- Distinguish basis of accounting from measurement focus.
- Compare full accrual and modified accrual treatment of capital assets, debt, inventory, prepayments, revenue, expenses, and expenditures.
- Classify exchange and nonexchange transactions and identify the four nonexchange categories.
- Apply the measurable-and-available test to sales taxes, property taxes, and grants.
- Familiarity with basic accrual-accounting terms and debit-and-credit entries.
When and What Governments Report
Governmental GAAP uses full accrual or modified accrual according to the statements and funds involved.
A basis of accounting determines when a transaction enters the records. Measurement focus determines which resources and obligations appear in the statements.
- Cash basis records transactions when money is received or disbursed, subject to special rules.
- Full accrual recognizes revenue when earned and expenses when incurred, without waiting for cash to move.
- Modified accrual recognizes revenue when measurable and available. It generally records expenditures when incurred, except for items connected with long-term liabilities.
Full accrual and the economic resources focus belong together. They apply to proprietary funds, fiduciary funds, and government-wide statements. This view includes all resources affecting the government's economic position, including capital assets and long-term liabilities.
Governmental fund statements use modified accrual with the current financial resources focus. Cash can settle present bills, so it qualifies as a current financial resource. A building cannot pay a bill, and long-term obligations will consume future rather than current resources.
Why might the General Fund and a water utility use different accounting perspectives?
The General Fund emphasizes resources available for present spending, while the utility is viewed through its broader economic position over time.
Recording Capital Purchases
Full accrual capitalizes and depreciates an asset; modified accrual reports the purchase as a current expenditure.
Accounting for Long-Term Borrowing
Full accrual reports debt as a liability, whereas modified accrual treats borrowing proceeds as an other financing source.
Examples of long-term obligations omitted from modified-accrual statements include pension and OPEB obligations, compensated absences, bonds, notes, asset-retirement and pollution-remediation obligations, leases, and SBITA liabilities.
Modified accrual reports only a long-term obligation's due-and-payable amount. If USD 100,000 on a USD 50,000,000 bond was due December 25 but remains unpaid until January 5, a calendar-year government reports USD 100,000 as a December 31 liability. It omits the remaining USD 49,900,000 because later resources will fund it.
Inventory and Items Paid in Advance
Full accrual requires the consumption method; modified accrual permits either the consumption or purchases method.
For inventory under full accrual, purchase creates an asset: Debit Inventory; Credit Cash. Use of the inventory then produces: Debit Expense; Credit Inventory. This consumption method recognizes cost as the resource is used.
A prepaid item follows the same logic. For an annual insurance policy bought June 1 by a December 31 year-end government, record Debit Prepaid Insurance and Credit Cash. At year-end, six months have been consumed, so debit Insurance Expense for half the policy cost and credit Prepaid Insurance.
- Consumption method: initially recognize the resource as an asset and record expense or expenditure as it is consumed.
- Purchases method: immediately record the full outlay, such as Debit Supplies Expenditure and Credit Cash, without recognizing an asset or a later consumption adjustment.
Exchange and Nonexchange Revenue
Revenue analysis begins by deciding whether equivalent value passes between the parties.
- Derived tax revenue arises from an underlying exchange. Examples include sales, income, excise, use, and motor-vehicle-fuel taxes. The government's right begins when the underlying exchange occurs.
- An imposed nonexchange assessment has no underlying exchange. Property taxes, fines, and penalties are examples.
- A higher-level government requires a lower-level government to provide a service and supplies resources for it, as with federally supported school breakfast and lunch programs.
- Both parties willingly participate, such as when a local or state government applies for a federal grant that it is not required to accept.
The Modified-Accrual Revenue Test
Modified-accrual revenue must be measurable and available, although receivable recognition is the same under both bases.
When an amount is measurable but misses the availability period, modified accrual credits Deferred Inflow of Resources—Unavailable Revenue instead of revenue. This prevents amounts unavailable for present obligations from increasing current-period revenue.
A receivable is recognized when the government is owed resources under either basis. The difference lies in whether the corresponding credit is revenue or, under modified accrual, an unavailable-revenue deferred inflow.
What practical result does the availability condition produce?
It keeps revenue that cannot fund present-period liabilities out of modified-accrual revenue for that period.
Applying the Rules to Taxes and Grants
Availability determines the modified-accrual year for taxes and grants after the underlying recognition requirements are satisfied.
Sales Tax Timing
Property Tax Timing
Grant Eligibility and Recognition
- Recipient characteristics: the government must qualify as the type of recipient specified by the award.
- Time requirement: revenue cannot be recognized before the authorized grant period begins.
- Reimbursement requirement: eligible expenditures must be incurred before reimbursement-based revenue is recognized.
- Contingency requirement: for a voluntary nonexchange award, any required action must occur before revenue recognition.
Recognizing Costs
Most costs are accrued when incurred, but modified accrual delays long-term-liability-related expenditures until they are due and payable.
Full accrual uses the term expense and recognizes the economic sacrifice when incurred. Modified accrual uses expenditure and normally recognizes it at the same point.
The major modified-accrual exception covers amounts associated with long-term debt, pensions, leases, compensated absences, and other long-term obligations. These become expenditures when due and payable because the related long-term liabilities are not reported.
Bringing the Two Views Together
The two bases answer different reporting questions while describing the same government.
| Feature | Full accrual / Modified accrual |
|---|---|
| Applied to | Full accrual: Government-wide statements and proprietary and fiduciary funds • Modified accrual: Governmental fund statements only |
| Measurement focus | Full accrual: Economic resources • Modified accrual: Current financial resources |
| Capital assets | Full accrual: Reported and depreciated • Modified accrual: Omitted; purchase is an expenditure |
| Long-term liabilities | Full accrual: Reported • Modified accrual: Omitted except for amounts due and payable |
| Receivables | Full accrual: Reported when owed • Modified accrual: Reported when owed, including long-term receivables |
| Accounts payable | Full accrual: Reported • Modified accrual: Reported |
| Inventory and prepayments | Full accrual: Consumption method required • Modified accrual: Consumption or purchases method, based on consistent policy |
| Revenue | Full accrual: Recognized when earned or when nonexchange requirements are met • Modified accrual: Also must be measurable and available |
| Costs | Full accrual: Expenses when incurred • Modified accrual: Expenditures when incurred, except long-term items when due and payable |
| Bond proceeds | Full accrual: Liability • Modified accrual: Other financing source |
The government-wide view presents total economic resources and obligations. Governmental fund statements instead emphasize the short-term resources available for current obligations and fiscal decisions.
A government purchases a USD 500,000 fire truck with proceeds from a 10-year bond. What appears in the General Fund and in the government-wide statements?
In the General Fund, report a USD 500,000 capital-outlay expenditure and a USD 500,000 other financing source, producing no net fund-balance effect from those two entries. Government-wide statements report a USD 500,000 capital asset and a USD 500,000 liability. Depreciation follows over 10 years, while principal payments reduce the liability.
Common misconceptions
Watch out: Modified accrual is merely cash basis accounting.
Instead: It includes accruals and records receivables and current payables; special rules concern revenue availability, measurement focus, and long-term obligations.
Watch out: The revenue availability window also determines when ordinary expenditures are recognized.
Instead: Availability is a revenue condition. Ordinary expenditures are accrued when incurred; long-term-liability-related amounts follow the due-and-payable rule.
Lesson recap
- First identify the statements or fund involved: full accrual serves government-wide, proprietary, and fiduciary reporting; modified accrual serves governmental funds.
- Ask two questions for each transaction: when should it be recognized, and which resources or obligations belong in this reporting view?
- Full accrual reports capital assets and long-term liabilities. Modified accrual reports capital purchases as expenditures and debt proceeds as other financing sources.
- Modified-accrual revenue requires measurement and availability in addition to the relevant earning or nonexchange criteria.
- Most costs are recognized when incurred, but modified accrual waits until long-term-liability-related expenditures are due and payable.