What Is Modified Accrual Accounting?

What Is Modified Accrual Accounting?

Let me explain modified accrual accounting to you—it's an alternative bookkeeping method that mixes accrual basis accounting with cash basis accounting. You recognize revenues when they become available and measurable, and with a few exceptions, you record expenditures when liabilities are incurred. I see this commonly used by government agencies.

Understanding Modified Accrual Accounting

To grasp how modified accrual accounting works, you first need to break down how traditional bookkeeping practices are influenced by function. Cash basis accounting recognizes transactions upon the exchange of cash—expenses aren't recognized until they're paid, and revenue isn't recognized until payment is received. That means future obligations or anticipated revenues aren't recorded in financial statements until the cash transaction happens.

In contrast, accrual accounting recognizes expenses when they're incurred, regardless of payment status, and records revenue when a legal obligation is created, like when goods are shipped or a service is completed. Modified accrual accounting borrows elements from both, depending on whether assets are long-term, such as fixed assets and long-term debt, or short-term, such as accounts receivable and inventory.

Recording Short-Term Events

The modified accrual practice follows the cash method when economic events affecting the short term occur. You record an economic event in the short term when the cash balance is affected. As a result, almost all items on the income statement are recorded using the cash basis, and items like accounts receivable and inventory aren't 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 affects how 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.

Special Considerations

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's not commonly used by public companies, however, as it doesn't comply with International Financial Reporting Standards (IFRS) or generally accepted accounting principles (GAAP), which outline procedures companies must follow for their official financial statements.

If you run a business that wants to use this method, you'll do so for internal purposes and then convert transactions from cash basis to accrual accounting to get them approved by auditors. Under GAAP, if a public company has average gross receipts for the past three years of $26 million or less, they can choose which accounting method to use.

Government Friendly

For governments, it's different. The Government Accounting Standards Board (GASB), 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 to finance current-year expenses and to demonstrate whether resources are being used according to legally adopted budgets. Modified accrual accounting meets those needs—it enables agencies to focus on short-term financial assets and liabilities and permits them to divide available funds into separate entities within the organization to ensure money is spent where intended. Companies may also use a modified cash basis method for internal record keeping.