Modified accrual accounting is an innovative bookkeeping approach that merges elements of both accrual basis accounting and cash basis accounting. This hybrid method recognizes revenues when they become available and measurable and typically records expenditures when liabilities are incurred, with some specific exceptions. Modified accrual accounting is predominantly used by government entities.
Key Insights into Modified Accrual Accounting
- Dual Methodology: Modified accrual accounting combines the best of accrual basis accounting with cash basis accounting.
- Operational Efficiency: It delivers the simplicity of cash accounting along with the sophisticated capacity of accrual accounting to align related revenues with expenses.
- Selective Application: Depending on whether assets are long-term or short-term, modified accrual accounting employs elements from both cash and accrual accounting.
- Government Usage: While public companies generally cannot use this method due to non-compliance with International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), it is widely accepted for use by government agencies.
The Functionality Behind Modified Accrual Accounting
Cash Basis Accounting
In cash basis accounting, transactions are recognized upon the actual exchange of cash. This method does not recognize expenses until they are paid and does not recognize revenues until payment is received. Future obligations or anticipated revenues are not documented in financial statements until the actual cash transactions occur.
Accrual Basis Accounting
On the other hand, accrual accounting records expenses when they are incurred, regardless of the payment status, and records revenue when a legal obligation is established. This approach signifies that the company has fulfilled its obligation and has earned the right to collect payments, typically when goods are shipped or services are rendered.
Hybrid Approach of Modified Accrual Accounting
Modified accrual accounting merges the cash and accrual methods depending on the nature of the assets involved.
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Short-Term Assets and Liabilities: Following the cash method, short-term economic events are recorded when there is a direct impact on the cash balance. Most items in the income statement under this method are recorded on a cash basis, hence accounts receivable and inventory are typically not documented on the balance sheet.
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Long-Term Assets and Liabilities: For long-term economic events expected to impact multiple reporting periods, the accrual method is used. Fixed assets and long-term debt are recorded on the balance sheet and systematically depreciated, depleted, or amortized over the life span of the asset or liability, enabling future financial statements to have enhanced comparability.
Why is Modified Accrual Accounting Ideal for Government Agencies?
Modified accrual accounting perfectly suits government agencies, focusing on short-term financial assets and liabilities. The Government Accounting Standards Board (GASB) sets the rules for modified accrual accounting for state and local governments, recognized as the official source of GAAP for these entities.
Benefits and Functionalities for Government Agencies
This accounting method serves multiple governmental requirements:
- Current-Year Focus: It determines if current-year revenues are sufficient to cover current-year expenses.
- Budget Compliance: Demonstrates whether resources are being used according to legally adopted budgets.
- Financial Management: Facilitates the use of funds as intended by partitioning available funds within different departments or entities in the organization.
While businesses mainly use modified accrual accounting for internal purposes, government agencies leverage its ability to focus on real-time financial obligations and maintain clear, organized records of short-term and long-term economic events.
Related Terms: accrual accounting, cash basis accounting, Government Accounting Standards Board, financial statements.
References
- Financial Accounting Standards Board. “About the FASB”.
- Internal Revenue Service. “Publication 538: Accounting Periods and Methods”, Page 8.
- Internal Revenue Service. “Publication 538: Accounting Periods and Methods”, Page 9.
- Governmental Accounting Standards Board. “About the GASB”.
- Governmental Accounting Standards Board. “GASB Concepts Statement No. 1 Summary”.
