What Is an Encumbrance in Governmental Accounting?

An encumbrance in governmental accounting is a formal reservation of appropriated funds that sets aside money to cover a specific future obligation, such as a purchase order or a signed contract. Think of it as a hold on a bank account: the dollars are still there, but they’re spoken for. Recording that hold before any cash moves keeps a department from committing the same appropriation twice and keeps total obligations inside the legal ceiling a legislature or governing body has set.

How the Reservation Works

Governmental funds like the General Fund use the modified accrual basis of accounting, which focuses on the flow of current financial resources. The question budget managers need answered every day is simple: has a department committed more money than its appropriation allows? Encumbrances answer that question in real time.

When a department issues a purchase order or signs a contract, it creates a legally binding commitment to pay a vendor later. At that moment, the estimated cost is recorded as an encumbrance. The entry reduces the department’s available appropriation balance on paper, even though no goods have arrived and no payment has been made. The remaining unencumbered balance shows exactly how much spending authority is left for new commitments.

An encumbrance is purely a budgetary entry. It is not an expenditure, and it is not a liability. The National Council on Governmental Accounting made that explicit: encumbrances outstanding at year-end “do not constitute expenditures or liabilities.”¹ The entry sets aside a portion of fund balance, signaling that those resources are already committed. When the actual bill arrives, the encumbrance is reversed and replaced with the real financial transaction.

Types of Encumbrances

Not every commitment looks alike. Governments generally distinguish three kinds, though terminology varies.

External encumbrances cover commitments to outside vendors or contractors. A purchase order for office furniture, a contract with a construction firm, or a travel authorization all create external encumbrances. This is the most common type and the one accounting textbooks focus on.

Internal encumbrances cover anticipated payments to other departments or units within the same government. Payroll obligations, interdepartmental service charges, and facility operations costs fall into this category. Some governments encumber projected payroll at the start of the fiscal year and update the encumbrance after each pay cycle.

Pre-encumbrances are informal reservations placed on funds before a purchase order has been issued. A department planning to replace aging equipment next quarter might enter a pre-encumbrance to earmark the funds even though no vendor has been selected. They carry less formal weight than a committed encumbrance.

The Accounting Cycle

Recording and clearing an encumbrance follows a predictable sequence. The entries touch budgetary accounts that sit alongside, but separate from, the financial accounts that track actual cash and liabilities.

Recording the Encumbrance

Say a parks department issues a purchase order for $50,000 in playground equipment. The accountant debits Encumbrances and credits Budgetary Fund Balance — Reserve for Encumbrances for $50,000. The debit reduces the available appropriation balance, and the credit creates a reservation showing where those funds are committed. No money has left the bank. The entry exists to notify anyone checking the budget that only the remaining unencumbered balance is available for new spending.

Reversing the Encumbrance and Recording the Expenditure

When the equipment arrives and the vendor’s invoice is approved, two things happen at once. First, the original encumbrance is reversed at its full original amount: debit Budgetary Fund Balance — Reserve for Encumbrances and credit Encumbrances for $50,000. That zeroes out the budgetary reservation.

Second, the actual transaction is recorded. If the invoice comes in at $49,500 rather than the $50,000 estimate, the accountant debits Expenditures and credits Vouchers Payable (or Cash) for $49,500. This entry formally recognizes the government’s obligation to pay and reduces current financial resources.

The $500 difference between the estimate and the actual invoice flows back into the department’s available appropriation balance. That freed-up amount can support new commitments for the rest of the year. If the invoice had come in higher than the estimate, the department’s available balance would have shrunk by the overage.

Encumbrances vs. Expenditures vs. Expenses

These three terms describe different moments in the life of a spending transaction, and mixing them up causes real confusion on financial statements.

An encumbrance marks the commitment, the point where a purchase order goes out the door. No goods have arrived. No payment is owed. The entry is budgetary only, and it never appears as an actual cost on the financial statements.¹

An expenditure is recorded under modified accrual accounting when the government receives the goods or services and becomes obligated to pay. Governmental funds use this term rather than “expense” because the focus is on when the liability becomes payable with current resources, not on when the resource gets consumed. Playground equipment creates an expenditure the day it’s delivered and the invoice is approved.

An expense is the full-accrual counterpart, used in proprietary funds (such as a water utility) and in the government-wide financial statements. An expense is recognized when resources are used up, which might happen long after payment. A dump truck purchased this year creates an expenditure immediately in the General Fund but generates depreciation expense over its useful life in the government-wide statements.

The sequence always runs in the same order: encumbrance first when the purchase order is issued, expenditure second when goods are received, and expense either concurrently or stretched over time through depreciation or amortization.

What Happens at Year-End

Outstanding encumbrances at fiscal year-end are handled based on whether the underlying appropriation lapses. Governments treat this differently depending on their own laws and policies.

Lapsing Appropriations

Under a lapsing appropriation, any unspent budget authority expires when the year closes. Outstanding encumbrances have to be closed out of the books, even if the purchase order is still pending with a vendor. The government isn’t canceling the contract; it still intends to honor it. But the budgetary entry gets removed. When the next year begins, the encumbrance is re-established against a fresh appropriation, and the new budget must include enough authority to cover those carryover commitments.¹

The NCGA standard requires that if a government intends to honor contracts in progress at year-end, it must disclose the outstanding encumbrances either in the notes or through a reservation of fund balance.¹

Non-Lapsing Appropriations

When appropriations do not lapse at year-end, or only the unencumbered portion lapses, outstanding encumbrances can stay open. There’s no need to reverse and re-establish them. The encumbered amounts carry forward automatically, and the related fund balance is reported as a reservation for the next year’s expenditures.¹ This is simpler from an accounting standpoint, though it does require careful monitoring so old encumbrances don’t linger on the books indefinitely.

Whichever method a government uses, it must disclose its encumbrance policy in the Summary of Significant Accounting Policies and apply that method consistently from year to year.¹

Where Encumbrances Show Up on the Financial Statements

Because an encumbrance is not a liability, it never appears in the liabilities section of a governmental fund’s balance sheet. Instead, it affects how the government classifies its fund balance. GASB Statement No. 54 controls here, and the rules are more nuanced than a simple “report it as committed.”

The core principle in GASB 54: encumbered amounts should not sit in the unassigned fund balance category. If resources have already been restricted, committed, or assigned for a particular purpose, encumbrances tied to that purpose don’t create a separate line item; they’re absorbed within the existing classification. If the encumbered amount would otherwise be unassigned, it must be reported as either committed or assigned fund balance, depending on how the government’s encumbrance process works.²

The choice between committed and assigned comes down to who made the decision. A committed fund balance requires formal action by the government’s highest level of decision-making authority, like a city council resolution or a legislative ordinance, and can only be redirected through that same type of formal action. An assigned fund balance reflects intent to use funds for a specific purpose but doesn’t require action by the highest governing authority; a budget director or finance committee can make the assignment, and the constraint is easier to modify.²

In practice, most routine purchase-order encumbrances end up as assigned fund balance, because they’re typically authorized by departmental officials rather than the governing body. Capital project encumbrances backed by a council resolution are more likely to land in the committed category. GASB 54 also requires that significant outstanding encumbrances be disclosed in the notes to the financial statements.²

Why This Matters: The Anti-Deficiency Act

Encumbrance accounting can look like bookkeeping housekeeping, but the consequences of getting it wrong are serious. At the federal level, the Anti-Deficiency Act makes it illegal for any officer or employee to make or authorize an expenditure or obligation that exceeds the amount available in an appropriation.³ Encumbrances are the front-line defense, because they flag commitments before the money is actually spent.

When a violation occurs, the head of the agency must report all relevant facts immediately to the President, Congress, and the Comptroller General.⁴ The report must identify the responsible employees, explain the circumstances, and describe what disciplinary action was taken.⁵

Employees who violate the Act face administrative discipline ranging from suspension without pay to termination. A knowing and willful violation is a criminal offense punishable by a fine of up to $5,000, imprisonment for up to two years, or both.⁶ State and local governments have their own versions of these rules, and while penalties vary, the underlying principle is the same: spending beyond your appropriation is not just an accounting error.

That’s why encumbrance accounting isn’t optional for most governmental entities. The NCGA standard puts it plainly: encumbrance accounting “should be utilized to the extent necessary to assure effective budgetary control and accountability.”¹ Without it, a department has no reliable way to know whether it has already committed funds that push it past its legal limit.

1
PwC Viewpoint. NCGAS 1 – Governmental Accounting and Financial Reporting Principles
2
Governmental Accounting Standards Board. Statement No. 54 – Fund Balance Reporting and Governmental Fund Type Definitions
3
Office of the Law Revision Counsel. 31 USC 1341 – Limitations on Expending and Obligating Amounts
4
Office of the Law Revision Counsel. 31 USC 1517 – Prohibited Obligations and Expenditures
5
The White House. OMB Circular A-11, Section 145 – Requirements for Reporting Antideficiency Act Violations
6
Office of the Law Revision Counsel. 31 USC 1350 – Criminal Penalty