What Is Modified Accrual Accounting?
Modified accrual accounting is an alternative bookkeeping method that combines accrual-basis accounting with cash-basis accounting. It recognizes revenues when they become available and measurable and, with a few exceptions, records expenditures when liabilities are incurred. Modified accrual accounting is commonly used by government agencies.
- Modified accrual accounting is a method that combines accrual-basis accounting with cash basis accounting.
- This bookkeeping system combines the simplicity of cash accounting with the more sophisticated ability of accrual accounting to match related revenues with expenses.
- Modified accrual accounting borrows elements from both cash and accrual accounting depending on whether the assets are long-term or short-term.
- Public companies cannot use this accounting method for financial statements, but it is widely accepted for use by government agencies.
- Public companies cannot use modified accrual accounting because it does not comply with International Financial Reporting Standards (IFRS) or the generally accepted accounting principles (GAAP).
Understanding Modified Accrual Accounting
To understand how modified accrual accounting works it is first essential to break down how the traditional bookkeeping practices are influenced by function.
- Cash-basis accounting recognizes transactions upon the exchange of cash. Expenses are not recognized until they are paid and revenue is not recognized until payment has been received. That means that future obligations or anticipated revenues are not recorded in financial statements until the cash transaction has occurred.
- In contrast, accrual accounting recognizes expenses when they are incurred, regardless of the payment status of the charges, and records revenue when a legal obligation is created. This indicates the company has fulfilled an obligation and has earned the right to collect, say at the point when the goods are shipped or at the completion of a service.
Modified accrual accounting borrows elements from both cash and accrual accounting, depending on whether assets are long-term, such as fixed assets and long-term debt, or short-term, such as accounts receivable (AR) and inventory.
Recording Short-Term Events
The modified accrual practice follows the cash method of accounting when economic events affecting the short-term have occurred. An economic event is recorded in the short-term when the cash balance has been affected. The result of this rule is that almost all items recorded on the income statement are recorded using the cash basis, and items including accounts receivable and inventory are not recorded on the balance sheet.
Recording Long-Term Events
Economic events expected to impact multiple reporting periods are recorded using rules similar to the accrual method. This directly impacts the way fixed assets and long-term debt are documented. Under the modified accrual method, these long-term items are recorded on the balance sheet and depreciated, depleted, or amortized over the life of the asset or liability. This systematic distribution of expenses or revenues allows future financial statements to have more comparability.
A modified accrual accounting system combines the simplicity of cash accounting with the more sophisticated ability of accrual accounting to match related revenues with expenses.
It is not commonly used by public companies, however, as it does not comply with International Financial Reporting Standards (IFRS) or the generally accepted accounting principles (GAAP), which outline what procedures companies must follow when preparing their officially reported financial statements. Businesses that wish to use this method must do so for internal purposes and then convert transactions recorded under a cash basis to accrual accounting to get them signed off by auditors.
Under GAAP, if a public company has average gross receipts for the past three years of less than $25 million, they can then choose which accounting method they would like.
For governments, it is a different story. The Government Accounting Standards Board (GASB), which is recognized as the official source of GAAP for state and local governments, establishes modified accrual accounting standards.
Modified accrual accounting is used and accepted by governmental agencies because they focus on current-year obligations. Governmental agencies have two key objectives: to report whether current-year revenues are sufficient enough to finance current-year expenses, and to demonstrate whether resources are being used according to legally adopted budgets.
Modified accrual accounting ticks those boxes. It enables government agencies to focus on short-term financial assets and liabilities. It also permits them to divide available funds into separate entities within the organization to ensure that money is being spent where it was intended.