lease audit take place?
Lease audits are often triggered by changes within a business, for example a change in leadership prompting a search for process improvements. System or process updates like the introduction of a new software solution can also trigger a lease audit, to ensure that data is clean and accurate before moving to a new system.
Less positive events can also be a trigger. Legal issues or the discovery of billing errors for one tenant could prompt a company to review all their leases to ensure that similar mistakes have not been made elsewhere. For retail tenants, a shift in their portfolio such as the loss of an important location could also lead to a review of lease agreements across the entire chain.
Regardless of the cause, regular lease audits can help to ensure that any mistakes are picked up in good time. Billing errors which are discovered too late could mean that companies are unable to recover missed payments or reclaim overpayments, so it’s important to ensure that robust processes are in place to keep on top of leases.
How is a lease audit carried out?
Carrying out a lease audit is a painstaking process. Each lease must be individually checked, categorised and the relevant details of dates and payments transferred into a consistent format ready for the required IFRS 16 calculations to be built. It’s vital that this standardised information is accurate, as mistakes can cost internal staff countless hours tracking mistakes back to their original source and verifying the data.
Completing this task manually across hundreds or even thousands of leases is extremely time consuming, forcing companies to devote huge amounts of resource to carrying out lease audits internally, or pay a law firm to do the work for them.
The good news is that software can significantly reduce the amount of manual work required in running a lease audit. A good lease accounting solution can streamline the process of auditing leases and preparing data for IFRS 16, reducing costs whilst helping to ensure accuracy.
How has AI changed the lease audit process?
AI-powered lease abstraction software can dramatically speed up the lease audit process, often by as much as 50 to 75%.
Rather than having a team of people read each lease, a machine learning software platform can automatically extract data from lease documents and format it ready to be passed into your finance system. AI lease abstraction is not only faster than reading leases manually, it can also be more accurate, eliminating human error and incorrect data entry.
AI lease audit software provides a full audit trail, making it easy to track back from the formatted data to the original lease clause it was extracted from, providing full confidence that the lease information is accurate. The formatted data files can be exported and sent directly to your auditors for a seamless audit process.
Streamline your lease audit processes
Without AI powered lease accounting solutions, lease audits can be painful and expensive, putting your company at risk of lost revenue if billing errors are not identified early enough, or non-compliance if human error leads to mistakes on your balance sheet.
Lease abstraction software can streamline the process of manually auditing leases, offering a robust audit trail and significantly increased speed to ensure that your audit processes run smoothly. Find out more about how MRI Contract Intelligence can help you today.
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