# Modified Cash-Basis Accounting: Pros and Cons Explained

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## What Is Modified Cash Basis?

Modified cash basis accounting mixes [cash](https://www.investopedia.com/terms/c/cashbasis.asp) and [accrual](https://www.investopedia.com/terms/a/accrualaccounting.asp) methods. It seeks to get the best of both worlds, recording sales and expenses for [long-term assets](https://www.investopedia.com/terms/l/longtermassets.asp) on an accrual basis and those of [short-term assets](https://www.investopedia.com/terms/c/currentassets.asp) on a cash basis. It's practical for internal purposes due to non-compliance with International Financial Reporting Standards (IFRS) and generally accepted accounting principles (GAAP).

The goal here is to provide a clearer financial picture without dealing with the costs of switching to full-blown accrual accounting. Modified cash basis is suitable for private companies, but public companies can't use it. Here are a few of its advantages and disadvantages.  
  

### Key Takeaways

*   Modified cash basis combines cash and accrual accounting, recording long-term assets on an accrual basis and short-term assets on a cash basis.
*   It provides a clearer financial picture than cash basis alone while avoiding the complexity of full accrual accounting.
*   This method is mostly used for internal purposes, as it doesn't comply with IFRS or GAAP.
*   Public companies must use the accrual method according to IFRS and GAAP standards for their official financial statements.
*   Modified cash basis is popular among private companies due to its simplicity and cost-effectiveness.

## How Modified Cash Basis Blends Accounting Methods

To understand how modified cash basis works, we must first examine traditional bookkeeping.

Cash basis accounting recognizes income when it is received and expenses when they are paid for. Its most significant advantage is its simplicity.

In contrast, accrual accounting recognizes income when a sale is fulfilled rather than when it is paid for and records expenses incurred, irrespective of cash movement. Accrual accounting is complex but helps match revenue with expenses, showing monthly costs and profits.

Modified cash basis uses cash or accrual accounting based on the asset type. It consists of the following features:

*   It records short-term assets, such as [accounts receivable](https://www.investopedia.com/terms/a/accountsreceivable.asp) (AR) and [inventory](https://www.investopedia.com/terms/i/inventory.asp), on a cash basis on the [income statement](https://www.investopedia.com/terms/i/incomestatement.asp), similar to cash basis accounting.
*   Longer-term assets, such as [fixed assets](https://www.investopedia.com/terms/f/fixedasset.asp) and [long-term debt](https://www.investopedia.com/terms/l/longtermdebt.asp), are recorded on the [balance sheet](https://www.investopedia.com/terms/b/balancesheet.asp). Like accrual accounting, [depreciation](https://www.investopedia.com/terms/d/depreciation.asp) and [amortization](https://www.investopedia.com/terms/a/amortization.asp) appear on the income statement as well.

## Pros and Cons of Using Modified Cash Basis Accounting

### Advantages

Modified cash basis balances short-term and long-term items using both techniques. Short-term items, like a regular monthly utility expense (a bill), are recorded according to the cash basis (as there is a related inflow or outflow of cash), which results in an income statement populated mainly with items based on the cash basis. Long-term items that do not change within a given financial year, such as a long-term investment [property, plant, and equipment](https://www.investopedia.com/terms/p/ppe.asp), are recorded using the accrual basis.

Accrual methods provide a clearer business view, while cash records help save costs; accrual records take more time.

### Disadvantages

If financial statements are subject to formal reviews, such as an analysis performed by [auditors](https://www.investopedia.com/terms/a/auditor.asp), investors, or a bank, the modified cash basis method will prove inadequate. The modified cash method may only be used for internal purposes because it does not comply with [International Financial Reporting Standards](https://www.investopedia.com/terms/i/ifrs.asp) (IFRS) or the [generally accepted accounting principles](https://www.investopedia.com/terms/g/gaap.asp) (GAAP), which outline what procedures companies must follow when preparing their officially reported financial statements.

This popularity makes modified cash basis accounting favorable to [private companies](https://www.investopedia.com/terms/p/privatecompany.asp). It also means that [publicly traded companies](https://www.investopedia.com/terms/p/publiccompany.asp) using this method cannot get their [financial statements](https://www.investopedia.com/terms/f/financial-statements.asp) signed off by auditors. Consistency is required, so transactions recorded on a cash basis must be converted to accrual. IFRS and GAAP require public companies to use the accrual method due to its matching principle.

For tax reporting purposes, companies with average annual gross receipts of less than $25 million for the last three consecutive years may choose either the cash or accrual accounting method.

## The Bottom Line

Modified cash basis accounting combines elements of both cash and accrual accounting. Advantages include its ability to balance short-term and long-term accounting items, and it's cost-effective compared to full accrual accounting. It has a few disadvantages, too, however, including its non-compliance with IFRS and GAAP, making it unsuitable for publicly traded companies and formal audits.

The method is most suitable for private companies looking for a practical internal accounting method that offers a clearer financial picture without the complexity of full accrual accounting. Businesses should carefully consider their specific needs and legal requirements when choosing an accounting method, possibly consulting a financial adviser or accountant.

> **Article Sources**
>
> 1.  Corporate Finance Institute. "[Modified Cash Basis](https://corporatefinanceinstitute.com/resources/knowledge/accounting/modified-cash-basis/)." Accessed Dec. 20, 2021.
>     
> 2.  Corporate Finance Institute. "[What Is the Accrual Principle?](https://corporatefinanceinstitute.com/resources/knowledge/accounting/accrual-principle/)" Accessed Dec. 20, 2021.
>     
> 3.  Internal Revenue Service. "[Publication 538: Accounting Periods and Methods](https://www.irs.gov/pub/irs-pdf/p538.pdf)." Page 9. Accessed Dec. 20, 2021.