What does the term 'encumbrances' refer to in governmental accounting?

In governmental accounting, 'encumbrances' refer to authorized liabilities that have not yet been settled. This concept is used to help governments manage their budgets effectively. When a government entity encumbers funds, it essentially reserves a portion of the budget for anticipated expenditures, ensuring that money is allocated for specific projects or purchases. This practice promotes fiscal responsibility by preventing overspending.

Encumbrances are recorded when a government entity issues a purchase order or a contract. Even though the payment has not yet been made, the encumbrance reflects the commitment to spend funds in the future, which helps in tracking and managing the budget. This approach provides a clearer picture of available resources, as it accounts for expected obligations ahead of time.

The significance of using encumbrances lies in their ability to provide transparency and control over budgetary expenditures, ensuring that the funds are appropriately designated for intended uses before they are actually spent. This is particularly important in the context of public sector financial management, where accountability and careful stewardship of taxpayer money are crucial.