What the Talk About Modified Accrual Accounting is all About
Puerto Rico is in the middle of a metamorphosis. But it’s not about biology. It’s about the way the Puerto Rico Government accounts for income and expenses. That change to a method called modified accrual accounting standards will enhance accuracy, transparency, and accountability. It is a major step forward for Puerto Rico.
What exactly is that change all about, and why is it important? Modified accrual standards mean the government has to count what it owes when it owes it — not whenever it gets around to paying it. It stops the government from hiding bills to make the budget look balanced when it really isn’t. When Puerto Rico slid into bankruptcy, accounting tricks hid fiscal trouble. Modified accrual accounting is the way to stop this from happening again.
As far back as the Middle Ages, people thought about how best to keep books – that is, how to keep an accurate record of income and expenses so finances remain in balance and record keepers remain honest. The Italian monk Luca Bartolomeo de Pacioli brought about a breakthrough in accounting with his concept of double-entry bookkeeping, matching every asset, like cash, with a liability, for example an invoice or a loan. The idea is that the two sides of the balance sheet, assets and liabilities, always match. That was more than 500 years ago. It might be hard to believe today, but it was a novel concept – and it has been used in finance ever since.
Over time, accountants built on that system, adding to the mechanism of how transactions are recorded a set of principles that regulate when transactions are recorded. Those rules, called accrual accounting, allow bookkeepers to track revenue and expenses accurately over time rather than in the moment. The principle of accrual accounting is simple: transactions like income are booked when they are earned rather than when they are received, and expenses are booked when they are incurred, rather than when they are paid.
Think about it this way: you think you are doing fine because there’s money in the checking account. But there’s a stack of unopened bills in your desk drawer, the car repair went on a credit card, and you skipped your car insurance payment. On paper, the account looks balanced. In reality, you’re sinking. You just haven’t counted what you owe.
Why does this matter? Accuracy and predictability. Accrual accounting is the answer to the question: What money has already been committed and, if we spend it, will we have enough for when each obligation is due?
It’s easy to hide costs outside the accrual accounting process. Going on a buying spree beyond your means with your credit card may mask the true hit to your finances until the credit card statement arrives. If you keep spending on credit, your finances deteriorate even if your checking account looks fine.
Puerto Rico ran that version of budgeting for 16 years. Puerto Rico’s fiscal crisis had several causes, including the long economic recession, people moving away, and the Government taking on too much debt. But all along, the Government used accounting tricks that modified accrual forbids.
So, when Congress passed PROMESA to create a legal path for Puerto Rico to reduce its debt and achieve fiscal responsibility, it mandated that the Government also use modified accrual accounting. That is the variation of accrual accounting used mainly by governments, particularly governments recovering from a fiscal crisis. For example, New York City must use modified accrual accounting since its fiscal crisis in the 1970s, and Detroit is using modified accrual accounting since it emerged from bankruptcy. But it’s not always a fiscal crisis that prompts the change to modified accrual accounting. Connecticut and New Mexico also use the method.
The Volcker Alliance, a nonprofit organization dedicated to empowering the public sector workforce, said in its 2017 Truth and Integrity in State Budgeting report that shifting from the cash-based accounting — what most governments use to prepare their budgets — to modified accrual accounting techniques “would more accurately depict governments’ financial health.” After all, modified accrual is already widely used in the comprehensive annual financial reports that audit state and local governments’ budgets after the fiscal year is completed.
Earlier this year, the Oversight Board and the Government worked out the applicable guidelines for developing the Commonwealth’s budgets in accordance with modified accrual accounting standards. The Puerto Rico Office of Management and Budget and the Oversight Board now together must ensure that the new accounting guidance is properly implemented and applied to the process of developing budgets, and that the Government budget for the fiscal years 2026 and 2027, respectively, comply with the guidelines. The auditors will then have to review the Government’s financials once the fiscal year has ended and determine whether the budget was, indeed, balanced under modified accrual standards at the end of the year. The budget shows whether the Government intends to keep revenue and expenses in balance; the audited financial statements show whether it actually managed to do so.
Director of New Mexico’s State Budget Division, Dr. Andrew Miner, addresses how Modified Accrual Accounting Standards drives a more efficient and timely budget process during A Better Plan: Symposium on Puerto Rico’s Fiscal Future
This change to modified accrual accounting is a milestone for Government accountability — a PROMESA statutory requirement that is now within reach of fulfillment. It also complements Puerto Rico’s broader fiscal sustainability framework. Pairing modified accrual accounting standards with other permanent reforms that uphold budget discipline, such as long-term financial planning, reserve management, debt affordability, establishing a centralized budget office, and passing laws that ensure fiscal responsibility for future generations are the path forward for Puerto Rico.
