Cash Basis vs Accrual Accounting

​Many would suggest that cities do accounting on the accrual basis “just like a business”. However, there are real differences between a business and government. The primary difference is in the profit motivation of a business compared to the governments’ focus on current-year activities and accountability to the public. For governments to achieve the objective of accountability, financial information must be relevant and reliable for reasonably informed users. Financial reports must satisfy numerous needs or objectives, including short-term financial position and liquidity, budgetary and legal compliance as well as issues having a long-term focus, such as planning, capital budgeting and maintenance.

Cash Basis Accounting

Cash basis accounting focuses on cash and current liquidity, not credit or long-term obligations. This method of accounting records when cash is exchanged and closely resembles how a citizen may run their own household budget. Most cities in Iowa also budget on the cash basis, making the actual activity reporting to budget comparisons easy to understand while maintaining legal compliance.

Modified Accrual Accounting

Modified accrual accounting combines cash-basis accounting and accrual-basis accounting, focusing on the main points of financial positions and changes in that position (sources, uses and balance of financial resources).

Under the modified accrual accounting method revenue recognition, business revenues are recognized when they are reasonably assured. In contrast, a city (governmental funds) primarily receives revenue as a result of its ability to levy property taxes or collect funds from another government such as federal and state entitlements or grants. Therefore the city’s revenues must meet two tests before they are recognized: 1) measurable and, more importantly 2) available to support the city’s expenditures. Standards dictate that property tax revenue be recognized only if cash is expected to be collected within 60 days. This standard has become the benchmark for many other types of revenue as well.

On the expense side, the private sector business expense is recorded when incurred, even if it will not be paid until a later date. For the modified accrual in a city, the current expenses such as wages, benefits, utilities and supplies are recorded within the current year needs of the city. A liability, such as loans or bonds, is not recorded as an expense until it is due (the current period).

Accrual (or full Accrual) Accounting

Accrual accounting is a financial reporting method in which the fiscal revenues are recorded when they are earned. The expenses are recorded when the action takes place. An example of this would be if a truck is ordered for $100,000 in April, received before year-end, but not paid for until after year-end; the liability is recorded at the time the truck is received. Liabilities are recorded when the good or service is received but payment has not yet occurred.

Other accounting practices identified with accrual accounting are depreciation of buildings and equipment, amortizations and profit or lost statements. Some cities or utility boards may prefer to account for the business type activity funds on the accrual basis throughout the year. Most, however still use the cash basis for budgeting and reporting throughout the year. For those cities wishing to reflect the more economic resources in their measurement focus while complying with the Government Accounting Standards Board (GASB), the year-end conversion to accrual is used for the financial statements.

In Iowa the cash basis of accounting is used by most cities. Many cities use the cash basis of accounting method, but do a year-end conversion to generally accepted accounting principles (GAAP) for the audited financial statements. This offers cash accounting during the year focusing on current-year obligations (are there sufficient revenues  to meet current expenses) and on short-term financial assets and liabilities. The year-end conversion provides the mechanism for those cities that must comply with GASB standards, the government standard-setting authority of GAAP. Publicly traded organizations must comply with GAAP standards. In order for cities to comply with GAAP, cities must conform to GASB standards. This is particularly important if the community wishes to borrow funds from investors on securities exchanges. GASB accounting standards aim to address issues of accountability to the public, and present financial statements that inform the public about the use of resources and the value those resources generate. They can be seen as a pivotal financial reporting tool because it more accurately conveys the economic picture of a city.

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