What Is Modified Accrual Accounting? Funds, Revenue, and Expenditures

Modified accrual accounting is the hybrid method that state and local governments use for their governmental funds: revenues are recorded only when they are both measurable and available to spend in the near term, while expenditures are recorded as soon as the obligation arises. The Governmental Accounting Standards Board requires it for governmental fund financial statements so that taxpayers, elected officials, and bond investors can see whether a government can pay this year’s bills with this year’s money and stay within its adopted budget.¹

Where It Sits Between Cash Basis and Full Accrual

Cash-basis accounting records transactions only when money physically changes hands. It’s simple, but it can badly misrepresent a government’s obligations. Full accrual records revenues when earned and expenses when incurred, regardless of when cash moves. It’s comprehensive, but it buries the question a budget officer actually needs answered: can we pay this year’s bills with this year’s money?

Modified accrual splits the difference. Revenue recognition is cash-like: money must be measurable and available before it counts. Expenditure recognition is accrual-like: most obligations are recorded as soon as they arise, not when the check clears.² A government using this method cannot count money it hasn’t collected as spendable revenue, and it cannot let unpaid bills hide until payment is made.

The reason for the hybrid comes down to mission. A business using full accrual wants to know its total economic position across years. A city council needs a more immediate answer: are enough resources flowing in this fiscal year to cover the services we’ve promised? Modified accrual answers that by filtering out long-term capital assets and multi-decade debt that won’t affect the current operating budget.

Which Funds Use Modified Accrual

GASB Statement 34 requires modified accrual for all five categories of governmental funds:¹

The general fund, which is the main operating account for most jurisdictions and pays for day-to-day services like police, fire, and public works.
Special revenue funds, which track restricted revenue sources committed to specific purposes, such as gasoline taxes earmarked for road maintenance or federal grants for public housing.
Debt service funds, which accumulate resources dedicated to paying principal and interest on long-term bond obligations.
Capital projects funds, which account for money set aside for constructing or acquiring major assets like bridges, schools, or municipal buildings.
Permanent funds, which hold resources where only the investment earnings can be spent while the principal is preserved.

All five measure near-term liquidity rather than long-term economic wealth. That is the core idea behind the current financial resources measurement focus: managers can see the actual dollars available for appropriation during the current legislative cycle without wading through fixed capital values or decades-long debt schedules.

Funds That Use Full Accrual Instead

Not every government fund uses modified accrual. Proprietary funds — enterprise funds like water and sewer utilities, and internal service funds like a centralized motor pool — use full accrual because they operate more like businesses, charging fees for services and needing to track whether those fees cover their costs.¹ Fiduciary funds, which hold resources in trust for outside parties like pension beneficiaries, also use full accrual. The dividing line is straightforward: if the fund delivers general government services funded by taxes, it uses modified accrual; if it charges user fees or holds assets for others, it uses full accrual.

The Measurable and Available Test for Revenue

Revenue recognition under modified accrual follows a two-part test established by GASB Statement 33. The revenue must be measurable, meaning the government can reasonably estimate the dollar amount it expects to collect. And it must be available, meaning the cash has actually been collected during the fiscal year or will be collected soon enough afterward to pay that year’s bills.³

For property taxes, most jurisdictions apply a 60-day collection window drawn from NCGA Interpretation 3. Taxes collected within 60 days after the fiscal year ends count as current-year revenue; anything collected later gets deferred to the next period. A homeowner’s property tax payment that arrives 90 days after year-end will not appear as revenue in the year the tax was levied, even though the government was legally entitled to the money the entire time. The availability test prevents governments from inflating current-year budgets with revenue that isn’t actually in hand.

Different Revenue Types Follow Different Timing

GASB Statement 33 divides government revenue into categories based on the underlying transaction, and each category follows slightly different recognition timing:

Derived tax revenues such as sales taxes and income taxes are recognized when the underlying economic activity occurs and the resources are available. A sales tax is tied to a purchase, so the revenue arises when the sale happens but only counts for the current year if collected within the availability window.³
Imposed nonexchange revenues such as property taxes and fines are recognized in the period for which they are levied or imposed, subject to the same availability requirement. Property taxes levied for fiscal year 2026 are 2026 revenue, but only the portion collected within the availability window.
Government-mandated and voluntary nonexchange transactions such as grants are recognized when all eligibility requirements have been met and the funds are available. A federal grant tied to completing a specific program milestone won’t show as revenue until the milestone is achieved and the cash is accessible.

The practical effect is conservative budgeting. A government cannot count on money it is merely owed. Only money it can actually spend.

How Expenditures Are Recorded

The outflow side uses the term “expenditures” rather than “expenses,” and the difference is real. Expenses in full accrual match costs to the periods that benefit from them, spreading a truck’s cost over its useful life through depreciation. Expenditures in modified accrual record the full use of current financial resources when the obligation arises.⁴ When a city receives $12,000 in office supplies, the full amount hits the books immediately.

Several exceptions apply for obligations that would distort the current-year budget if recorded up front:

Debt service, meaning principal and interest on long-term bonds, is not recorded as it accrues over time. The expenditure is recognized only when each payment actually comes due, so a 20-year bond does not appear to consume the entire operating budget in year one.⁴
Compensated absences, meaning accumulated vacation and sick leave, are recorded as a current expenditure only for the portion due to employees who have separated from the government or have vested balances requiring payout.
Claims and judgments are recorded as an expenditure only when they require the use of current spendable resources, not when the lawsuit is first filed or the claim first asserted.

The logic is consistent: modified accrual records only expenditures that will actually draw down the fund’s current resources. The rest is captured in the government-wide statements, where full accrual picks up the long-term picture.

Purchase Method Versus Consumption Method

Governments have a choice in how they record supplies and inventory. Under the purchase method, the expenditure is recorded the moment supplies are bought, even if they sit in a warehouse for months. Under the consumption method, the expenditure is recorded when the supplies are actually used.⁵ The consumption method produces more accurate period-by-period reporting; the purchase method is simpler to administer. Both are acceptable under GASB standards, but the choice affects year-end fund balances. A government that buys a year’s worth of supplies on the last day of the fiscal year will show very different numbers depending on which method it uses.

Fund Balance Classifications

The fund balance is the difference between a governmental fund’s assets and its liabilities, and it tells you how much financial cushion a government has. GASB Statement 54 established five classifications, organized from most constrained to most flexible:⁶

Nonspendable, meaning resources that can’t be spent in their current form, such as prepaid items or inventories that haven’t been consumed.
Restricted, meaning amounts that can only be spent for purposes dictated by a constitution, an outside funding source, or enabling legislation. A federal grant requiring the money to go toward affordable housing falls here.
Committed, meaning amounts earmarked for specific purposes by the government’s highest decision-making authority, typically a city council resolution or legislative action. Changing the commitment requires the same level of formal action.
Assigned, meaning resources intended for a particular purpose but lacking that formal commitment. In funds other than the general fund, any balance not classified as restricted or committed falls here by default.
Unassigned, meaning the residual balance in the general fund after everything else is accounted for. This is the government’s most flexible money. In other governmental funds, an unassigned balance appears only if spending has exceeded the restricted, committed, or assigned amounts, which is a deficit signal.

These classifications tell a reader how much of a reported fund balance is genuinely available for new spending versus locked into existing obligations. A city showing a $10 million total fund balance might have only $2 million in the unassigned category, which paints a different picture of fiscal flexibility than the headline number suggests.

The Statements Modified Accrual Produces

Modified accrual feeds two primary financial statements that together provide a snapshot of short-term fiscal health.

Balance Sheet

The governmental funds balance sheet reports current assets like cash, short-term receivables, and amounts due from other funds, along with current liabilities like accounts payable and accrued wages. It deliberately excludes long-term items. Buildings, roads, and equipment do not appear as assets. Multi-decade bond obligations do not appear as liabilities. The bottom line is the fund balance, broken into the five classifications above, showing what remains available for future appropriation.¹

Statement of Revenues, Expenditures, and Changes in Fund Balances

This statement tracks the flow of resources over the fiscal period: revenue coming in, expenditures going out, other financing sources and uses, and the resulting change in fund balance from beginning to end. Governments also present budgetary comparison information, either as a basic statement or as required supplementary information, that lines up actual financial activity against the adopted budget to demonstrate legal compliance.¹ Residents and bond investors use these reports to verify that the government lived within its means and followed the restrictions placed on specific funds.

Reconciling to Government-Wide Statements

GASB Statement 34 requires every state and local government to also produce government-wide financial statements using full accrual. Those statements capture what modified accrual deliberately leaves out: capital assets, long-term debt, depreciation, and accrued interest.¹

To bridge the two views, governments present a reconciliation, typically at the bottom of the fund financial statements or in an accompanying schedule, showing the adjustments needed to convert modified accrual numbers to full accrual numbers. The major adjustments include:

Capital assets. Spending on buildings, infrastructure, and equipment shows up as an expenditure in the fund statements, reducing fund balance, but must be recorded as an asset on the government-wide statements and depreciated over its useful life.
Long-term debt. Issuing a bond creates no expenditure under modified accrual, since it’s an inflow of financial resources, but the full obligation appears as a liability on the government-wide balance sheet. Principal payments recorded as expenditures in the fund statements are reclassified as debt reductions.
Revenue timing differences. Property taxes collected outside the 60-day availability window are deferred in the fund statements but recognized as revenue in the government-wide statements, since under full accrual the government earned those taxes when they were levied.
Accrued liabilities. Compensated absences, claims, and accrued interest that don’t hit the fund statements until payment is due are recognized immediately on the government-wide statements.

The reconciliation is what makes the dual reporting model work. Modified accrual answers the near-term question of whether this year’s resources can pay this year’s bills. Full accrual answers the long-term question of the government’s total financial position. Read together, they give a more complete picture than either alone.

How Encumbrances Fit In

Governments that use modified accrual frequently rely on encumbrance accounting to prevent overspending. An encumbrance is a reservation of fund balance created when a purchase order or contract is approved but before the goods or services are delivered. It is not an expenditure, because the government hasn’t received anything yet, but it signals that the money is spoken for and shouldn’t be allocated elsewhere.

Without encumbrances, a department could commit to more contracts than its budget can cover, and the problem wouldn’t surface until the invoices arrived. Recording the commitment when the purchase order is issued gives budget managers a real-time view of how much of their appropriation is still truly available. When the goods arrive and the actual expenditure is recorded, the encumbrance is reversed. At year-end, outstanding encumbrances may either lapse with the appropriation or carry forward to the next fiscal year, depending on the jurisdiction’s policies. That treatment varies widely, so understanding local rules on carryover versus lapsing matters for anyone reading a government’s financial statements.

1
GASB. Summary – Statement No. 34
2
Governmental Accounting Standards Board. Summary of Interpretation No. 6
3
GASB. Summary – Statement No. 33
4
Institute of Education Sciences. Financial Reporting Liabilities
5
Governmental Accounting Standards Board. Summary of Statement No. 11
6
GASB. Summary of Statement No. 54