What is modified accrual accounting?
Modified accrual accounting is defined as an accounting method that combines accrual accounting and cash-basis accounting.
Cash-basis accounting is an accounting approach that recognises revenues and expenses when cash is received or paid out.
On the other hand, accrual accounting records income when it is produced and expenses when liabilities are incurred, regardless of when cash is collected or paid.
Modified accrual accounting takes the features from both accrual and cash-basis accounting methods. It uses the cash-basis method to record short-term events and follows the accrual method for long-term events. The long-term events include long-term debts and fixed assets, while the short-term events include accounts receivable, accounts payable and inventories.
The method aims to avoid giving an impression of having a surplus when the money is set aside for a future purpose. As a result, revenues are recorded only when they may be applied to obligations.
This does not imply that the funds will be immediately available. Instead, the funds will be gathered in the near future. This approach often has a 12-month time constraint for receiving payments.
Understanding modified accrual accounting
The US Government Accounting Standards Board (GASB) creates the modified accrual basis of accounting. However, it does not comply with the Generally Accepted Accounting Principles (GAAP) or the International Financial Reporting Standards (IFRS). Modified accrual accounting is used and accepted by governmental agencies because they focus on current-year obligations.
The GASB creates the method to measure current-year income, expenditures and financial resources in government funds because government agencies have a different purpose and requirement for accounting than public companies.
The method is less commonly used by public companies because it does not comply with GAAP, which specifies rules for companies when preparing their official financial statements. However, public companies can still use the modified accrual method to record their business activities accurately and indicate their financial health to stakeholders, but only for internal purposes.
How does modified accrual accounting work?
An example of modified accrual accounting is when a local government agency needs to calculate whether current-year revenues are sufficient to support current-year expenses. It indicates whether the government is running a surplus or a deficit. A government agency should also track whether it is using its funds according to the budget plan. Such requirements can be accomplished through using the modified accrual approach.
Using the modified accrual approach can help reflect recent revenues and expenditures by documenting short-term events using the cash-basis accounting method. The government body can then divide the money into internal entities, which enables it to keep better track of whether funds are being spent as intended. In addition, it makes it simpler for the government to adjust its budget plan.
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