What is encumbrance accounting?

Encumbrance accounting is an accounting method used by organizations to track and manage commitments for future expenditures and budgetary control. It helps ensure that funds are reserved for specific purposes and prevent overspending.

Here are some key points about encumbrance accounting:

1. Purpose: The main purpose of encumbrance accounting is to provide financial visibility and control over committed expenses. It allows organizations to accurately track and report the availability of funds for commitments already made.

2. Budgetary Control: Encumbrance accounting helps ensure that expenditures are within approved budgets. It allows management to monitor and manage spending based on the available budget and avoid overspending.

3. Types of Commitments: Encumbrances can arise from various types of commitments, such as purchase orders, contracts, agreements, or pending invoices. When a commitment is made, the corresponding funds are set aside and encumbered in the accounting system.

4. Accounting Entries: In encumbrance accounting, three main types of accounting entries are made - encumbrance, expenditure, and reversal. When a commitment is made, an encumbrance entry is recorded, which reduces the available fund balance. Once the actual expense is incurred, an expenditure entry is recorded, reducing both encumbrance and fund balance. If the commitment is cancelled or not fully utilized, a reversal entry is made to clear the encumbrance and restore the fund balance.

5. Reporting: Encumbrance accounting provides accurate and up-to-date reporting of encumbered balances, expenditures, and available fund balances. This information is useful for decision-making, budget planning, and monitoring financial performance.

6. Timing: Encumbrance accounting is typically performed during the budgeting and planning process, as well as throughout the fiscal year to reflect changes in commitments. It helps organizations maintain financial control and avoid exceeding allocated budgets.

Overall, encumbrance accounting enables organizations to have a clear understanding of their financial commitments, control spending, and ensure budget compliance. It enhances financial transparency and accountability in managing resources.