How does modified accrual accounting work for government funds?
Governmental entities perform their accounting in terms of three types of funds:
- Governmental funds
- Proprietary funds
- Fiduciary funds
Proprietary and fiduciary funds use full accrual accounting, just like private entities. However, municipalities use modified accrual accounting for governmental funds — funds for activities supported by taxes, grants, or other regulatory income.
One of the most noticeable differences between modified accrual accounting and full accrual accounting is revenue recognition. Under modified accrual accounting, revenues are recognized in the same manner as on a cash basis. That means they are accounted for when measurable and available to an entity. Full accrual accounting does not impose the availability requirement.
Inventories and prepaid items must use the consumption method under modified accrual accounting, but full accrual accounting allows the purchase method alternative.
Capital asset acquisitions are recognized as expenditures on their acquisition dates under modified accrual accounting. In contrast, full accrual accounting recognizes the cost of the asset and depreciates/amortizes it over its useful life.
Under modified accrual accounting, expenditures are accounted for when they are expended or subject to accrual because they are expected to use expendable resources. It is similar to the result under the full accrual basis since an entity can always measure expenditures when incurred; however, adjustments for the matching principle occur in full accrual accounting.
Example:
Governments use modified accrual accounting for governmental funds because they generally must stay within current-year budgets. They can use it to see if their current-year revenues can support current-year expenses.
Under modified accrual accounting, revenue is reported when it is earned and both measurable and available; there is no availability requirement under full accrual accounting.
When government entities prepare their financial results at fiscal year-end, they first present a broad financial statement for each fund type. Then, governmental funds must be converted from modified accrual to full accrual accounting. This is presented alongside the other two funds.
What’s important here?
Modified accrual accounting is used for governmental funds — funds for activities supported by taxes, grants, or other types of regulatory income. Under this method, revenues are recognized when they become both measurable and available, which means that they are expected to be collected within the current or soon-to-be-completed fiscal period, or within a certain period of time after the end of the fiscal period.
Expenditures, on the other hand, are recognized when they are incurred, except for long-term assets and certain other items which are capitalized and depreciated over their useful lives. Modified accrual accounting differs from full accrual accounting in that it only recognizes revenues and expenditures when they are likely to have a significant and immediate impact on the government's financial resources.
