What Exactly is the Cumulative Effect Adjustment?

The cumulative effect adjustment is an adjustment to the opening balance of equity based on the retrospective adjustment of the financial statements to adopt new accounting standards or to re-state previously issued financial statements. The adjustment is disclosed in audited financial statements in accordance with GAAP.

What is the Cumulative Effect Adjustment Approach?

There are two main transition approaches to implementing ASC 842 and, as a matter of policy election, organizations will choose one of the two. 

The first approach is to adjust comparative periods as shown in their financial statements. An ASC 842 cumulative effect adjustment example would be if the organization shows three years of financial data in their financial statements, they would choose to implement ASC 842 as of the first fiscal year shown in their financial statements. In this case, a cumulative effect adjustment is recognized as of the earliest period presented.

If an organization chooses not to adjust comparative periods, they will apply ASC 842 to each lease that has commenced as of the beginning of the reporting period in which the organization first applied ASC 842 with a cumulative effect adjustment as of that date.

It is important to note that, in both approaches, the organization begins reporting the ROU asset and lease liability for all leases as of the transition date. Equity is not affected.

Does ASC 842 Apply to Compilations?

Compilations are financial statements provided by accountants who are not related to your business. ASC 842 applies to all organizations following GAAP, therefore leases on the financial statements will be reported in compilations as well.

What is an Example of How Cumulative Effect Adjustment Affects Equity?

In many cases when an accounting standard is implemented, an adjustment is made to equity in order to begin reporting under the new standard. Under ASC 842, the calculations for reporting leases classified as capital leases, now called finance leases, did not change, so there is no adjustment to be made, and therefore there is no equity effect. 

For leases classified as operating leases, an ROU asset and lease liability is recorded as of the effective date, and therefore equity is not affected in this scenario either.

However, there are a few additional scenarios in which there could be an equity effect. 

1. Initial direct costs. If a client chooses to reassess leases by not electing the practical expedient, the definition of initial direct costs has now changed and, as a result, their opening entry might affect equity.

2. Hindsight for impairment or lease term. If your client does elect the practical expedient to use hindsight on impairment or lease term of a leased asset, it may affect their equity.

3. Operating lease transition under IFRS 16. Under IFRS 16, there are two options to determine the ROU Asset for what were operating leases. One option is consistent with ASC 842 and would not affect equity. Another option measures the ROU Asset as if IFRS 16 was applied at the lease commencement date. The journal entry for this option (including the new lease liability and removal of existing balances under IAS 17), would include an entry to equity.

4. Other scenarios that could affect equity. Built-to-suit arrangements, currency translation differences, and sale-leaseback transactions can also affect equity.

Within LeaseCrunch’s lease accounting software, all adjustments are made as part of the existing balances through the ROU asset when the initial journal entry is booked.

Was the Cumulative Effect Adjustment More Relevant When Companies were Switching to ASC 842?

No. Under ASC 842, almost all adjustments flowed through to the balance sheet by way of ROU assets; therefore, there were no adjustments to equity.

Need Help Utilizing the Cumulative Effect Adjustment?

Contact us here at LeaseCrunch today. We offer a white-glove customer service experience and lease accounting software developed by CPAs and lease accounting experts. Our service is unparalleled and our technology helps countless organizations perform lease accounting efficiently and accurately. 

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FAQs

Does ASC 842 Affect the Balance Sheet?

Since all leases except short-term leases are required to be accounted for on balance sheet post-ASC 842 implementation, the answer is usually yes; ASC 842 affects balance sheets.

What is the Current Period Adjustment Method for ASC 842?

There are two transition approaches for adopting ASC 842, the effective date method and the comparative method.

• Effective Date Method:

  • Organizations can apply the standard as of the beginning of the current reporting period for which they are adopting.

• Comparative Method:

  • This method requires all periods presented in the financial statements to be reported as if they were under the new standard.

  • Organizations using the comparative method will restate prior periods as if they had always been following the standard.