BAR CPA Exam: How to Prepare Journal Entries to Record Encumbrances of State and Local Governments

Introduction

Overview of Encumbrances in State and Local Government Accounting

Definition of Encumbrances

In this article, we’ll cover how to prepare journal entries to record encumbrances of state and local governments. Encumbrances are commitments related to unperformed contracts for goods or services in government accounting. When a government entity, such as a state or local government, issues a purchase order or signs a contract, it creates an obligation to pay in the future. The term “encumbrance” reflects the financial commitment to these future expenditures, ensuring that funds are set aside for specific purposes, even though the actual cash outflow has not yet occurred.

In essence, encumbrances are an accounting mechanism used to reserve a portion of the budget for future spending. They help prevent overspending by recognizing the committed funds before the goods or services are actually delivered.

Purpose and Significance in Public Sector Accounting

The use of encumbrances is critical in the public sector, where government entities must adhere to strict budgets. Encumbrances serve as a tool for budgetary control, helping governments track obligations and ensure that they do not exceed authorized spending levels. This system is designed to help governments manage their resources effectively and maintain compliance with legal budget requirements.

Encumbrances also provide transparency and accountability by offering a real-time snapshot of future financial obligations. They help government officials and stakeholders understand how much of the budget has been committed to future expenses, making it easier to manage public funds responsibly.

Key Principles in Accounting for Encumbrances under GASB (Governmental Accounting Standards Board)

The Governmental Accounting Standards Board (GASB) governs the accounting principles for state and local governments, including the treatment of encumbrances. Under GASB, encumbrances are not considered liabilities because no goods or services have yet been received. Instead, they are treated as reservations of the budget, helping governments ensure that they stay within authorized spending limits.

Key principles include:

• Budgetary Reporting: Encumbrances are part of the budgetary reporting process. They are recorded in a separate budgetary account to show that funds have been reserved for specific purposes.
• No Impact on Financial Statements: Encumbrances do not appear directly on the financial statements in governmental funds. They are considered part of budgetary control, not formal expenditures, and do not reduce the fund balance.
• Transparency and Compliance: Encumbrances enhance transparency by allowing governments to show financial commitments, ensuring compliance with budgetary statutes and preventing unauthorized expenditures.

By adhering to these principles, state and local governments can maintain fiscal discipline and provide accurate reports on how taxpayer funds are being managed.

Understanding Encumbrances in State and Local Government Accounting

Definition of Encumbrances in Governmental Accounting

Explanation of Encumbrances as Part of Budgetary Control

In governmental accounting, encumbrances are used as a critical element of budgetary control. When a government entity enters into a commitment, such as issuing a purchase order or entering into a contract, the encumbrance system records that commitment, reserving a portion of the budget for future expenditures. This process ensures that the government does not overcommit funds, as it provides a real-time reflection of future financial obligations.

The encumbrance system operates as a safeguard against overspending by making sure that funds are set aside for specific purposes, even before the actual expenditure occurs. This proactive approach to financial management helps government entities track their commitments and obligations more efficiently, ensuring that funds are available when invoices are received or payments need to be made.

Difference Between Encumbrances and Actual Expenditures

Encumbrances and actual expenditures are distinct concepts in governmental accounting, though they are closely related. An encumbrance represents a commitment to spend funds in the future, but it does not involve the transfer of money. When a purchase order is issued or a contract is signed, the government records an encumbrance to reflect the anticipated expenditure.

An actual expenditure, on the other hand, occurs when the goods or services are delivered, and the government is obligated to make a payment. At this point, the encumbrance is reversed, and the actual expenditure is recorded in the financial system.

In summary:

• Encumbrance: A commitment to spend funds, recorded when a purchase order or contract is issued.
• Actual Expenditure: The spending of funds, recorded when goods or services are received, and payment is due.

The difference between the two is significant for tracking financial commitments and maintaining an accurate reflection of both reserved and available budgetary funds.

The Importance of Managing Encumbrances for Budgetary Compliance

Managing encumbrances is vital for maintaining budgetary compliance in state and local government accounting. Governments are typically required by law to adhere to strict budgets, and encumbrances play a key role in ensuring that they do not exceed these spending limits. By recording encumbrances, government entities can ensure that funds are available for future obligations, preventing the risk of over-committing resources.

Proper management of encumbrances also enhances budgetary transparency. By tracking commitments before actual expenditures occur, government entities provide a clearer picture of their financial position, allowing stakeholders to see how much of the budget has been allocated to future obligations. This transparency promotes accountability and ensures that public funds are managed responsibly.

In addition, accurate management of encumbrances helps in avoiding budget overruns. Without encumbrance accounting, a government might unknowingly spend more than its available resources, leading to financial strain. Encumbrances help keep spending in check by continuously comparing actual available funds with committed funds, ensuring that future spending aligns with the authorized budget.

Ultimately, managing encumbrances is crucial for maintaining fiscal discipline and ensuring that government entities comply with legal and regulatory budgetary requirements.

Budgetary Accounting vs. Financial Accounting

How Encumbrances Fit into Budgetary Control

In state and local government accounting, encumbrances are a key component of budgetary control. Unlike private sector accounting, which primarily focuses on the recognition of revenue and expenses, governmental accounting emphasizes adherence to legally approved budgets. Encumbrances are recorded when a government entity commits to spending, such as issuing a purchase order or entering a contract.

By recording these commitments, the encumbrance system reserves the necessary funds within the budget, ensuring they are earmarked for specific expenditures. This process helps governments avoid overspending, as it provides a forward-looking approach to resource allocation. Encumbrances act as placeholders in the budget, reducing the available balance and signaling that those funds are no longer free for other purposes.

In budgetary control, encumbrances are not considered actual expenditures. Instead, they represent anticipated spending, allowing the government to monitor and manage its commitments effectively. This proactive approach ensures that the remaining budget is clear and only includes funds not yet committed, making it easier to adhere to the budgetary constraints set by the governing authority.

The Role of Encumbrances in Ensuring Funds are Available for Committed Expenses

Encumbrances play a crucial role in ensuring that funds are available for committed expenses. When a government entity issues an encumbrance, it effectively sets aside the required funds from the budget to cover the future costs of goods or services that have been contracted but not yet received. This reservation of funds guarantees that the necessary financial resources are available when the time comes to fulfill the commitment.

Without an encumbrance system, government entities could inadvertently spend more than what has been allocated, leading to potential budget shortfalls. Encumbrances prevent this by recognizing commitments as soon as they are made, before the actual cash outflow occurs. This ensures that the entity does not overspend its budget, maintaining financial discipline and compliance with legal spending limits.

In addition, encumbrances help in tracking long-term obligations and future expenses, such as multi-year contracts or large capital projects. By monitoring these commitments in the budget, governments can plan their financial activities more effectively and maintain a clear picture of the available resources for future use. This system also enhances transparency, providing a detailed account of committed funds and helping stakeholders understand the government’s financial position regarding future expenditures.

The role of encumbrances in budgetary accounting is to ensure that the government does not exceed its budget by setting aside funds for committed expenses, offering both fiscal control and accountability in managing public resources.

Steps to Prepare Journal Entries for Encumbrances

Step 1: Record Encumbrances When a Purchase Order is Issued

When a government entity issues a purchase order or signs a contract, it creates a future obligation to spend funds, even though the actual payment may not occur until the goods or services are delivered. To reflect this commitment in the accounting system, the government uses encumbrance accounting to reserve funds for the future expenditure.

In this process, the encumbrance is recorded to signify that part of the budget has been set aside for this specific purpose. This entry ensures that the funds are no longer available for other uses, reducing the risk of overspending and providing better control over the government’s budgetary resources.

Detailed Explanation of How Encumbrances are Recorded

When a purchase order is issued or a contract is signed, the government entity records an encumbrance to reserve the necessary funds. This encumbrance does not affect the financial statements in the same way that an actual expenditure would, but it does reduce the available budgetary balance. By doing so, the government ensures that the funds will be available when the goods or services are received and payment is due.

The journal entry for recording an encumbrance involves debiting the Encumbrances account, which represents the commitment, and crediting the Budgetary Fund Balance – Reserved for Encumbrances account, which reflects the portion of the budget that has been set aside for the future expenditure.

This entry occurs in the budgetary accounts, which are separate from the financial reporting accounts. The focus here is on maintaining budgetary control and ensuring that all future commitments are properly accounted for in the budget.

Example Journal Entry

Here is an example of how the journal entry would look when a purchase order is issued:

• Debit: Encumbrances
  (This represents the commitment to purchase goods or services and serves to record the encumbrance.)
• Credit: Budgetary Fund Balance – Reserved for Encumbrances
  (This entry reflects the reserved portion of the budget that is now committed to this particular expenditure.)

The journal entry is as follows:

Debit: Encumbrances XXX
Credit: Budgetary Fund Balance – Reserved for Encumbrances XXX

This entry signifies that the budgetary balance has been reduced by the committed amount, ensuring that funds are available when the time comes to fulfill the purchase order or contract. While the goods or services have not yet been delivered, the government has taken an important step in reserving the funds and maintaining proper budgetary control.

Step 2: Adjustments or Reversals of Encumbrances

How Adjustments Are Made if There Are Changes in the Purchase Order

After an encumbrance has been recorded to reserve funds for a purchase order or contract, adjustments may be necessary if there are changes to the terms or scope of the commitment. These changes could include modifications to the quantity or price of goods or services, partial fulfillment of an order, or even the cancellation of the commitment. When any of these situations arise, the original encumbrance needs to be adjusted or reversed to reflect the new financial reality.

For instance, if a government entity decides to reduce the quantity of goods ordered or negotiate a lower price, the initial encumbrance would be too high. In this case, the entity would reduce the encumbrance to match the updated purchase order or contract value. Conversely, if a purchase order is canceled entirely, the encumbrance must be fully reversed, releasing the reserved funds back into the available budget.

To adjust or reverse an encumbrance, the government entity essentially reverses part or all of the original encumbrance entry, depending on the nature of the change. Adjusting or reversing encumbrances ensures that the budgetary accounts remain accurate and that any released funds are available for other potential expenditures.

Example Journal Entry for Changes or Cancellations

When adjustments or cancellations to a purchase order occur, the original encumbrance must be reduced or eliminated. This involves debiting the Budgetary Fund Balance – Reserved for Encumbrances account (to release the reserved portion of the budget) and crediting the Encumbrances account (to reverse the commitment).

For example, if a purchase order for $10,000 is reduced to $6,000, the government would need to adjust the encumbrance by $4,000. If the purchase order is canceled entirely, the full amount of the original encumbrance would be reversed.

Journal Entry for Adjustments or Cancellations

Here’s an example of how the journal entry would look for a cancellation or adjustment:

• Debit: Budgetary Fund Balance – Reserved for Encumbrances
  (This releases the portion of the budget that is no longer committed to the purchase order.)
• Credit: Encumbrances
  (This reduces or eliminates the original commitment recorded in the encumbrances account.)

The journal entry is as follows:

Debit: Budgetary Fund Balance – Reserved for Encumbrances XXX
Credit: Encumbrances XXX

For example, if a $4,000 adjustment is made to the original encumbrance:

Debit: Budgetary Fund Balance – Reserved for Encumbrances 4,000
Credit: Encumbrances 4,000

This entry reflects the reduction or elimination of the initial encumbrance, ensuring that the budget accurately reflects the updated commitment or the release of funds in case of cancellation. Maintaining these adjustments is crucial for accurate budget management and for preventing overspending or mismanagement of public funds.

Steps to Prepare Journal Entries for Encumbrances

Step 3: Recording Actual Expenditures When Goods or Services Are Received

Reversing the Original Encumbrance Entry

Once the goods or services that were ordered are received, the encumbrance must be reversed to reflect that the commitment has now been fulfilled. The original encumbrance was a budgetary placeholder, so now that the expenditure is ready to be recognized as an actual cost, the encumbrance is no longer needed.

Reversing the encumbrance involves debiting the Budgetary Fund Balance – Reserved for Encumbrances, which releases the funds from their reserved status, and crediting the Encumbrances account, eliminating the commitment from the accounting records. This step clears the encumbrance and prepares the accounts for the recognition of the actual expenditure.

Recording Actual Expenditure for Goods/Services Received

Once the encumbrance is reversed, the actual expenditure is recorded. This reflects the government’s liability to pay for the goods or services now that they have been delivered. The expenditure is recorded in the Expenditure account, representing the outflow of resources, and the corresponding credit entry is made to either Accounts Payable or Cash, depending on whether the payment is made immediately or deferred.

This process ensures that the financial records accurately capture the shift from a budgetary commitment to an actual expenditure. It also helps maintain proper budgetary and financial control, as the expenditure now appears on the government’s financial statements.

Example Journal Entry

Here is the journal entry for recording the actual expenditure and reversing the original encumbrance:

• Reversing the Encumbrance:
  • Debit: Budgetary Fund Balance – Reserved for Encumbrances
    (This releases the reserved portion of the budget now that the goods or services have been received.)
  • Credit: Encumbrances
    (This eliminates the original commitment from the accounting records.)
• Recording the Actual Expenditure:
  • Debit: Expenditure
    (This reflects the actual outflow of resources for the goods or services received.)
  • Credit: Accounts Payable (or Cash, depending on timing)
    (This records the liability to pay for the goods or services, or the cash payment if made immediately.)

The journal entries would look like this:

Debit: Budgetary Fund Balance – Reserved for Encumbrances XXX
Credit: Encumbrances XXX

Debit: Expenditure XXX
Credit: Accounts Payable (or Cash) XXX

For example, if the original purchase order was for $5,000 and the goods have now been received:

Debit: Budgetary Fund Balance – Reserved for Encumbrances 5,000
Credit: Encumbrances 5,000

Debit: Expenditure 5,000
Credit: Accounts Payable (or Cash) 5,000

This process ensures that the government’s financial records accurately reflect both the release of reserved funds and the recognition of the actual cost. By reversing the encumbrance and recording the expenditure, the government maintains clear and accurate control over its budget and financial statements, adhering to both budgetary and accounting standards.

Key Considerations in Recording Encumbrances

Budgetary Compliance

Importance of Recording Encumbrances to Prevent Overspending and Ensure Funds Are Properly Allocated

One of the primary purposes of recording encumbrances in state and local government accounting is to maintain budgetary compliance. Governments operate under strict budgetary constraints, which are often legally mandated, making it crucial to manage and control expenditures effectively. Encumbrances play a pivotal role in preventing overspending by reserving portions of the budget for future obligations as soon as a purchase order or contract is issued.

Recording encumbrances ensures that financial commitments are reflected in the accounting system before the actual cash outflow occurs. This helps government entities avoid exceeding their authorized spending limits. By setting aside funds at the moment of commitment, such as when a contract is signed or a purchase order is issued, the government safeguards against inadvertently committing resources that may no longer be available once the goods or services are delivered.

Encumbrances act as a mechanism to guarantee that funds are properly allocated and will be available when needed. For example, if a local government orders supplies in May but the invoice isn’t due until July, the encumbrance ensures that the funds are “frozen” for this purpose, preventing other expenditures from using the same financial resources in the interim.

Moreover, budgetary compliance is essential for maintaining trust and transparency with the public, ensuring that government funds are managed responsibly and in accordance with the law. Without a proper encumbrance system, governments run the risk of overspending, misallocating resources, or violating budgetary restrictions. Encumbrances allow for better planning and control over financial resources, as they provide a clear view of future commitments and how much of the budget remains unencumbered.

Recording encumbrances is a critical step in maintaining budgetary discipline, ensuring that governments do not overspend and that allocated funds are reserved for their intended purposes. This practice supports overall financial stability and compliance with legal budgetary mandates, enhancing both fiscal responsibility and accountability.

Year-End Encumbrances

How Encumbrances Are Handled at Year-End and Carried Over into the Next Fiscal Period

At the end of the fiscal year, year-end encumbrances become a critical aspect of government budgetary control and financial management. Encumbrances represent commitments for goods or services that have not yet been delivered or paid for, and these obligations often extend into the next fiscal period. To ensure proper financial reporting and compliance with budgetary requirements, governments need to manage year-end encumbrances carefully.

When the fiscal year ends, the funds encumbered but not yet expended are typically carried over into the next fiscal period. This is because the goods or services tied to those encumbrances are still expected to be delivered, and the government remains committed to those financial obligations. To maintain continuity in financial control, these encumbrances are rolled forward to ensure that the reserved funds are available in the new fiscal year.

Carrying forward encumbrances helps avoid issues like overspending in the new fiscal period, as the reserved amounts remain allocated to their respective commitments. Without this rollover, there would be a risk of unintentionally spending funds on other projects, creating budgetary shortfalls when the original encumbered items are received.

Closing Encumbrances in Budgetary Accounts vs. Accrual of Liabilities in Financial Accounting

In governmental accounting, there is an important distinction between how encumbrances are handled in budgetary accounts versus how liabilities are recognized in financial accounting. At year-end, this distinction becomes particularly relevant as governments close out one fiscal period and prepare for the next.

• Budgetary Accounts: In budgetary accounting, encumbrances are considered commitments of budgetary funds. At year-end, if these commitments have not yet resulted in actual expenditures (i.e., the goods or services have not yet been received), the encumbrance is carried forward into the next fiscal period. This carryover ensures that the government continues to reserve the necessary funds for future obligations. Encumbrances do not appear on the financial statements but are crucial for maintaining budgetary control.
• Accrual of Liabilities in Financial Accounting: In financial accounting, liabilities are recorded when the goods or services are received, regardless of when the payment is made. If the government has received the goods or services before the fiscal year-end but has not yet paid for them, a liability must be accrued in the financial statements. This ensures that the financial statements accurately reflect the government’s obligations at the end of the fiscal period. Unlike encumbrances, which are a budgetary concept, accrued liabilities appear on the government’s balance sheet as part of financial reporting.

In practice, if an encumbrance is still outstanding at year-end and the goods or services have not been received, the encumbrance is carried forward in the budgetary accounts. If the goods or services have been delivered by year-end but not paid for, the encumbrance is reversed, and the government records the expenditure and liability in its financial statements.

Year-end encumbrances are carefully managed to ensure that funds are reserved for future commitments and that financial obligations are properly recorded. In budgetary accounting, encumbrances are carried forward into the next fiscal year, while in financial accounting, liabilities are accrued when goods or services are received. This distinction ensures both budgetary compliance and accurate financial reporting.

Impact on Financial Statements

How Encumbrances Affect Fund Balance Reporting in Governmental Funds

In governmental accounting, encumbrances do not directly impact the financial statements in the same way that actual expenditures or liabilities do. Instead, they play a role in budgetary control and are reported in the budgetary comparison schedules, which are often supplementary to the basic financial statements. However, encumbrances indirectly affect the reporting of fund balance in governmental funds, which is a key measure of available resources.

Encumbrances are essentially commitments of budgeted funds for future expenses. These commitments are recorded in budgetary accounts, not in the primary financial statements. However, when a portion of the budget is encumbered, it reduces the unassigned fund balance in the governmental fund’s financial reporting. This means that although the encumbered amounts are not actual liabilities or expenditures, they reduce the portion of the fund balance that is available for new spending.

On the financial statements, particularly on the Governmental Funds Balance Sheet, encumbrances can be reflected as part of the Assigned Fund Balance or Committed Fund Balance, depending on the nature of the reserved funds. This presentation signals that these funds are not available for general use and have been set aside for specific future obligations.

• Assigned Fund Balance: Represents amounts intended to be used for specific purposes, which can include encumbered funds.
• Committed Fund Balance: Represents amounts that have been formally committed to specific purposes by the government’s highest decision-making authority.

Although encumbrances themselves are not reported as liabilities on the Statement of Net Position, they help inform the reporting of fund balance in governmental funds by showing how much of the available balance is already committed to future expenses. This ensures that governments do not overstate their available resources.

Ensuring Compliance with GASB and Other Applicable Standards

To ensure accurate financial reporting and budgetary compliance, governments must adhere to the guidelines established by the Governmental Accounting Standards Board (GASB). GASB provides the framework for how encumbrances should be treated within the context of governmental fund accounting.

Under GASB standards, encumbrances are not considered liabilities, as no actual payment or transfer of goods or services has taken place. Instead, they are part of budgetary control, ensuring that funds are reserved and available for committed expenses. The treatment of encumbrances is guided by GASB Statement No. 54, which outlines how governments should classify and report fund balances, including those funds that are restricted, committed, or assigned.

To comply with GASB:

• Governments must record encumbrances in budgetary comparison schedules, which highlight the differences between actual expenditures and budgeted expenditures, including encumbrances.
• Encumbrances should be properly classified in the fund balance as Assigned or Committed, based on the level of authority required to make the financial commitment.
• Governments should not report encumbrances as liabilities in the financial statements but must ensure that they are appropriately reflected in the fund balance classification.

By following these standards, governments can provide transparent and accurate financial reports that reflect their budgetary commitments while ensuring compliance with GASB requirements. This approach enhances fiscal accountability and ensures that stakeholders have a clear understanding of how much of the government’s budget is already allocated to future spending.

While encumbrances do not appear directly as liabilities on financial statements, they play a crucial role in fund balance reporting by reducing the amount of funds available for discretionary spending. Proper classification of encumbered funds under GASB standards ensures accurate financial reporting and compliance with legal and budgetary requirements.

Common Mistakes and Best Practices

Common Errors in Recording Encumbrances

Failure to Record Encumbrances Properly or in a Timely Manner

One of the most frequent errors in encumbrance accounting is the failure to record encumbrances accurately or in a timely manner. When purchase orders or contracts are issued but the related encumbrances are not immediately recorded, the government’s financial records may not reflect its true commitments. This delay can lead to overspending, as the available budget may appear larger than it actually is.

Additionally, late recording of encumbrances can disrupt budgetary control and make it difficult for government officials to manage finances effectively. Ensuring that encumbrances are promptly recorded when obligations are made is crucial for maintaining accurate budgetary records and preventing budget overruns.

Misclassification Between Encumbrances and Expenditures

Another common mistake is the misclassification between encumbrances and expenditures. Encumbrances represent commitments for future spending, while expenditures reflect actual outflows of funds. Misclassifying encumbrances as expenditures can distort financial reports, leading to confusion about the government’s fiscal position. This error may also result in incorrect fund balances, as expenditures reduce fund balances while encumbrances only reserve funds within the budget.

It’s essential to clearly distinguish between these two types of transactions in accounting records. Encumbrances should only be recorded when there is a commitment, and expenditures should only be recognized when goods or services have been received and the payment obligation is due.

Best Practices for Managing Encumbrances

Regular Reconciliation of Encumbrances with the Budget

To avoid errors and maintain budgetary compliance, it is important to regularly reconcile encumbrances with the overall budget. By performing periodic reconciliations, government entities can ensure that the funds reserved through encumbrances align with the actual commitments. This practice allows for the timely identification of discrepancies, such as over-encumbrances or instances where encumbrances should have been reversed but were not.

Regular reconciliation also helps in adjusting for any changes in contracts or purchase orders, ensuring that the budget reflects the most current financial commitments. This proactive approach ensures accuracy in both budgetary reporting and financial management.

Training for Accounting Personnel on Budgetary Control and Proper Journal Entry Processes

Proper management of encumbrances requires that accounting personnel have a clear understanding of budgetary control procedures and how to correctly record encumbrances in the accounting system. Providing thorough training on how and when to record encumbrances, how to adjust them, and how to reverse them when expenditures are recognized is critical for ensuring accuracy in financial records.

Training should also include guidance on the difference between budgetary and financial accounting, the importance of adhering to GASB standards, and the steps for preparing proper journal entries. Well-trained personnel are less likely to make errors, and effective training ensures that encumbrance accounting is performed consistently and accurately across the organization.

By implementing these best practices, government entities can maintain effective budgetary control, avoid common mistakes, and ensure that their financial records provide a clear and accurate picture of their future commitments.

Example Scenarios and Journal Entries

Scenario 1: Issuance of a Purchase Order

When a government entity issues a purchase order, an encumbrance is recorded to reserve funds in the budget for the future expense. This ensures that the committed funds are set aside and not available for other uses, maintaining budgetary control. Here is the journal entry for recording the encumbrance when the purchase order is issued:

Example Journal Entry for Recording an Encumbrance:

• Debit: Encumbrances (to represent the commitment of funds)
• Credit: Budgetary Fund Balance – Reserved for Encumbrances (to reserve the portion of the budget)

Debit: Encumbrances $10,000
Credit: Budgetary Fund Balance – Reserved for Encumbrances $10,000

In this case, a purchase order of $10,000 is issued, and the government reserves that amount in the budget for the future payment.

Scenario 2: Partial Fulfillment of a Purchase Order

When only part of the goods or services from a purchase order are delivered, the government must adjust both the encumbrance and the expenditure records. The portion of the encumbrance corresponding to the delivered goods should be reversed, and an expenditure should be recorded for the amount paid or payable. The remaining portion of the purchase order remains encumbered until the full delivery is received.

Adjusting Encumbrances and Expenditures for Partial Delivery:

For example, if $6,000 worth of goods has been delivered on a $10,000 purchase order, the following entries are made:

1. Reversing the Encumbrance for the Delivered Portion:
   • Debit: Budgetary Fund Balance – Reserved for Encumbrances
   • Credit: Encumbrances

Debit: Budgetary Fund Balance – Reserved for Encumbrances $6,000
Credit: Encumbrances $6,000

2. Recording the Actual Expenditure for Delivered Goods:
   • Debit: Expenditure
   • Credit: Accounts Payable (or Cash, depending on the timing of the payment)

Debit: Expenditure $6,000
Credit: Accounts Payable (or Cash) $6,000

After these entries, the remaining $4,000 of the purchase order remains encumbered, and the budgetary balance will reflect that $6,000 has been expended.

Scenario 3: Cancellation of a Purchase Order

If a purchase order is canceled, the original encumbrance must be fully reversed to release the funds back into the budget. This process removes the encumbrance and restores the budgetary fund balance, making those funds available for other purposes.

Reversing the Original Encumbrance Entry:

For example, if a $10,000 purchase order is canceled, the following journal entry is made:

• Debit: Budgetary Fund Balance – Reserved for Encumbrances
• Credit: Encumbrances

Debit: Budgetary Fund Balance – Reserved for Encumbrances $10,000
Credit: Encumbrances $10,000

This entry removes the encumbrance from the budget, restoring the full $10,000 to the unreserved budgetary fund balance. The funds are now available for other uses, as the original commitment no longer exists.

Conclusion

Recap of Key Points

Understanding and recording encumbrances is a crucial aspect of state and local government accounting, as it ensures effective budgetary control and compliance with legal spending limits. Encumbrances represent commitments for future expenditures and help prevent overspending by setting aside budgeted funds when purchase orders or contracts are issued. Proper management of encumbrances helps governments monitor their financial obligations, ensuring that funds are available when goods or services are received.

Key points to remember:

• Encumbrances are recorded in the budgetary accounts, not the financial statements, but they affect the fund balance by reducing the available resources for new expenditures.
• Encumbrances are reversed when actual expenditures occur, and any remaining encumbrances at year-end are carried forward to the next fiscal period.
• Regular reconciliation and proper classification of encumbrances help maintain budgetary compliance and ensure accurate financial reporting.

Final Tips for Exam Preparation

For those studying for government accounting exams, including the BAR CPA exam, mastering encumbrances is essential. To prepare effectively:

• Practice preparing journal entries: Work through various scenarios, including issuing purchase orders, adjusting encumbrances for partial fulfillment, and reversing encumbrances for canceled orders. Ensure that you understand the flow of encumbrances from commitment to expenditure.
• Focus on budgetary vs. financial accounting: Understand the distinction between budgetary control and financial reporting. Encumbrances affect the budget but do not appear directly in the financial statements, so clarity on this concept is key.
• Review GASB standards: Ensure you are familiar with GASB guidelines, particularly in how encumbrances should be classified in the fund balance and the importance of adhering to these standards for government financial reporting.

By thoroughly understanding the role of encumbrances and practicing journal entries, you’ll be well-prepared for exam questions on this important topic in government accounting.