Modified Cash Basis Accounting (U.S. GAAP Context)
Under U.S. GAAP, the modified cash basis of accounting is a special purpose framework that blends elements of both the cash basis and accrual basis of accounting. It is commonly used by small businesses and other nonpublic entities seeking more informative reporting than pure cash basis statements without adopting the full complexity of accrual accounting.
Common Adjustments under the Modified Cash Basis
1. Capitalization of Long-Term Assets
- Cash basis treatment: All expenditures are expensed when paid.
- Modified cash basis treatment: Property, plant, and equipment (PP&E) are capitalized and depreciated over their useful lives.
Dr. Equipment $50,000
Cr. Cash $50,000
(Record purchase of equipment)
Later, record depreciation:
Dr. Depreciation Expense $5,000
Cr. Accumulated Depreciation $5,000
2. Recognition of Long-Term Debt
Long-term liabilities such as notes payable or mortgages are recorded, even though pure cash basis reporting would not recognize them until payment.
Dr. Cash $100,000
Cr. Notes Payable $100,000
3. Accruals for Income Taxes Payable or Interest Payable
Selected accruals—such as income taxes payable or interest payable—may be recognized to better match expenses with the periods in which they are incurred.
Dr. Interest Expense $2,000
Cr. Interest Payable $2,000
4. Recording Inventory and Cost of Goods Sold (COGS)
Inventory can be maintained, and cost of goods sold is recognized to provide a more accurate measure of income.
Dr. Inventory $15,000
Cr. Cash $15,000
Period-end adjustment:
Dr. Cost of Goods Sold $10,000
Cr. Inventory $10,000
5. Accrual of Payroll Liabilities
Wages earned but not yet paid may be accrued so that expenses are matched with the related revenues.
Dr. Salaries Expense $8,000
Cr. Salaries Payable $8,000
6. Prepaid Expenses and Unearned Revenue
Prepayments and deferred revenues can be adjusted to reflect the proper reporting period.
Dr. Prepaid Insurance $3,000
Cr. Cash $3,000
Dr. Cash $5,000
Cr. Unearned Revenue $5,000
Summary of Typical Modified Cash Basis Adjustments
| Category | Treatment under Modified Cash Basis |
|---|---|
| Fixed assets | Capitalized and depreciated |
| Long-term debt | Recorded as liabilities |
| Inventory | Recognized; COGS adjusted |
| Accruals (interest, taxes) | May be recorded |
| Prepaid expenses | Recognized and amortized |
| Unearned revenue | Recognized as liability |
| Investments | Recorded at cost |