6.3 Budgetary Accounting
Key Takeaways
- Governmental budgets are legally binding and integrated into the general ledger using budgetary accounts.
- Budgetary accounts (Estimated Revenues, Appropriations) have opposite normal balances compared to actual operating accounts.
- Encumbrances reserve a portion of appropriations when a purchase order is issued to prevent overspending.
- When goods are received, the original encumbrance is reversed for the estimated amount, and the actual expenditure is recorded.
- At year-end, all budgetary accounts are closed out by reversing the initial entries.
6.3 Budgetary Accounting and Encumbrances
In the corporate world, a budget is an internal management tool. In the governmental sector, a legally adopted budget has the force of law. It represents both the authorization to spend and the legal limit on spending. Because of this legal significance, governmental accounting systems incorporate budgetary accounts directly into the general ledger to ensure expenditures do not exceed appropriations. This integration is primarily seen in the General Fund, Special Revenue Funds, and sometimes other governmental funds.
The Budgetary Accounts
Budgetary accounts are used to record the budget and track its status throughout the year. They are temporary accounts that are opened at the beginning of the fiscal year and closed at the end. They have normal balances that are the opposite of their related actual accounts.
- Estimated Revenues: An anticipatory asset account (Normal Balance: Debit). Represents the total amount of revenues expected to be collected during the year.
- Appropriations: An anticipatory liability account (Normal Balance: Credit). Represents the legal authorization granted by the legislative body to incur liabilities for purposes specified in the budget.
- Estimated Other Financing Sources / Uses: Used for anticipated interfund transfers or bond issuance proceeds.
- Budgetary Fund Balance: A plug account to balance the initial budgetary entry. If Estimated Revenues exceed Appropriations, it has a credit balance (anticipated surplus). If Appropriations exceed Estimated Revenues, it has a debit balance (anticipated deficit).
The Budgetary Cycle Journal Entries
1. Adopting the Budget
At the beginning of the fiscal year, the adopted budget is recorded. Assume a city council adopts a budget with Estimated Revenues of $5,000,000 and Appropriations of $4,900,000.
Debit: Estimated Revenues 5,000,000
Credit: Appropriations 4,900,000
Credit: Budgetary Fund Balance 100,000
Note: This entry is simply reversed for the exact same amounts at the end of the year, regardless of actual results.
2. Encumbrance Accounting
An encumbrance is a commitment related to an unperformed contract for goods or services. It is an administrative tool used to prevent overspending. When a purchase order is issued, funds are "encumbered" (set aside), reducing the unencumbered balance of the appropriation.
Assume the city issues a purchase order for three new police cars at an estimated cost of $120,000.
Entry to record the encumbrance:
Debit: Encumbrances 120,000
Credit: Budgetary Fund Balance - Reserve for Encumbrances 120,000
This entry reserves a portion of the fund balance so it is not inadvertently spent elsewhere.
3. Fulfilling the Commitment
When the goods are received, two entries are required: one to reverse the encumbrance at the original estimated amount, and one to record the actual expenditure at the actual invoice amount.
Assume the police cars arrive, but the actual invoice is $122,000 (perhaps due to unexpected delivery fees or minor upgrades).
Entry to reverse the encumbrance (always for the original estimate):
Debit: Budgetary Fund Balance - Reserve for Encumbrances 120,000
Credit: Encumbrances 120,000
Entry to record the actual expenditure:
Debit: Expenditures 122,000
Credit: Vouchers Payable (or Cash) 122,000
Notice that the expenditure account is debited for $122,000, leaving a net reduction in available appropriations of $122,000 from this entire cycle.
Closing the Accounts at Year-End
At the end of the fiscal year, all temporary accounts must be closed. In governmental accounting, this involves closing both the budgetary accounts and the actual operating accounts. The goal is to return the temporary accounts to a zero balance and transfer the net results to the unassigned fund balance.
Closing the Budgetary Accounts
The initial budget entry is reversed for the exact amounts originally recorded (plus or minus any budget amendments made during the year).
Debit: Appropriations 4,900,000
Debit: Budgetary Fund Balance 100,000
Credit: Estimated Revenues 5,000,000
Closing the Actual Accounts
Actual revenues and expenditures are closed to Fund Balance. Assume actual revenues were $5,050,000 and actual expenditures were $4,850,000.
Debit: Revenues 5,050,000
Credit: Expenditures 4,850,000
Credit: Fund Balance - Unassigned 200,000
Treatment of Outstanding Encumbrances
What happens if a purchase order was issued but the goods were not received by year-end? The encumbrance account must be closed out, but the government still intends to honor the commitment in the following year.
The typical process is:
- Close the Encumbrances account against the Reserve for Encumbrances.
- In the actual Fund Balance, reclassify an amount equal to the outstanding encumbrances from "Unassigned" to "Committed" or "Assigned" (depending on the level of authority that made the encumbrance).
Debit: Budgetary Fund Balance - Reserve for Encumbrances 120,000
Credit: Encumbrances 120,000
Debit: Fund Balance - Unassigned 120,000
Credit: Fund Balance - Assigned 120,000
When the goods are received in the next fiscal year, the expenditure will be recorded directly against the new year's accounts, or a separate "Expenditures - Prior Year" account may be used, depending on the specific government's policies.
Summary of the Budgetary Equation
At any point in time during the year, a fund manager can determine how much spending authority remains by calculating the unencumbered balance:
Available Appropriations = Appropriations - (Expenditures + Encumbrances)
This simple formula is the heart of budgetary control. By systematically recording the budget, tracking commitments via encumbrances, and accurately capturing expenditures, governments can ensure they remain accountable to taxpayers and do not spend more resources than they have legally authorized.
What is the normal balance of the Appropriations account, and what does it represent?
A city orders a new fire truck for an estimated cost of $400,000. When the truck arrives, the actual invoice is for $395,000. For what amount should the encumbrance be reversed?
At year-end, the budgetary accounts must be closed. How is the initial entry to record the budget closed out?
How do you calculate the available appropriations during the year?