An encroachment, as the name suggests, is when someone who doesn’t own a property interferes with it in a physical way. “An easement refers to someone’s right to use real estate owned by another party,” DeMarkey explains. An encumbrance can be either financial or non-financial, depending on its nature. Wolters Kluwer is a global provider of professional https://simple-accounting.org/what-is-encumbrance-in-accounting/ information, software solutions, and services for clinicians, nurses, accountants, lawyers, and tax, finance, audit, risk, compliance, and regulatory sectors. It is important, from the buyer’s perspective, to be aware of any encumbrances on a property, since these will often transfer to them along with ownership of the property.

encumbrance accounting meaning

The offers that appear on this site are from companies that compensate us. But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you. Our Purchase Orders are printed with our Terms and Conditions which form the contractual agreement of the transaction. Encumbrance when it comes to real estate, due to its many applications, has many different types.

Financial encumbrance: Liens

We continually strive to provide consumers with the expert advice and tools needed to succeed throughout life’s financial journey. Please contact the offices listed below with questions about specific encumbrances or to request liquidation. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers.

  • If you’re still unsure about a property after performing a title search, consider talking to a real estate attorney who can provide legal advice and guidance on how to deal with the matter.
  • In Contracts & Grants (C&G) funds, payroll encumbrances carry forward until the award end date.
  • When the money is paid out, the bookkeeper zeros out the encumbrance account and reports the money as a paid expense.
  • Encumbrance accounting is also referred to as commitment accounting, which involves setting aside money ahead of time to meet anticipated expenses.
  • As a result, they’re able to avoid exceeding the allocated budgets and minimize overspending.
  • Verify purchase order transactions so you can see what encumbrances materialized into actual paid expenses.

Conditions, however, may change over the course of a year or over the period set by the budget. An important part of business finance and cash flow is making sure you understand how much of your available funds you can afford to place in reserve for the encumbrance account. Your reserve funds should be treated as if they don’t exist, and only dipped into for approved purchases or expenses. Though it may be tempting to leave extra money in the general fund to pull from whenever something comes up, doing so could easily over-extend your budget and place serious constraints on your cash flow. Once the encumbrance is approved, the funds are no longer available for use in other transactions. Any encumbrance funds are not part of the actual funds ledger balance, because payments haven’t been processed.


Encumbrances can be frustrating, time-consuming and sometimes even costly to deal with. But you should not walk away from an encumbered property simply because of its status. Make sure you understand exactly what the encumbrance means — and how it will encumber you. There are a number of different types of encumbrances that may affect a home.

Financial statements indicate how budgetary resources are allocated to payment commitments before the actual expenditure incurs with encumbrance accounting. Encumbrance accounting sets aside specific assets to pay anticipated liabilities. For example, a company may reserve a sum of cash to settle up its accounts payable. The presence of an encumbrance can give the illusion that there are more available funds inside an account than what is actually free for use.

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A restrictive covenant is an agreement that a seller writes into a buyer’s deed of property to restrict how the buyer may use that property. There might be a provision that requires the buyer to leave a building’s original facade intact, for example. As long as they do not break the law, restrictive covenants can be as specific and arbitrary as the parties are willing to agree to.

  • If business conditions continue as they are when you set the budget, then the encumbrance will become an expense.
  • When it comes time to pay necessary encumbered funds, the “encumbrance” disappears in that amount and becomes an actual expense.
  • You may not be bothered by a legal encumbrance like a zoning regulation.
  • Our award-winning editors and reporters create honest and accurate content to help you make the right financial decisions.
  • Such financial encumbrances in particular can create challenges for both home sellers and homebuyers, meaning extra expenses at best or blocking closings at worst.

A negative easement restricts the title-holder, for example, by preventing them from building a structure that would block a neighbor’s light. We saved more than $1 million on our spend in the first year and just recently identified an opportunity to save about $10,000 every month on recurring expenses with Planergy. Barbara is a financial writer for Tipalti and other successful B2B businesses, including SaaS and financial companies. She is a former CFO for fast-growing tech companies with Deloitte audit experience.

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This sort of financial encumbrance may make it difficult to sell the house, because the responsibility for the debt would transfer to the new owner. A gas company called Pipers Co. is currently offering easement agreements to home owners living in certain town, as part of their effort to build new pipelines to serve other locations. In management accounting, encumbrance is a management tool used to reflect commitments in the accounting system and attempt to prevent overspending. Encumbrances allow organizations to recognize future commitments of resources prior to an actual expenditure.

What is an example of an encumbrance in accounting?

Encumbrances are also known as pre-expenditures since they act as budgeted reserve funds before the actual expenditure. While appropriations are money set aside for budgetary line items, encumbrances are reserves for a specific item. Some examples of encumbrances are utility payments, tax payments, and payroll.

Zoning laws are one common example of a legal encumbrance and may be the reason that you live next door to other families rather than a business. Legal encumbrances might restrict you from building certain structures on your property, like an accessory dwelling unit, without getting permission to do so. They might also limit the types of water, septic or power systems https://simple-accounting.org/ that your property can utilize if they don’t comply with environmental regulations. A lien on a property means that if a financial obligation isn’t met within a certain period of time, the creditor may seize the property and sell it in order to recoup the money owed. It can also mean the creditor’s debt must be satisfied before the property can be sold.

In this case, property value will be severely affected since it opens the door for a potential seizure of the asset. Contrary to this, an unencumbered property is one that can be freely used and disposed by the owner, since there is no claim against it, as is the case for properties that have no mortgage or were bought in cash. A lien is a type of security interest, an encumbrance that affects the title to a property.