Modified Accrual Accounting

What is 'Modified Accrual Accounting'

Modified accrual accounting is an accounting method commonly used by government agencies that combines accrual-basis accounting with cash-basis accounting. Modified accrual accounting recognizes revenues when they become available and measurable and, with a few exceptions, recognizes expenditures when liabilities are incurred. A modified accrual accounting system can also divide available funds into separate entities within the organization to ensure that the money is being spent where it was intended.

BREAKING DOWN 'Modified Accrual Accounting'

The modified accrual method of accounting costs less to maintain than full accrual accounting. However, the modified accrual method is not an acceptable basis for external reporting of financial statements for public companies.

Modified Accrual Accounting Method in Government

The Government Accounting Standards Board (GASB), which is recognized as the official source of generally accepted accounting principles (GAAP) for state and local governments, establishes modified accrual accounting standards. To distinguish government accounting from business accounting, modified accrual accounting uses some different terminology than other accounting methods.

Cash Method and Accrual Method

The modified accrual method of accounting is derived from two other methods of accounting: the cash method and the accrual method. The cash method 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. A limited number of liability accounts are used under the cash method of accounting because the obligation is not recorded, even if it is coming due. Future obligations or anticipated revenues are not recorded in the financial statements until the cash transaction has occurred.

Alternatively, the accrual method of accounting recognizes expenses when they are incurred regardless of the payment status of the charges. Liabilities are used to record future payment obligations that have not yet been fulfilled. Revenue is recorded when it is earned and realizable. This indicates the company has fulfilled an obligation and has earned the right to collect an asset in the future.

Recording Short-Term Events

The modified accrual method of accounting 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 balance sheet 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 is recorded. 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.