Encumbrances accounting ensures that budgetary control is maintained; which statement is true about encumbrances?

• A. They are recorded as liabilities on the balance sheet
• B. They are recorded as expenditures immediately
• C. They generally appear as a reservation of fund balance
• D. They increase cash balance

Answer: (C)

Encumbrances are a budgetary accounting tool used to track commitments for future expenditures within governmental funds. When a purchase order or contract is issued, an encumbrance is recorded to show that a portion of the appropriation is set aside for that obligation. This reduces the amount of fund balance that is freely available, effectively reserving funds for the anticipated outflow. Because encumbrances reflect commitments rather than actual payments or expenses, they are not recorded as expenditures and they do not involve cash at the time the encumbrance is established. They also do not create a liability on the balance sheet in the same way as an actual payable; instead, they appear as a reservation of fund balance. The encumbrance is cleared when the related purchase is actually made and the expenditure is recorded, at which point the reserved amount is released. For these reasons, the statement that encumbrances generally appear as a reservation of fund balance best describes their nature.