As a small business owner, you need to track your income and expenses. And to organize your business finances, you must select an accounting method. One method you can choose is modified cash-basis accounting.
Learn the ins and outs of the modified method, how it differs from other accounting methods, and its advantages.
What is modified cash-basis accounting?
Modified cash-basis accounting, otherwise known as hybrid accounting, uses aspects of both cash-basis and accrual basis accounting. Typically, cash-basis is considered the simplest method, while accrual is the most complex. The modified method is a happy medium for business owners who need aspects from both cash and accrual accounting.
Modified cash-basis uses the same types of accounts as accrual basis. However, with the accrual method, you must record income when transactions take place—with or without the transfer of money—and record expenses when you are billed.
Because other methods can have certain limitations, a business may opt to use modified cash-basis to develop a more accurate financial snapshot.
Common industries that use modified cash-basis include:
- Growing businesses
- Small businesses
By using aspects from cash-basis and accrual, the modified cash-basis method can better balance short and long-term accounting details. You can record both short-term items like utility bills and long-term items like property using modified cash-basis accounting.
A modified cash-basis system also uses double-entry bookkeeping. In double-entry accounting, every entry to an account requires you to create a corresponding and opposite entry to a different account.
Modified cash-basis accounting can be used for internal purposes. However, it does not comply with the Generally Accepted Accounting Principles (GAAP). Because of GAAP’s standards, you might need to adjust some transactions to remain compliant (e.g., convert cash-basis transactions to accrual).
Keep in mind that not all businesses need to follow GAAP’s standards. Check the Financial Accounting Standards Board’s website for more information regarding which GAAP principles your business must follow.
Cash-basis vs. modified cash-basis accounting
Although their names may sound similar, cash-basis and modified cash-basis accounting have differences.
With cash-basis accounting, only cash accounts are available. You record income when you receive it and report expenses when you pay them. You can record things like cash, equity, income, cost of goods sold, and expenses. Typically, you can’t use cash-basis accounting if you need to track inventory, fixed assets, or loans.
Modified cash-basis is a little more time-consuming than cash-basis accounting. Because there are more accounts, you may spend more time recording transactions. And rather than only handling cash accounts, modified cash-basis includes both cash and accrual accounts.
As mentioned, modified cash-basis allows you to include short-term items like cash-basis accounting. But, you can also include long-term items like you can with the accrual method. Unlike with cash-basis, you can record accounts receivable, current and fixed assets, and accounts payable with modified cash accounting.
Comparing accounting methods
Now that you know more about the different accounting methods, let’s compare how the methods vary.
Here is a breakdown of some of the types of accounts you can use with each accounting method:
|Type of Account||Cash-basis||Modified Cash-basis||Accrual Basis|
|Cost of Goods Sold||X||X||X|
|Long Term Liabilities||X||X|
When do you use modified cash-basis?
You might decide to use modified cash-basis accounting to take advantage of both its cash-basis and accrual method features. Using modified cash-basis gives businesses a clear financial picture of their business. And, business owners don’t have to worry about converting from cash to accrual basis accounting.
When you first start your business, you may choose to stick with cash-basis accounting since it is easy to understand. And when your business grows, you might decide to change your accounting method.
If you are starting out, consider using basic accounting software. As you grow, you can upgrade to a more advanced system for your small business books.
If you are not sure if the modified cash method is best for your small business, consider reaching out to an accountant to discuss your options.
Reasons to use modified cash accounting
If you’re unsure about which type of accounting method to choose, consider looking at some advantages of modified cash-basis accounting.
For many small business owners, accrual basis accounting might be too complex and difficult to understand. Using modified cash-basis is easier to comprehend than the accrual method, but also gives you access to more accounts than cash-basis.
If you are ready to take a step forward from cash-basis, modified cash-basis is a good start. Modified cash-basis allows for flexibility. And, it is not as much of a commitment as accrual basis accounting.
Need an easy way to track your business’s transactions? With Patriot’s online accounting software, you can choose cash-basis, modified cash-basis, or accrual accounting. And, we offer free, USA-based support. Try it for free today!
This article has been updated from its original publication date of April 4, 2019.
This is not intended as legal advice; for more information, please click here.