Modified Accrual Accounting

Modified accrual accounting is a hybrid bookkeeping method that blends elements of cash-basis and accrual-basis accounting. It recognizes revenues when they are both measurable and available to finance current-period expenditures, while generally recording expenditures when liabilities are incurred. This approach is widely used by government entities because it emphasizes current-year resource availability and budgetary compliance.

How it differs from cash and accrual accounting

• Cash-basis accounting records revenues and expenses only when cash is received or paid. It ignores receivables, payables, and other noncash obligations until cash changes hands.
• Accrual accounting records revenues when earned and expenses when incurred, regardless of cash flow, providing a more complete picture of long-term financial position.
• Modified accrual combines the two:
• Short-term inflows and outflows are treated more like cash accounting (focus on available cash).
• Long-term items (fixed assets, long-term debt) are treated like accrual accounting and are recorded on the balance sheet and allocated over time (depreciation, amortization, depletion).

Recording short-term vs long-term events

• Short-term events: Revenues are recognized when they are measurable and available to pay current obligations; many income-statement items follow cash-basis timing. Short-term assets such as most receivables and inventories are handled with an emphasis on current availability.
• Long-term events: Fixed assets, long-term debt, and other multi-period items are capitalized and systematically allocated over their useful lives, similar to accrual accounting. This creates comparability across reporting periods.

Why governments use it

Government entities use modified accrual accounting because it:
– Focuses on whether current-year resources are sufficient to meet current-year obligations.
– Aligns financial reporting with legally adopted budgets and fund accounting practices.
– Allows governments to track and report on resources that are restricted or earmarked for specific purposes.

The Governmental Accounting Standards Board (GASB) establishes the standards for state and local governments that use this method.

Limitations and special considerations

• Modified accrual is not generally acceptable for external financial reporting by public companies under IFRS or standard business GAAP; corporations typically must use full accrual accounting for audited financial statements.
• Organizations that prefer modified accrual for internal reporting often convert to full accrual for external reporting and audit purposes.
• Private or smaller entities may have more flexibility in choosing accounting methods under certain regulatory or tax rules, but external reporting standards normally require accrual accounting.

Key takeaways

• Modified accrual accounting blends cash and accrual methods to emphasize current-period resource availability while accounting for long-term obligations.
• It recognizes revenues when measurable and available and records expenditures when liabilities are incurred.
• It is the standard approach for many government funds because it supports budgetary control and reporting on current financial resources.
• It is generally not used for public-company financial statements, which require full accrual accounting.

Simple examples

• Short-term: A grant receivable is recognized only when the funds are measurable and available to be used this year.
• Long-term: A municipal building is capitalized and depreciated over its useful life, even though its purchase affects multiple reporting periods.