Modified cash basis combines elements of accrual and cash accounting methods. It is a viable compromise that brings together the benefits of both methods while minimizing the drawbacks. It is effective for day-to-day expenses but not for formal financial statements.
A modified cash basis is an accounting strategy that combines specific elements of two commonly used accounting methods. This strategy combines specific processes found in the accrual accounting method with methods used with cash accounting. Since both source methods are somewhat limited in their accounting approach, the modified cash basis is sometimes considered a viable compromise that brings together the benefits of both methods while minimizing the drawbacks.
To understand how this strategy works, it is important to have an idea of what happens with the accumulation and cash methods. With the cash method, revenue is recognized when it is received. At the same time, expenses are recognized when they are settled, rather than when they are incurred. By contrast, an accrual method recognizes income as soon as it is earned and expenses as they occur. Both approaches to financial record keeping are considered consistent with generally accepted accounting principles.
With a modified cash basis, both approaches can be used to track specific types of income and expenses. A common model is to use the cash method of accounting to account for short-term income and settlement of outstanding expenses, while using the accrual method to manage long-term assets and liabilities. Small businesses and start-ups are more likely to use this type of accounting approach, given the greater degree of flexibility afforded by record-keeping based on the use of a modified cash basis.
There are different opinions about the effectiveness of using this technique. Supporters of the concept see it as a viable way to manage day-to-day expenses while enjoying the ease of accrual accounting relative to long-term liabilities. Detractors see this blended approach to financial accounting as accentuating the positive in many situations, but doing little in the way of presenting a complete picture of what is happening with the company’s finances.
While a modified cash basis may be effective for the purpose of reporting the company’s interim activity to shareholders and other investors, this approach is generally not considered an option when it comes to preparing formal financial statements for tax purposes or for preparation of dividends to shareholders. Modified accounting methods are considered outside the scope of generally accepted accounting principles. This makes it necessary for companies that use a modified cash basis for daily financial tracking to revert to a true cash accounting or true accrual accounting method when preparing documentation for anything other than internal use.
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