What is an encumbrance in accounting?

An encumbrance in accounting refers to a commitment or obligation in the form of a purchase order, contract, or any other agreement that sets aside a portion of an organization's budget for future payment. Encumbrances are typically used to reserve funds for future expenses, such as goods or services that have been ordered but not yet received, employee salaries, or other contractual obligations.

Encumbrances are recorded in financial statements as liabilities until the actual payment is made. They are important for budgeting and financial planning purposes, as they allow management to track committed funds and ensure that there are sufficient resources available to meet future obligations. Encumbrances also provide transparency and accountability in financial reporting by clearly indicating the extent of the organization's financial commitments.

Overall, encumbrances help organizations manage their finances more effectively by ensuring that funds are properly allocated and accounted for in advance of actual expenditures.