What is Modified Cash Accounting?
Modified cash accounting is an accounting method that combines elements of the two main accounting practices: cash and regularization accounting. It seeks to get the best of both worlds, recording sales and expenses for long term assets on the basis of accrued rights and those of current assets on a cash basis. The objective here is to provide a clearer financial picture without addressing the costs of moving to full accrual accounting.
Key points to remember
- Modified cash accounting is an accounting practice that combines elements of the two main accounting methods: cash accounting and accrual accounting.
- Long-term assets are accounted for using the accrual method and current assets using the cash method.
- Accrual accounting methods give a clearer picture of business performance, while using cash accounting records for other items keeps costs down where possible.
- The modified cash method can only be used for internal purposes as it does not conform to International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP).
- Both IFRS and GAAP require public companies to use the accrual method of accounting for their financial statements, with some caveats for GAAP.
Understanding Modified Cash Accounting
To understand how modified cash accounting works, it is first essential to break down how traditional accounting practices are influenced by function.
Cash basis accounting recognizes income when received and expenses when paid. Its most significant advantage is its simplicity.
In contrast, accrual accounting recognizes revenue when a sale is made rather than when it is paid for and records expenses incurred, independent of cash flow.
Accrual accounting is a bit more complicated. Nevertheless, it is beneficial to allow a business to match income and associated expenses and understand what it costs to run the business each month and how much it earns.
Modified cash accounting borrows elements from both cash and accrual accounting, depending on the nature of the asset. It consists of the following features:
Advantages and Disadvantages of Modified Cash Accounting
The modified cash method of accounting better balances short-term and long-term accounting elements by borrowing elements from both techniques. Short-term items, such as a regular monthly utility expense (a bill), are recorded on a cash basis (because there is a related cash inflow or outflow), resulting in an income statement populated primarily by cash-based items. based. Long-term items that do not change in a given year, such as a long-term investment fixed assets, are accounted for using the accrual method.
Accrual accounting methods give a clearer picture of business performance, while using cash accounting records for other items helps reduce costs where possible; keeping a full set of accrual records takes more time.
If the financial statements are subject to formal reviews, such as an analysis by listeners, investors or a bank, the modified cash method of accounting will prove to be inadequate. The modified treasury method can only be used for internal purposes because it does not comply with the International Financial Reporting Standards (IFRS) or the generally accepted accounting principles (GAAP), which describe the procedures companies must follow when preparing their officially published financial statements.
This makes modified cash accounting popular with private companies. It also means that listed companies using this method cannot get their financial state signed by the auditors. Consistency is required, so transactions recorded on a cash basis should be converted to accrual. This is so because under both IFRS and GAAP, public companies are required to report their financial statements using only the accrual method due to its matching principle.
For tax reporting purposes, businesses with average annual gross revenues of less than $25 million for the last three consecutive years can choose either the cash or accrual method.