The modified accrual method is defined as an alternative accounting method that combines the two basic methods of accounting, the accrual method and the cash method. While the accrual method recognizes earned revenue and expenses incurred regardless of when cash is received or paid, and the cash method records revenues and expenses when cash is received or paid, the modified accrual method uses both. It records short-term economic events through the cash method, while long-term economic events are recorded through the accrual method.
Companies, big or small, do not commonly use the modified accrual method of accounting. However, any public company can use this accounting method if they choose but only for internal purposes, but government agencies commonly use it.
To be able to understand how the modified accrual method works in accounting, first, we have to comprehend the two traditional accounting methods that were mentioned above and how they influence it.
The cash method of accounting only records a transaction when cash is received or given. When expenses are encountered, they will only be registered in the income statement when they are paid. As for revenues, until the payment is received, they are not recorded. Instead, they are recorded in the company’s balance sheet.
For the accrual method of accounting, both expenses and revenues are recorded in the balancesheet when they are encountered, regardless of when the payment is made. Through this method, a company can see that for the obligation fulfilled they have the right to collect at a future date. The accrual method registers both expenses and revenues under the matching principle; for every amount spent, another is earned.
For long-term assets, the modified accrual method uses the accrual method of accounting, while short-term assets are registered through the cash method of accounting.
When a company has an economic event that would otherwise be registered on multiple accounting periods, they use similar rules to the accrual method. First, they register the expense or revenue of the asset or liability on the balance sheet. Then the asset is depreciated, depleted, or amortized during the useful life of the asset. Like this, the company is more aware of future economic events, so they have a better understanding of how long-term events can affect the financial situation of the company. Examples of long-term events are fixed assets or long-term debts, and they are registered in the balance sheet.
When the economic event only impacts the company’s short-term and will only be registered in one or a few accounting periods, they can follow the cash method. When an expense is incurred, it is registered in the company’s income statements, and when revenue is received, it will be registered in the income statements. The two are not matched.The economic event, revenue or expense, is registered when the balance of cash has been impacted. Examples of short-term events are accounts receivable or inventory, and they are registered in the income statement.