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Modified accrual accounting is a method that combines accrual basis accounting with cash basis accounting. It acknowledges revenues when they become available and measurable. Often, modified accrual accounting also records expenditures when liabilities are incurred. Public companies cannot use this method for financial statements, but numerous government agencies use it. 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).

What Are the Basic Rules of Modified Accrual Accounting? 

Modified accrual accounting combines features of the cash and accrual method. For the cash method of accounting, revenues and expenses are documented when the cash is received or paid. Under the accrual method, revenues are noted when they are earned (goods or services are delivered), and expenses are recorded when incurred (products are consumed). Modified accrual accounting differentiates short-term and long-term events and acknowledges them in various ways.

Short-Term Events 

Modified accrual accounting uses cash basis accounting to report short-term events. Short-term events are the economic events that affect the short-term items on a balance sheet. Some inclusions are account receivables, inventory, and account payables.

Events are documented when the cash balance is changed. Meaning, that almost all the income statement items are recorded in cash-basis accounting. Short-term assets and liabilities are no longer on the balance sheet.

Long-Term Events 

Long-term events consist of economic events that affect the items or more than one accounting period. Fixed assets (PP&E) and long-term debts are instances of long-term assets and liabilities. Modified accrual accounting handles long-term events the same way accrual accounting does. Long-term assets and liabilities are logged on the balance sheet. Depreciation, amortization, and debt repayments are reported over the life of assets and debts.

Nonetheless, there are some differences between modified accrual accounting and full accrual accounting in recognizing the current portion of long-term debt. For full accrual accounting, the portion is acknowledged in the period and value when it is incurred. Modified accrual accounting recognizes the current portion of long-term debt as it matures. Also, it can be disclosed to the extent of liquidation with available financial resources that are expendable.

Revenues and Expenditures 

Revenues are available when they can finance current expenditures paid within 60 days. Modified accrual accounting recognizes revenues when they are available and reasonable to gauge. Expenditures are reported in the same manner as accrual accounting. They are acknowledged in the period which they incur, no matter when the cash payments occur. 

Certain items can take on different names in modified accrual accounting. For instance, net income can be called excess or deficiency, while expenses can be referred to as expenditures.

Why is modified accrual accounting necessary? 

Government agencies use modified accrual accounting. These entities have different goals from for-profit and nonprofit entities. Government entities concentrate on current-year obligations while the modified accrual basis mainly focuses on short-term financial assets and liabilities.

Local governments aim to reflect whether the current-year revenues are enough to cover the current-year expenditure. It determines whether the government is facing a surplus or deficit. A government agency should be able to track if it is using its financial resources according to the budget plan. The modified accrual method can meet this requirement.

Since the modified accrual method records short-term events on a cash basis, it clearly illustrates the recent revenues and expenditures. A government agency can also categorize the fund into its internal entities. It helps the local government better track if it is spending money as planned and makes it easier to adjust its budget.

Who uses modified accrual accounting?

Government agencies usually use modified accrual accounting. While it is public, for-profit companies can use it and may rely on a different accounting method that follows GAAP or IFRS. Businesses can use modified accrual accounting as an internal accounting system, but audited records often need the accrual-basis system. State and local governments use GAAP, established by the Government Accounting Standards Board (GASB), that solidifies modified accrual accounting practices.

Government agencies use this accounting strategy because they mainly focus on current-year financial obligations. The primary objectives of these organizations are evaluating whether government entities use resources according to legally adopted budgets and showing if current-year revenues are large enough to finance current-year expenses. Modified accrual accounting achieves both of these goals since it allows government agencies to consider short-term liabilities and assets, and helps them divide available funds into specific units within an organization.

What is the difference between accrual and modified accrual?

The primary difference between accrual and modified accrual accounting is how they each take note of current long-term debt. When companies use full accrual accounting, they acknowledge the portion of long-term debt in the period and value when an agency incurs it. In contrast, modified accrual accounting identifies the current portion of long-term debt as it changes, depreciates, and depletes throughout the duration of its existence.

Professionals often use the modified accrual accounting method to track short-term events on a cash basis. So, it represents recent expenditures and revenues more accurately than other methods. This allows government agencies to adjust their budgets when necessary to adapt to the requirements of government entities’ spending and ensure that their spending aligns with the agencies’ plans.