Modified Accrual Accounting

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What is modified accrual accounting? How does it differ from full accrual accounting? What are some of its features and characteristics? Have you come up here with all these questions in your mind? So, here you go, and all your answers to your queries.

What is Modified Accrual Accounting?

It is an accounting method that is used by government agencies. This is basically a combination of two accounting methods: Cash Basis accounting and Accrual basis accounting. Where Modified accrual accounting recognizes revenues only when measurable and available. And recognize expenses when they incur.

For instance, you may record the transactions in which you receive cash on behalf of the sale of your goods or services. In addition, you may also record the transactions in which goods and services are sold but the amount is yet to be received. This will be the accrual basis of accounting and the prior one is cash basis accounting.

The Main Focus Of All Accounting Methods

The main focus between them all is when to record revenue and expenditure.

  1. In cash basis accounting: You record transactions only when you receive cash or pay cash. If you have received cash, record it. If you have paid cash, record it. And in the absence of cash, there will be no transaction.
  2. Accrual accounting: It is the process of accounting where you measure and records all the revenues and expenses when they earn and incur. In simple words, recording expenses and revenue when they incur regardless of the receiving of the payment.
  3. Modified accrual accounting: It is a combination of both. So, it recognizes revenues when measurable and available. And recognize expenses when incurred.

Main Features of Modified Accrual Accounting

The two main features are:

  1. Revenue recognition
  2. Expense recognition

Letโ€™s have a look into both of these features to have a clear understanding of modified accrual accounting.

Revenue Recognition

In this accounting method, revenues recognize only when measurable and available.

  • The term โ€œmeasurableโ€ means you can write the amount in it. In other words, you know how much amount you are going to earn.
  • While the term โ€œavailableโ€ here reflects the idea that you have access to your revenue in the near future. For instance, it is available to you in 30 days, 60 days, or 90 days.

Letโ€™s understand it with a simple modified accrual accounting example. Your company sells machinery, you sold a machine for $10,000 but you have not billed the customer yet. In this case, your revenue is measurable. In simple words, you know how much amount you are going to earn. But you havenโ€™t received the amount as yet. So, you can make a journal entry under modified accrual accounting as follows.

xxx   Account Receivable$10,000 
                Merchandise $10,000

Expense Recognition

Furthermore, in accrual basis accounting, expenses are recorded when incurred. Same works in a modified accrual system. For instance, you have bought machinery but havenโ€™t received an invoice from the supplier. Here, in this case, you can see that you have received the machinery and havenโ€™t paid yet. Liability is incurred. You have to pay for it in near future so, you have to record this expense. So, machinery is an asset so it will be debited. On the other hand, liability is incurred but you have not paid for it. So, a credit to the accounts payable.

xxx   Machinery                        $10,000 
                Accounts Payable $10,000

Expenditures are usually recorded on an accrual basis except for some cases given below:

  1. Debt service expenditures are not recognized until due or paid.
  2. Incurred but unpaid debt service expenditures which are not accrued.

Accrual expenses is the opposite of prepaid expenses. In prepaid, you pay before even receiving the services โ€œpaying beforeโ€. On the other hand,  in accrual, you have received the service but not paid for them โ€œpaying afterโ€.

Accrual vs prepaid expenses

Main Characteristics

Modified accrual accounting includes both cash basis accounting and accrual basis accountingโ€™s features.

The question that arises here is which assets and liabilities are we recognizing (recording) in modified accrual accounting?

The answer to this question is based on two following methods.

The Cash basis accounting method allows you to record short-term events such as inventory, account receivables, and payables.  In this method, you record all short-term events in the income statement only when you receive cash, and pay in cash. Futures anticipations are not recorded until cash is not received.

The Accrual basis accounting method allows you to record long-term events. In this method, you record all long-term assets and liabilities on the balance sheet.

Why Modified Accrual Accounting?

Just as mentioned earlier it includes both cash basis and accrual basis accounting. Hence it has the best of both the accounting processes.

The method uses different terminology which distinguishes it from accrual and cash basis accounting. For instance, we call net income an excess or deficiency, and for expenses use the expenditure word.

Accrual Accounting Vs Modified Accrual Accounting

Accrual Accounting

  • The accounting system recognizes transactions when revenue is earned and expenses are incurred. Regardless of cash received or paid.
  • In accrual accounting, revenues are recognized in the fiscal year in which you earn the revenue and that revenue is measurable. Availability is not taken into account.
  • We use the term โ€œexpenditureโ€  in modified accrual accounting. There is no expenditure in accrual accounting.

Modified Accrual Accounting

  • It recognizes revenue when measurable and available.
  • Modified accrual is the combination of accrual basis and cash basis accounting.
  • Modified accrual can also be called modified cash. It is used when we deal with governmental funds. Therefore, it is mostly used by government agencies.

Usage Of Modified Accrual Accounting

Who uses modified accrual accounting? The answer is โ€œIt is usually used by the government agenciesโ€. Government Accounting Standards Board (GASB) set standards and guidelines for this accounting system. Private organizations donโ€™t normally use it because it does not follow GAAP and IFRS standards. But a private company may in rare cases use it for its internal purpose. So, here a question arises why do governments use modified accrual accounting? The answer is that it fulfills the demand of a governmental company by letting it know whether current-year revenues are enough for current-year expenses. The governmental fund recognizes revenue as soon as cash is received and the revenue is both measurable and available.                                  

Key Points

  • Modified accrual includes the best of both cash-basis and accrual-basis accounting.
  • You record long-term assets such as fixed assets on the accrual basis and short-term assets on the cash basis accounting.
  • Government Accounting Standards Board (GASB) set standards for Modified accrual accounting.
  • Under this system, revenues are recognized when measurable and available. While expenses are recognized when incurred.

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