Modified Accrual Accounting

A different bookkeeping technique, modified accrual accounting, combines accrual and cash-based accounting. With a few exceptions, it records expenses when obligations are incurred and acknowledges revenues when they are quantifiable and accessible. 

Governmental organizations frequently employ modified accrual accounting. It combines accrual basis accounting with cash basis accounting. This accounting method combines the ease of cash accounting with accrual accounting, a more complex capacity to reconcile associated revenues and costs. 

Whether long-term or short-term assets, this accounting draws components from cash and accrual accounting; although public firms do not permit this accounting approach, it is commonly used by government organizations.

This accounting is not permitted under generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS) for public firms (GAAP).

Therefore, analyzing how the function affects conventional bookkeeping techniques is crucial to comprehend how modified accrual operates. When money is exchanged, transactions are recorded using the cash basis of accounting. 

Revenue is not recorded until payment has been received, and expenses are not recorded until they have been paid. It implies that until the cash transaction has happened, future liabilities or anticipated incomes are not reported in financial accounts.

Contrarily, accrual accounting records income when a legal obligation is established and recognizes costs as they are incurred, regardless of the charges' payment status. 

This signifies that the business has performed its duty and gained the right to collect, such as when the product is transported, or the job is finished.

Whether assets are long-term, like fixed and long-term debt, or short-term, such as accounts receivable (AR) and inventories, modified accrual accounting draws components from cash and accrual accounting.

Basic Rules

The benefits of the cash and the accrual methods are combined in this accounting. Revenues and costs are recorded when cash is received or paid under the cash method of accounting.

When goods or services are supplied, revenues are recorded when they are generated, and costs are recorded when they are spent, according to the accrual approach (products are consumed). 

Short-term and long-term events are distinguished in modified accrual accounting and are recognized in various ways.

1. Short-Term Events

To record short-term occurrences, modified accrual accounting is used alongside cash-basis accounting. 

The balance sheet's short-term assets are account receivables, inventories, and payables. The affecting economic events are viewed as short-term occurrences.

When the cash balance changes, the occurrences are recorded. As a result, virtually all items on the income statement are reported using cash-basis accounting.

The balance sheet no longer includes short-term assets and liabilities.

2. Long-Term Events

Long-term assets and liabilities include fixed assets (PP&E) and long-term loans. Long-term economic events, as opposed to short-term ones, impact the items or span more than one accounting period.

Long-term events are handled similarly to short-term ones in modified accrual accounting. The balance sheet includes long-term assets and liabilities. Depreciation, amortization, and debt repayments are reported throughout the assets' and loans' lives.

Modified accrual accounting differs from full accounting when recognizing the current share of long-term debt. The part is recognized in the period and value incurred under full accrual accounting. 

The present part of long-term debt is recognized when it matures under modified accrual accounting. It can also be reported up to the point of liquidation using accessible, squanderable cash resources.

3. Revenues and Expenditures

When revenues are available and may be expected, they are recorded using this accounting. When revenues can cover the immediate expenses that must be paid within 60 days, they are accessible. 

Similar to accrual accounting, expenses are recorded. Regardless of when the cash payments are made, they are recorded in the period they are incurred.

In modified accrual accounting, several things have new names. For instance, net income is referred to as an excess or a deficit, while costs are referred to as such.

Cash Accounting Vs. Accrual Accounting Vs. Modified Accrual Accounting

Some of the differences are:

1. Cash Accounting

Many professionals and small organizations use cash accounting as their primary accounting system out of convenience.

Using this approach, firms do not record transactions as they happen but rather when money exchanges hands. 

Although "currency changing hands" and "transactions occurring" may appear the same at first glance, a deeper examination reveals a thin line that distinguishes the two concepts.

Whether payments are paid, transactions end as soon as the contract's performance is finished. Think about a joint purchase made by two companies.

It has been determined that the buyer would pay the seller on credit two months after the contract has been fulfilled. When the sale is over, the transaction is finished. However, payment in cash only occurs two months after the deal is finalized. 

As a result, the sale's gains are only recognized two months after the transaction. Understanding this idea is crucial when learning the distinctions between cash, accrual, and modified accounting systems. 

The time the different business transactions are allotted is the main distinction between the three. Let us examine each of the three techniques in more detail.

2. Accrual Accounting

Contrary to the cash accounting system, accrual accounting identifies and records transactions as they happen instead of waiting until the money exchanges hands.

Compared to the cash accounting system, it includes more concepts, such as accounts receivable and payable, and maintains better inventory control.

Let us return to the earlier illustration of the bulk selling contract between two businesses. Instead of simply one transaction being recorded, there will now be two in the vendor's books of accounts.

The first transaction will be recorded when a sale is made, and the accounts the receivable-purchaser account will get the appropriate debit. 

The second transaction happens when money is exchanged, deducted from the cash account, and credited to the accounts receivable-purchaser account.

In conclusion, after the money is received, both accounting procedures will result in a debit to cash and a comparable credit to sales, which is the net impact. 

The accrual approach acknowledges profits sooner, as soon as the transaction occurs, which is the key distinction between the two methods.

Advantages of Accrual Accounting

There are various benefits to accrual accounting, most of which are connected to the correct reporting of revenue and expenses:

1. It gives a precise view of the company's entire cash flow. Numerous commercial transactions occur over the deducted several months and, as a result, multiple accounting periods. 
2. According to accrual accounting, revenue and costs incurred in one month may continue into the following or even longer.
3. Investors favor accrual accounting. Compared to companies that employ cash-basis accounting techniques, organizations that use accrual accounting are frequently seen as more stable and established.

Disadvantages of Accrual Accounting

The accrual accounting technique has various drawbacks, most of which involve the personnel required to manage the system:

1. Small businesses might need more staff to manage this approach. The recording and reporting of transactions is often the responsibility of employees-or even an entire department-in larger firms. 
2. For instance, a hospital would have a department for account receivables to monitor patient billings and a department for accounts payable to monitor hospital spending.
3. Monthly reporting is necessary for accrual basis accounting. Accrual accounting requires regular report generation to be accurate. 
4. The income statement and balance sheet are often among the monthly financial statements that most business managers are familiar with. However, reports for accounts payable and receivable are generated more frequently.
5. Taxes. Although reporting income as incurred rather than waiting until you have cash on hand is a benefit of utilizing accrual accounting, this also implies that a corporation must pay taxes on money it has yet to receive.

3. Modified Accrual Accounting

The first transaction will be recorded when a sale is made, and the accounts the receivable-purchaser account will get the appropriate debit. 

The second transaction happens when money is exchanged, deducted from the cash account, and credited to the accounts receivable-purchaser account.

In conclusion, after the money is received, both accounting procedures will result in a debit to cash and a comparable credit to sales, which is the net impact. 

The accrual approach acknowledges profits sooner, as soon as the transaction occurs, which is the key distinction between the two methods.

However, modified accrual accounting is not acknowledged as a suitable approach by the International Financial Reporting Standards (IFRS), which most corporations follow. It is the reason why companies use the accrual system of accounting.

Contrasts between Modified and Full Accrual

Researched and authored by Fatemah Kamali | LinkedIn

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