Just when you thought you had the basics of cash basis and accrual basis accounting covered, there’s a third option to throw into the mix: modified cash basis.
What is modified cash basis?
Modified cash basis is a method of accounting that uses features of both the cash basis and accrual basis of accounting. Modified cash basis is a hybrid of sorts—the financials are prepared using the cash basis of accounting with accrual adjustments added.
Why add these accrual adjustments? Businesses often want more insight than cash basis accounting can provide but don’t necessarily want the expense or time it takes to maintain a set of accrual books.
A quick refresher on cash vs. accrual
Cash basis accounting only recognizes revenue when cash is received, and expenses when they are paid. For example, a freelancer wouldn’t record revenue on their books until they’ve received a cheque and it’s cleared the bank.
With accrual basis accounting, revenue is recorded when it is earned and expenses are recorded when they are incurred. In the freelancer scenario, they might record revenue when the project has been completed, even though the cheque is still in the mail.
Modified cash basis borrows aspects from both.
Modified cash basis: a few examples
What does this mean for your financials? This can look like many different things, depending on your books. One example of modified cash basis is how short-term and long-term items are treated.
A short-term item, such as recurring monthly expenses (rent, facilities, internet) are recorded on the income statement according to cash basis. Long-term items that don’t change much during the financial year, such as fixed assets or property, plant, and equipment are recorded on the balance sheet using the accrual method.
Why use modified cash basis?
Modified cash basis provides an extra level of insight into your financials that you aren’t able to gain by just using cash basis. Modified cash accounting also costs less than accrual accounting. If you’re a small business owner using cash basis but need some extra insight into, say, inventory or accounts receivable, modified cash basis can be the middle ground that you need.
Who should use modified cash basis?
Anyone can choose to use modified cash basis unless your business dictates otherwise. Certain businesses are required to use the accrual method of accounting.
Another caveat—modified cash basis can’t be used if you need audited financial statements.
But if your business is privately held and you don’t have any of those requirements, modified cash basis can be used for those who want to customize their books.
Some of these modified cash customizations can include:
- Inventory adjustments
- Depreciation adjustments for assets
- Future payables, such as payroll
Some businesses do their bookkeeping in cash basis but need to file on an accrual basis. This means they take steps to convert cash basis accounting to accrual basis once they start doing their tax prep. If you use a modified cash basis, you can save yourself from some of the steps you need to take.
What will this look like on my financial statements?
One of the most common uses of modified cash basis are inventory adjustments.
Say you’re an ecommerce startup and you’ve started to sell your goods online. Your bookkeeping is pretty simple and you want to cut costs so you’ve decided to use cash basis accounting.
Cash basis accounting is working for you but you’d still like to your monthly inventory and cost of goods sold on your financial statements.
Take a look at the balance sheet below prepared by Bench—we use cash basis accounting but have included an accrual adjustment to record inventory because that’s useful information for the business owner and doesn’t require an overhaul to the accrual accounting method.
Currently using cash basis accounting and unsure how to incorporate modified cash basis adjustments to your books? Bench can help. We’ll do your bookkeeping for you using the cash basis method, and we’ll make any modified cash basis adjustments you need. Some common adjustments include inventory, payroll, and CPA-requested accrual adjustments.