What is an encumbrance, and why is it not the same thing as an expenditure?

Question

AcadiFi · Accepted Answer

An encumbrance is a budgetary commitment, usually created when a government issues a purchase order. It is not an expenditure because no goods or services have been received yet. The purpose is control: by recording the commitment early, the government can reserve part of the appropriation and avoid overspending the budget before invoices arrive.

Example: The Town of Silver Creek approves a supplies budget of $300,000. In March it issues a purchase order for road salt estimated at $90,000. The town records an encumbrance for $90,000 and a corresponding budgetary reserve effect. When the salt later arrives and the actual invoice is $88,000, the encumbrance is reversed and the town records an expenditure for $88,000. The remaining $2,000 stays available in the budget.

```mermaid
flowchart TD
  A[Appropriation] --> B[Purchase order]
  B --> C[Record encumbrance]
  C --> D[Goods received]
  D --> E[Reverse encumbrance]
  E --> F[Record expenditure]
```

The FAR trap is treating the purchase order itself as an expenditure. Expenditures are tied to receipt of goods or services and use of current financial resources. Encumbrances are only budgetary control tools. If you separate budget accounting from actual spending accounting, this topic becomes much less intimidating. Practice more in our CPA FAR question bank.

What is an encumbrance, and why is it not the same thing as an expenditure?

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