The concept is most commonly used in governmental accounting, where encumbrances are used to ensure that there will be sufficient cash available to pay for specific obligations. By using encumbrances, a government entity can be assured that it will not over-extend its finances. A downside of encumbrances is that they increase the complexity of government accounting to some extent.

If for example, the IT department seeks to purchase $30,000 in new computer equipment, someone in the department will make a pre-encumbrance request to approve the purchase. If management approves, the IT department writes the purchase order, which creates the encumbrance. Contract and Grant Cost Share Encumbrances are created for purchase orders that are cost-share funded and coded with balance type code CE.

Drafting a Pre-Encumbrance

Encumbrances are important in determining how much funds are available as a projected expense planning tool. Encumbrance accounting helps your company with budget visibility and analysis by recording planned future payments. Rather than just looking at current transactions, this type of accounting encourages tracking upcoming expenses to help show a more detailed encumbrance accounting view of your cash flow. Encumbrance accounting, also known as commitment accounting, tracks anticipated spending to budgeted amounts. The first step encumbers newly entered purchase order line items into the General Ledger to help prevent overspending. After that, you unencumber the line items once they go into an Accounts Payable invoice for payment.

A mechanic’s lien is a claim on personal or real property the claimant has performed services on. An example is if a contractor made adjustments to your property that were never paid for. When it comes time to pay necessary encumbered funds, the “encumbrance” disappears in that amount and becomes an actual expense. As the company rolls through the budgeted year, the amount actually spent rises and the encumbered funds declines.

What Is An Encumbered Fund?

This allows organizations to determine the amount of funds available for future spending. As a result, they’re able to avoid exceeding the allocated budgets and minimize overspending. With how essential an accurate fund balance is, there are many ways accounting teams have tried to track this data.

With Encumbrances, no payments leave the University and no actual expense would be generated on a ledger, since it is an expectation of a future actual transaction. Verify purchase order transactions so you can see what encumbrances materialized into actual paid expenses. A tax lien is a lien imposed by a government to force the payment of taxes; in the U.S., a federal tax lien trumps all other claims on a debtor’s assets.