If you’ve ever looked at a budget report and seen a column labeled “encumbrances”, it’s natural to wonder:
- Is this a liability?
- Is it an expense?
- Why is it separate from actual expenditures?
In accounting, an encumbrance is not just a vague “obligation.” It’s a budget control tool that shows money that has been committed but not yet spent.
Encumbrances are used heavily in governments, universities, and nonprofits to prevent overspending and to give managers a clear picture of how much of the budget is already spoken for.
This guide explains:
- What an encumbrance is in accounting (and what it isn’t)
- How encumbrance accounting works in government and fund accounting
- The difference between encumbrances, accruals, and liabilities
- Step‑by‑step encumbrance journal entry examples
- Common questions and misconceptions
Encumbrance in Accounting: Simple Definition
In accounting, an encumbrance is: A recorded commitment of funds for future spending, usually based on a purchase order, contract, or other firm obligation, before it turns into an actual expenditure.
Key points:
- Encumbrances reserve budget for anticipated expenses.
- They are not yet expenses and not usually liabilities under GAAP.
- They are internal, budgetary entries used to manage and monitor spending against a budget.
Quick example
Suppose a department has a $50,000 annual budget for equipment.
- The department issues a purchase order for $10,000 of laptops.
- The organization records a $10,000 encumbrance against the equipment budget.
- Even though no invoice has arrived yet, the budget report shows:
Encumbered funds: $10,000
Available budget = $50,000 – encumbrances – actual expenditures
This helps managers see that $10,000 of their budget is already committed and not available for new purchases.
Why Organizations Use Encumbrance Accounting
Encumbrance accounting exists primarily as a budget control and planning tool. It answers the question: “How much of our budget is already committed, even if the invoices haven’t arrived yet?”
The budget equation
A simple way to see this is: Available budget = Original budget – Encumbrances – Actual expenditures
- Original budget: the amount appropriated or authorized to spend.
- Encumbrances: commitments (usually POs or contracts) for which money has been reserved.
- Expenditures: actual expenses for goods/services received and invoiced.
By tracking encumbrances, organizations can:
- Prevent overspending before it happens
- Make better cash flow and procurement decisions
- Provide transparency to stakeholders (boards, councils, donors, taxpayers)
Who uses encumbrance accounting?
Encumbrance accounting is especially common in:
- Government entities (state, local, special purpose governments)
- Public universities and colleges
- Nonprofits with grant or program budgets
- Any organization that manages strict appropriations or grant budgets
Private‑sector for‑profit companies can use encumbrances internally, but it’s far less common outside of specialized industries or large ERP systems.
What Is an Encumbrance in Governmental Accounting?
In governmental accounting, encumbrances are a key part of managing appropriations and fund balances.
Governmental funds and appropriations
Governments often operate with appropriation budgets — legal authorizations to spend specific amounts for certain purposes. For example:
- A city council appropriates $500,000 for street repairs in a fiscal year.
- The public works department issues multiple purchase orders and contracts for materials and services.
Each PO or contract becomes an encumbrance, reducing the uncommitted portion of the appropriation.
Internal control & reporting
Encumbrances in governmental accounting:
- Help ensure spending stays within appropriated limits
- Provide visibility into committed vs available budget
- Are typically reported on budgetary reports and internal summaries, not as GAAP liabilities on government‑wide financial statements
Important: In many cases, encumbrances are treated as budgetary accounts, separate from the GAAP accounts used for external financial statements. They are an internal control mechanism rather than a formal requirement of GAAP/IFRS.
Encumbrance vs Accrual vs Liability: What’s the Difference?
Encumbrances are easy to confuse with other accounting terms. Here’s how they differ.
Encumbrance
- A commitment of funds based on a purchase order, contract, or requisition.
- Recorded for budget control, not because a GAAP expense or liability has occurred yet.
- Used mainly in government/university/nonprofit settings.
Accrual
- An accounting recognition of revenue or expense when it is earned or incurred, regardless of cash.
- Under accrual accounting:
- You record an expense when goods or services are received, even if you haven’t paid yet.
- Results in actual expenses and liabilities (e.g., Accounts Payable).
Liability
- A present obligation arising from past events, which will result in an outflow of resources (payment, services, etc.).
- Examples:
- Accounts Payable
- Accrued expenses
- Loans payable
Side‑by‑side comparison
| Concept | Trigger | Purpose | GAAP Liability? | Appears on Budget Reports? |
| Encumbrance | PO/contract/firm commitment | Budget control | Usually no | Yes |
| Accrual | Expense incurred / revenue earned | Proper period recognition | Yes (if payable) | In financial statements |
| Liability | Legal/contractual obligation | Reflect obligations | Yes | Yes (in financials) |
Bottom line: An encumbrance signals “we intend to spend this money,” while an accrual/liability signals “we already owe this money.”
Encumbrance Accounting Example: Budget to PO to Expenditure
Let’s look at a simplified encumbrance accounting example, using government‑style budgetary entries.
Scenario
- A department has a $50,000 budget for equipment.
- It issues a purchase order (PO) for $10,000 of equipment.
- Later, the vendor delivers the equipment and sends an invoice for $9,500 (slightly under PO).
- The department then pays the invoice.
We’ll focus on three stages: encumbrance, expenditure, payment.
Note: Specific account names and debits/credits may vary by jurisdiction and software. This is a simplified conceptual view.
Step 1: Record the encumbrance when the PO is issued
When the PO for $10,000 is approved:
- The organization records a budgetary entry to show that $10,000 of the budget is committed.
Budgetary journal entry (simplified):
- Debit: Encumbrances – Equipment $10,000
- Credit: Budgetary Fund Balance – Reserve for Encumbrances $10,000
This doesn’t record an expense or a liability. It simply reserves budget so reports show:
- Encumbrances: $10,000
- Available budget: reduced accordingly
Step 2: Relieve the encumbrance and record the actual expenditure
When goods are received and the invoice for $9,500 arrives:
- The encumbrance is reduced (liquidated) because the commitment has now turned into an actual transaction.
- The organization records the actual expenditure and a liability (Accounts Payable).
2a. Reverse (liquidate) the encumbrance for the amount of the invoice ($9,500):
- Debit: Budgetary Fund Balance – Reserve for Encumbrances $9,500
- Credit: Encumbrances – Equipment $9,500
Now the encumbrance balance related to this PO is reduced to $500 (if the government chooses to keep the unused portion encumbered) or fully relieved depending on policy.
2b. Record the actual expenditure and liability:
- Debit: Expenditures – Equipment $9,500
- Credit: Accounts Payable $9,500
At this point:
- Encumbrance is reduced
- An actual expenditure and liability are on the books
Step 3: Pay the invoice
When the invoice is paid:
- Debit: Accounts Payable $9,500
- Credit: Cash $9,500
The liability is cleared, and cash decreases.
What about the remaining $500 on the PO?
If the full $10,000 PO isn’t used:
- Some governments cancel the unused portion of the encumbrance (the $500), freeing that budget for other uses.
- Others may adjust encumbrances to match actual contract status.
The key takeaway: encumbrances track committed but not yet expended budget, and are adjusted as contracts are fulfilled or changed.
Pre‑Encumbrance, Encumbrance, and Expenditure
Many organizations distinguish three stages in the lifecycle of a purchase:
1. Pre‑encumbrance (Requisition)
- A requisition is submitted requesting the purchase of goods or services.
- At this stage, funds may be marked as “pre‑encumbered” to indicate a pending request.
- This is often an internal status — not always recorded as a formal accounting entry.
2. Encumbrance (Purchase Order / Contract)
- The requisition is approved and becomes a purchase order or contract.
- At this point, an encumbrance is recorded as a budgetary entry.
- The encumbrance shows that part of the budget is firmly committed.
3. Expenditure (Invoice / Payment)
- Goods or services are received, and an invoice is issued.
- The encumbrance is liquidated (reduced), and an expenditure is recorded.
- When payment is made, cash is reduced and the liability is cleared.
This three‑stage approach gives organizations visibility into:
- Requested purchases (pre‑encumbrances)
- Committed purchases (encumbrances)
- Actual spending (expenditures)
Common Questions and Misconceptions About Encumbrances
Are encumbrances required under GAAP or IFRS?
In most cases:
- Encumbrance accounting is a budgetary or internal control system, not a GAAP/IFRS requirement.
- External financial statements typically do not show encumbrances as liabilities.
- Some governments may disclose encumbrances in notes or supplementary budgetary schedules.
Do encumbrances appear on the balance sheet?
Usually no:
- Encumbrances are tracked in budgetary accounts, not in the same way as assets, liabilities, and equity.
- They appear on budgetary reports and internal management reports rather than on the GAAP balance sheet.
Is an encumbrance the same as an encumbrance on property (lien)?
No — these are different uses of the same word:
- Encumbrance in accounting (budgetary): A commitment of funds for a future expenditure.
- Encumbrance on property: A claim or legal interest in property (e.g., lien, mortgage, easement) that may limit its transfer or use.
They share a common idea of “burden” or “restriction,” but in different contexts.
FAQs
1. What is an encumbrance in accounting?
An encumbrance in accounting is a recorded commitment of funds for goods or services that an organization intends to purchase but has not yet received or paid for. It’s a budget control tool, not an actual expense or liability.
2. Why do organizations use encumbrance accounting?
Organizations (especially governments, universities, and nonprofits) use encumbrance accounting to:
- Prevent overspending their budgets
- See how much budget is already committed vs truly available
- Improve cash flow planning and internal control
3. What is an encumbrance in governmental accounting?
In governmental accounting, an encumbrance is a budgetary entry that records a commitment of appropriated funds (usually based on a PO or contract). It reduces the available balance of an appropriation to ensure spending stays within legal limits.
4. How does encumbrance accounting work in a budget?
In budget reports, you typically see:
- Original budget
- Plus/minus budget amendments
- Minus encumbrances
- Minus actual expenditures
- Equals available budget
Encumbrances reduce available budget as soon as commitments are made, not just when invoices hit.
5. What is the difference between an encumbrance and an accrual?
- Encumbrance: Reserve of budget for future spending, based on a PO or contract; internal control.
- Accrual: Recognition of an expense (and liability) when goods or services are received, regardless of cash; GAAP concept.
Encumbrances come before expenses are incurred; accruals represent actual expenses and obligations.
6. Is an encumbrance the same as a liability?
No. An encumbrance is generally not a liability under GAAP. It’s a budgetary record of an intent to spend, not a current legal obligation. A liability arises when the organization actually owes money (e.g., after receiving goods/services and being invoiced).
7. What are pre‑encumbrances, encumbrances, and expenditures?
- Pre‑encumbrance: A pending request to spend (requisition).
- Encumbrance: A formal commitment of funds (purchase order or contract).
- Expenditure: An actual expense recognized when goods or services are received and invoiced.
8. How do you record an encumbrance in journal entries?
A common simplified approach in governmental fund accounting is:
- At PO (encumbrance):
- Debit Encumbrances
- Credit Budgetary Fund Balance – Reserve for Encumbrances
- When invoice arrives (expenditure):
- Debit Budgetary Fund Balance – Reserve for Encumbrances
- Credit Encumbrances
- Debit Expenditures
- Credit Accounts Payable
- At payment:
- Debit Accounts Payable
- Credit Cash
Specific account names and structures may vary by jurisdiction and software.
9. When is an encumbrance reversed or liquidated?
Encumbrances are typically reduced or removed when:
- The related goods/services are received and invoiced (turned into expenditures), or
- The purchase order or contract is canceled or reduced.
10. How does an encumbrance in accounting differ from a property encumbrance (lien)?
- Accounting encumbrance: Budgetary commitment of funds.
- Property encumbrance: Legal claim or restriction on a property (e.g., lien, mortgage, easement) that affects ownership or use.
They share a term but refer to different types of “burdens.”
How Northstar Can Help Your Business
Encumbrances might look like an extra layer of complexity, but they serve a straightforward purpose:
- Show what portion of your budget is already committed,
- Help you avoid overspending, and
- Give managers and stakeholders a clearer picture of future obligations.
If your organization struggles to:
- Understand encumbrance balances on budget reports
- Tie encumbrances to actual expenditures and contracts
- Build clear, reliable budget‑to‑actual reporting
Northstar Financial Advisory can help you design and maintain accounting and reporting systems that make your budget commitments easier to track and manage — whether you’re a public entity, nonprofit, or growing organization that needs more robust budgeting and forecasting.
If you’d like support in building clearer encumbrance and budget reporting into your accounting processes, you can start by reviewing your current GL structure, budget tools, and reporting needs with a professional advisor.
