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A modified cash basis is an accounting strategy that combines specific elements of two commonly used accounting methods. This strategy pairs specific processes found in the accrual accounting method with methods that are employed with cash accounting. Since both of these source methods are somewhat limited in their approach to accounting, the modified cash basis is sometimes considered a workable compromise that brings together the benefits of both methods while minimizing the drawbacks.
In order to understand how this strategy works, it is important to have an idea of what takes place with both the accrual and the cash methods. With the cash method, income is recognized at the time 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 at the time they take place. Both of these approaches to financial recordkeeping are considered to be in keeping with generally accepted accounting principles.
With a modified cash basis, both of these approaches may be used to keep track of specific types of income and expenses. One common model is to utilize the cash accounting method to account for short-term income and settlement of outstanding expenses, while using the accrual method for managing long-term assets and liabilities. Small businesses as well as companies that are just launching are more likely to make use of this type of accounting approach, given the greater degree of flexibility provided by recordkeeping based on the use of a modified cash basis.
There are differing opinions regarding the effectiveness of using this technique. Supporters of the concept see it as a workable way to manage day to day expenses while also enjoying the ease of accrual accounting in relation to long-term liabilities. Detractors see this combined approach to financial accounting method as accentuating the positive in many situations, but accomplishing little in the way of presenting a complete picture of what is happening with company finances.
While a modified cash basis can be effective for purposes of reporting interim company 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 the preparation of dividends to shareholders. Modified accounting methods are considered outside the scope of generally accepted accounting principles. This makes it necessary for companies using a modified cash basis for day to day tracking of finances to either revert to a true cash accounting or a true accrual accounting method when preparing documentation for anything other than internal use.
Cash and modified cash basis of accounting are not generally accepted accounting principles in the US.