Key Accounting Considerations Leading Into Your Year-End Audit

As the year comes to a close, many companies prepare for year-end audits, an important process that can impact financial reporting, regulatory compliance, and investor confidence. While year-end audits are vital for maintaining transparency and accuracy in financial reporting, there are several key accounting considerations that businesses often overlook or misunderstand. These considerations can lead to significant errors or delays in the audit process.

Some of the most critical areas that require attention as you approach your year-end audit are lease modifications and remeasurements, impairment testing for goodwill and indefinite-lived intangibles, and the changes under FASB Topic 326 concerning credit losses. By understanding these areas in detail, companies can ensure smoother audits, improved financial statements, and avoid any last-minute surprises.

Lease Modifications and Remeasurements

One of the most common areas where companies run into trouble during their year-end audits is lease modifications. Under ASC 842, lease modifications occur when the terms and conditions of a lease contract change, resulting in a change in the lease's scope or consideration. While certain amendments (like renewing a lease without changing its terms) may not require special accounting treatment, others, such as extending a lease with additional space or altering the lease term, do.

It’s crucial for businesses to carefully assess lease modifications before the year-end audit. Lease modifications can result in either a remeasurement of the lease liability and right-of-use (ROU) asset or the need to account for the modification as a new lease altogether. Misunderstanding these changes can lead to incorrect financial reporting.

Here’s a quick overview of how lease modifications should be approached:

• Effective Date of Modifications: The modification is effective once both parties agree to the change.
• Separate vs. Non-Separate Contracts: If the modification grants additional rights that weren’t part of the original lease, it could be treated as a separate contract. If it’s not considered separate, the lessee must reassess lease classification and remeasure both the lease liability and the ROU asset.

Additionally, businesses should be aware of remeasurement events, which occur when there are changes in lease assumptions (such as lease terms or fixed payments) that impact the lease’s accounting. These can happen due to a variety of business decisions, such as deciding to sublet part of a leased property or making significant leasehold improvements. Understanding when a remeasurement event occurs is essential to ensure that the lease accounting remains accurate and compliant. 

Impairment Testing for Goodwill and Indefinite-Lived Intangible Assets

Another critical area of year-end audits is the impairment testing for goodwill and indefinite-lived intangible assets. Under ASC 350, companies are required to test goodwill and certain intangible assets for impairment, especially when there are indications that the carrying value of these assets may not be recoverable.

For most businesses, this testing is conducted annually. However, businesses must be aware of specific triggering events that may require earlier impairment testing. These events may include:

• Macroeconomic conditions: A decline in general economic conditions, changes in interest rates, or shifts in the market could impact the value of goodwill or intangible assets.
• Industry and market conditions: Changes in market demand, increased competition, or regulatory developments can lead to asset impairments.
• Company-specific events: Changes in management, key personnel, or strategic direction could signal the need for impairment testing.

The complexity of goodwill impairment testing means that businesses must be proactive in assessing whether any of these triggering events have occurred. Failing to conduct impairment tests in a timely manner can lead to unexpected delays in the audit process.

FASB Topic 326: The CECL Model

The Current Expected Credit Loss (CECL) model under FASB Topic 326 changed how companies account for credit losses on financial assets carried at amortized cost, such as loans and receivables. Under the CECL model, companies are required to estimate credit losses over the entire contractual term of an asset, rather than waiting for losses to be probable.

Key factors to consider:

• Recognition Timing: The CECL model requires losses to be estimated and recognized upon the initial recognition of the asset.
• Risk Pooling: The CECL model requires financial assets with similar risk characteristics to be evaluated together. This pooling method will help entities more accurately estimate credit losses for portfolios of similar assets.
• Forward-Looking Information: The CECL model requires the use of forward-looking information, such as economic forecasts, when estimating expected credit losses, in addition to historical cost and current economic conditions. This is a significant shift from only considering historical loss data and current economic conditions used under the previous model.

Applying the CECL model may require significant adjustments to accounting processes and systems. Financial institutions and other businesses with large credit portfolios will need to adopt robust models for estimating credit losses to ensure compliance with this standard.

Year-End Audits: A Year-Long Process

While the year-end audit is a critical event, it should not be treated as a last-minute rush. Successful audits are the result of year-long preparation, where accounting teams ensure compliance with evolving standards and manage potential risks proactively. By addressing these key accounting considerations—lease modifications, goodwill impairment, and credit loss estimation—companies can streamline their audit process and avoid costly delays or errors.

If your business needs assistance navigating the complexities of these accounting standards and preparing for your upcoming audit, our team of experts is here to help. From implementing new processes to ensuring accurate lease accounting and impairment testing, we can guide you through the most challenging aspects of year-end reporting.

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