Final answer:
The incorrect statement about Agency Funds is that they use modified accrual accounting, because they actually use accrual accounting. Agency funds are custodial in nature and assets must be offset by liabilities, and these assets and liabilities are recognized when the government becomes responsible for them.
Step-by-step explanation:
The incorrect statement with respect to Agency Funds is that: a. Agency funds use modified accrual accounting. This is because Agency Funds, which account for resources held by a government as an agent for others, actually use accrual accounting. Unlike governmental funds, which use modified accrual accounting, agency funds recognize assets and liabilities when the related events occur, regardless of the timing of related cash flows. In an agency fund:
- Assets accounted for in an agency fund belong to the party or parties for which the government acts as an agent, aligning with statement b.
- Liabilities in agency funds absolutely must offset assets as the government holds these assets in a purely custodial capacity, which corresponds to statement c.
- The recognition of assets and liabilities at the time the government becomes responsible for the assets, as described in statement d, is accurate for agency funds as they reflect the fiduciary nature of the relationship.
The example illustrating the use of a T-account by banks can help us understand the principles of accounting, where all transactions are recorded in such a way that the total assets always equal the sum of liabilities and net worth. Agency funds also maintain this balance where total assets are equal to total liabilities, and there is no net worth or fund balance because the assets do not belong to the government itself.