Modified Accrual Accounting: Definition & Overview
There are different methods by which entities can keep their books.
The cash-basis accounting method is frequently used by non-profit and public organizations. Governmental organizations, however, frequently employ other methods such as modified accrual accounting.
But what exactly is modified accrual accounting? Why do public companies tend to stay clear of it?
Read on as we find out why.
Table of Contents
- Modified accrual accounting is a revenue system.
- It combines elements from accrual and cash basis accounting.
- You can use the modified accrual accounting system to record short-term assets as well as long-term assets.
- Government agencies will typically use the modified accrual accounting system.
- Public companies tend not to use it due to its non-compliance with GAAP and IFRS.
What Is Modified Accrual Accounting?
Modified accrual accounting is a bookkeeping method. It takes accrual basis accounting and combines it with cash basis accounting. It works by recognizing revenues at the moment they become available and measurable. It mostly records expenditures when they incur liabilities.
This form of accounting is commonly used by government agencies.
Basic Rules of Modified Accrual Accounting
A modified accrual accounting system takes the simplicity of cash accounting. It then mixes it with the more complex ability of accrual accounting. This is to match related revenues with expenses.
This system is not used often by public companies. This is mainly because it doesn’t comply with the widely used standards: International Financial Reporting Standards (IFRS) or the Generally Accepted Accounting Principles (GAAP). These principles outline what procedures companies have to follow. This is when they are preparing their officially reported financial statements.
Any business that wants to use this method has to do so for internal purposes. The transactions under a cash basis would then convert to accrual accounting. This is so that an auditor can sign them off.
Under GAAP, the rules change if a public company meets certain criteria. This is when they have an average gross receipts value over the past three years of $25 million or less. They can then choose which accounting method they would like to follow.
Modified Accrual Accounting When Recording Short-Term Events
This practice follows the cash method of accounting. This is when economic events that are affected in the short term have taken place, or any economic event recorded in the short term, at the point when the cash balance is affected in any way.
The result of this rule is that nearly every item that is recorded on the income statement is recorded using the cash basis, and any items including accounts receivable and inventory are not recorded on the company’s balance sheet.
Modified Accrual Accounting When Recording Long-Term Events
When an economic event can expect to impact a number of reporting periods, it’s recorded using similar rules to the standard accrual method. This impacts the way that fixed assets and longer-term debts are documented.
Under the modified accrual accounting system, these long-term items are recorded on a company’s balance sheet. They are then depleted, depreciated, or amortized over the life of the liability or asset. This allows future financial statements to be more easily compared.
Governmental Modified Accrual Accounting
When it comes to governments it works slightly differently. The Government Accounting Standards Board (GASB) is recognized as the official source of GAAP. GASB is for local and state governments, and establishes the modified accrual accounting standards.
The modified accrual accounting method is accepted and used by government agencies because it focuses on current-year obligations. A standard government agency will have two main objectives: (1) to report whether current-year revenues are good enough to finance current-year expenses, and (2) to show that resources are being used according to the legally adopted budgets.
Modified accrual accounting is used because it is able to tick both of these boxes. It allows governmental agencies to focus on short-term financial assets as well as liabilities. It also allows them to divide the available funds into separate entities that are within the organization. This ensures that money is being spent in the correct proportions and places.
How Does Modified Accrual Work?
Before we look at the way in which this method works, let’s first take a look at the main two elements of it. These are:
- The cash basis accounting system
- The accrual basis accounting system
The cash basis accounting system recognizes transactions upon the exchange of cash. The expenses aren’t recognized until they are paid, and the revenue is not recognized until the payment is received. This means that any future obligations, or expected revenues, aren’t recorded in financial statements until the cash transaction has actually been completed.
In contrast to this, accrual accounting recognizes expenses when they incur. This is regardless of the payment status of the charges. It records revenue when a legal obligation has been created, not when it has been fulfilled.
This shows that the company in question has fulfilled its obligation, and has therefore earned the right to collect at the point when the goods have been shipped or when the service has been completed.
The Benefit Of Modified Accrual Accounting
The benefit of modified accrual accounting is simple. It takes elements from both accrual and cash accounting. Though this depends on two things: whether the assets in question are long-term assets (e.g. fixed assets and long-term debt) or short-term assets (e.g. accounts receivable and inventory).
This allows the relationship between expenses and revenue to be much clearer and provides much better insight into the profitability of a company. It also gives a clearer and more accurate financial picture, especially in regards to the assets and liabilities on a company’s balance sheet.
Modified accrual accounting is a useful method of accounting. It takes elements from both cash accounting and accrual accounting. It gives a clear picture of a company’s assets and liabilities and gives clarity to the relationship between revenue and expenses.
It also allows Governmental organizations to concentrate on short-term financial assets and liabilities. In order to make sure that money is being used as intended, it also enables them to split available cash across various organizational bodies.
FAQs on Modified Accrual Accounting
There is one main difference between accrual accounting and modified accrual accounting. This is in the way that they recognize current debt. Accrual recognizes it in the period and value when the company incurs it. Whereas, modified accrual identifies the debt as it changes, depletes, and depreciates.
Both state and local governments use modified accrual accounting.
The method works for fund-based financial statements. This is from government funds, to time revenues and expenditures.
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