Common IFRS 16 Audit Findings & How to Avoid Them

Years after IFRS 16 became effective, auditors continue to identify significant issues with lease accounting. These findings range from technical accounting errors to control deficiencies and inadequate documentation.

This article examines the most common audit findings, explains why they occur, and provides practical steps to avoid them. Whether you're preparing for an upcoming audit or looking to strengthen your lease accounting processes, understanding these issues is essential.

Finding 1: Lease Identification Issues

The most fundamental and persistent audit finding relates to identifying which arrangements contain leases. Entities frequently fail to identify embedded leases or incorrectly classify service arrangements as leases.

Common Problems

Issue	Example	Impact
Embedded leases missed	Dedicated equipment in outsourcing contracts	Understated assets and liabilities
Service contracts treated as leases	IT services without identified assets	Overstated assets and liabilities
Substitution rights misassessed	Supplier has substantive substitution right ignored	Incorrect lease identification
No systematic review process	Leases identified only when obvious	Incomplete lease population

The Identified Asset Question

A contract contains a lease only if there is an identified asset. Auditors frequently challenge:

• Whether the asset is explicitly or implicitly specified
• Whether the supplier has a substantive substitution right
• Whether a portion of an asset can be an identified asset (physical or capacity portion)

How to Avoid This Finding

• Implement a systematic contract review process. Review all significant contracts (not just those titled "lease") against IFRS 16.9-11 criteria. Include procurement, IT, logistics, and outsourcing contracts.
• Document the assessment. For each contract assessed, document: (a) whether an identified asset exists, (b) substitution rights analysis, (c) who has the right to direct use, and (d) conclusion with reasoning.
• Train contract reviewers. Ensure procurement, legal, and business teams can flag potential embedded leases before contracts are signed.

Finding 2: Lease Term Determination

Determining the lease term requires assessing whether the lessee is "reasonably certain" to exercise extension options or not exercise termination options. This judgement-heavy area frequently attracts audit challenges.

Common Problems

• No documented analysis of whether extension/termination options will be exercised
• Inconsistent assessments across similar leases
• Economic incentive factors ignored (leasehold improvements, relocation costs, strategic importance)
• Failure to reassess when significant events or changes occur
• Automatic inclusion/exclusion of options without proper analysis

Economic Incentive Factors to Consider

• Leasehold improvements: Significant unamortised improvements suggest extension is likely
• Costs to terminate: Restoration obligations, removal costs, contract penalties
• Availability of alternatives: Scarcity of suitable replacement properties/equipment
• Importance to operations: Headquarters, flagship stores, specialised facilities
• Historical practice: Track record of exercising options on similar leases
• Option terms: Exercise price relative to market rate at option date

How to Avoid This Finding

• Create a lease term policy. Establish a documented policy for assessing lease terms, including the factors to consider and who makes the final determination.
• Document each assessment. For each lease with options, prepare a memo documenting the factors considered, information gathered, and conclusion reached with supporting rationale.
• Establish a reassessment process. Implement triggers for reassessment: significant leasehold improvements, changes in business strategy, approaching option dates, or significant events.

Finding 3: Discount Rate Issues

The incremental borrowing rate (IBR) is often the most material estimate in IFRS 16 calculations. Auditors frequently find insufficient documentation to support the rates used.

Common Problems

Issue	Why It's a Problem
Using a single rate for all leases	IBR should reflect lease-specific factors (term, currency, security)
No documentation of methodology	Auditors cannot verify the rate is appropriate
Using parent company rate for subsidiaries	IBR is entity-specific, and subsidiaries may have different credit risk
Not adjusting for collateral	IBR assumes secured borrowing; using unsecured rates overstates the IBR
Stale rates	Using rates from transition without updating for new leases
No term-matching	Using a 5-year rate for a 10-year lease

IBR Documentation Checklist

Your IBR documentation should include:

• Reference rate used and source (e.g., government bond yield, SOFR)
• Credit spread adjustment and basis (credit rating, recent borrowing)
• Term adjustment methodology
• Collateral/security adjustment
• Currency-specific considerations
• Entity-specific factors (for group entities with different credit profiles)

How to Avoid This Finding

• Establish an IBR methodology. Document a clear methodology for determining IBRs, including data sources, adjustments, and how to handle different lease types.
• Involve treasury. Treasury teams often have the best insight into the entity's actual borrowing costs. Involve them in IBR determination.
• Update rates regularly. Establish a process to update IBRs periodically (at least quarterly) and use appropriate rates for new leases based on commencement date.

Finding 4: Variable Payment Classification

Determining which variable payments to include in the lease liability is a frequent source of errors.

Common Problems

• In-substance fixed payments missed: Payments structured as variable but with no realistic variability
• Index-linked payments excluded: CPI-linked rent increases not included using current index
• Performance-based payments included: Turnover rent incorrectly included in lease liability
• No remeasurement for index changes: Failing to update lease liability when index-linked payments change

Variable Payment Classification Guide

Payment Type	Include in Liability?	Treatment
Fixed payments	Yes	Include at commencement
In-substance fixed	Yes	Include at commencement
Index-linked (e.g., CPI)	Yes	Use current index; remeasure when payments change
Rate-linked (e.g., SOFR)	Yes	Use current rate; remeasure when payments change
Usage-based (e.g., per km)	No	Expense as incurred
Performance-based (e.g., turnover rent)	No	Expense as incurred

How to Avoid This Finding

Document the classification of each variable payment element and establish a process to identify and remeasure index-linked payments when the underlying index changes.

Finding 5: Modification vs Remeasurement Confusion

The distinction between lease modifications and remeasurements is frequently confused, leading to incorrect accounting treatments.

Key Distinction

Aspect	Modification	Remeasurement
Definition	Change to scope or consideration not part of original terms	Reassessment of existing terms due to specified triggers
Trigger	Contract amendment, negotiation	Change in assessment, index change, significant event
Discount rate	Updated (revised) rate	Updated for term/purchase option changes; original for index changes
P&L impact	May have gain/loss if separate lease criteria not met	Generally adjustment to ROU asset
Example	Adding space to a lease	Exercising an extension option that was previously excluded

Common Errors

• Treating a modification as a remeasurement (using wrong discount rate)
• Not recognising a modification when terms genuinely change
• Accounting for a rent review as a modification rather than index remeasurement
• Failing to assess if a modification creates a separate lease

How to Avoid This Finding

• Establish clear definitions. Document in your accounting policy what constitutes a modification vs a remeasurement, with examples relevant to your lease portfolio.
• Create a decision tree. Develop a flowchart to guide staff through the assessment: Did the contract change? Was it within the original terms? What is the nature of the change?
• Document each change. For every lease change, document whether it's a modification or remeasurement, the basis for that conclusion, and the accounting treatment applied.

Finding 6: Disclosure Completeness

IFRS 16 requires extensive disclosures. Auditors frequently identify missing or incomplete disclosures.

Commonly Missing Disclosures

• Maturity analysis errors: Not providing all five required time bands, or inconsistency between undiscounted maturity analysis and recognised liability
• Variable lease expense: Not disclosing variable payments not included in the lease liability
• Short-term and low-value disclosures: Not disclosing expense for leases subject to practical expedients
• Sublease income: Not separately disclosing income from subleasing ROU assets
• Extension/termination options: Not disclosing potential future cash outflows not reflected in the liability
• ROU asset additions: Not disclosing additions to ROU assets during the period

How to Avoid This Finding

Use a comprehensive disclosure checklist each reporting period. See our Disclosure Requirements guide for a complete list.

Finding 7: Transition Errors

Although IFRS 16 has been in effect for several years, errors from the initial transition continue to affect financial statements.

Persistent Transition Issues

• Incorrect opening balances: Errors in the initial ROU asset or lease liability not subsequently corrected
• Practical expedients not consistently applied: Electing different approaches for similar leases
• Portfolio approach misapplied: Grouping dissimilar leases or using inappropriate single discount rates
• Operating lease straight-line adjustments missed: Not including deferred rent in the ROU asset

How to Avoid This Finding

If transition errors are identified, consider whether they are material enough to require restatement. For prospective items, ensure current period accounting is correct and disclose the error if material.

Finding 8: Control Deficiencies

Beyond specific accounting errors, auditors frequently identify weaknesses in the overall control environment for lease accounting.

Common Control Deficiencies

Deficiency	Risk	Remediation
No complete lease register	Leases omitted from accounting	Implement centralised lease tracking system
Decentralised lease signing	Leases entered without finance awareness	Require finance review of all lease contracts
No review of calculations	Calculation errors undetected	Implement independent calculation review
Manual spreadsheet processes	Formula errors, version control issues	Use dedicated lease accounting software
No policy documentation	Inconsistent treatment, key person risk	Document accounting policies and procedures
Inadequate segregation of duties	Fraud risk, errors not caught	Separate lease entry, calculation, and review roles

Building a Strong Control Environment

• Maintain a complete lease register. Implement a centralised system to track all leases, including key dates, terms, and options. Reconcile regularly to the general ledger.
• Establish review and approval processes. Require independent review of all lease calculations and journal entries before posting. Document the review performed.
• Perform regular reconciliations. Reconcile the lease subledger to the general ledger monthly. Investigate and resolve differences promptly.
• Document policies and procedures. Create comprehensive documentation covering all aspects of lease accounting, from identification to disclosure.

Audit Preparation Checklist

Use this checklist before your audit to proactively address common findings:

• Complete lease population with supporting contract review documentation
• Lease term assessments documented for all leases with options
• IBR methodology documented with supporting calculations
• Variable payment classification documented for each lease
• All modifications and remeasurements documented with accounting treatment
• Disclosure checklist completed and reconciled to supporting schedules
• Roll-forward schedules prepared reconciling opening to closing balances
• Lease register reconciled to general ledger
• Key judgements and estimates documentation prepared