The modified cash basis of accounting uses elements of both the cash basis and accrual basis of accounting. Under the cash basis, you recognize a transaction when there is either incoming cash or outgoing cash; thus, the receipt of cash from a customer triggers the recordation of revenue, while the payment of a supplier triggers the recordation of an asset or expense. Under the accrual basis, you record revenue when it is earned and expenses when they are incurred, irrespective of any changes in cash.
The modified cash basis establishes a position part way between the cash and accrual methods. The modified basis has the following features:
- Records short-term items when cash levels change (the cash basis). This means that nearly all elements of the income statement are recorded using the cash basis, and that accounts receivable and inventory are not recorded in the balance sheet.
- Records longer-term balance sheet items with accruals (the accrual basis). This means that fixed assets and long-term debt are recorded on the balance sheet, and depreciation and amortization in the income statement.
The modified cash basis provides financial information that is more relevant than can be found with cash basis record keeping, and generally does so at less cost than is needed to maintain a set of full-accrual accounting records. Thus, it can be considered a cost-effective approach to bookkeeping.
The modified cash basis uses double entry accounting, so the resulting transactions can be used to construct a complete set of financial statements. It is not possible to have a modified cash basis of accounting using only the single entry system.
There are no exact specifications for what is allowed under the modified cash basis, since it has developed through common usage. There is no accounting standard that has imposed any rules on its usage. If the modified cash basis is used, transactions should be handled in the same manner on a consistent basis, so the resulting financial statements are comparable over time.
The modified cash basis is not allowed under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), which means that a business using this basis will need to alter the recordation of those elements of its transactions that were recorded under the cash basis, so that they are now accrual basis transactions. Otherwise, an outside auditor will not sign off on its financial statements. However, these changes are fewer than what would be required if a business were to make a full transition from the cash basis to the accrual basis of accounting.
Conversely, the modified cash basis may be acceptable as long as there is no need for the financial statements to be compliant with GAAP or IFRS; this may be the case if the financial statements are only to be used internally; this situation most commonly arises when a business is privately held and has no need for financing.