Budget and Encumbrance

Budgetary control refers to the process of recording budget data and tracking encumbrance and actual data against a budget.

 

“Funds checking” is the feature of budgetary control that helps prevent overspending budgets by verifying available funds online before processing a transaction.

 

Encumbrance is the amount reserved for approved spending but not yet materialized.

 

Encumbrance accounting is completely off the balance sheet, that is, they are a separate set of records that helps to monitor spending.  Under this setting, when a PO is issued, no liability is recorded on the balance sheet.  A balance sheet liability is recorded when the goods are received, at the same time the corresponding encumbrance entry will be reversed.

 

Funds Available refers to the amount of budget remains unutilized, including those that had been ordered.

 

Funds Available = Budget – Amount already spent – Encumbrance. 

 

Example 1:

Annual budget for Company on computer purchase was $80K.  Up to this moment Company had already spent $50K.  Now, a P.O. was issued for another $25K computer purchase.  Then it follows that:

Funds Available = Budget – Amount already spent – Encumbrance

                =  $80K  –      $50K           –    $25K

                =   $5k

When the $25K P.O. was issued, an encumbrance entry is created automatically into GL to reserve funds.  After which, any computer purchase above the funds available $5K requested will not be granted.  Encumbrance controls your spending at the PO level.

 

Encumbrance is reversed when the item is received and a real liability is booked on the B/S.

 

Example 2:

 

Company has a budget of $10K for air-tickets for the year 2005.  Currently the actual expense for air-tickets had already reached $9K what happens to the P.O. process when an air-ticket that costs $2K is requested?

 

There are two types of budgetary control – “Advisory” and “Absolute”

 

If air-ticket expenses are defined to be controlled by the “Advisory” budgetary control option, any P.O. issued that would have exceeded the budget would merely be “warned” by system, by way of a warning message, before a P.O. is issued.  A significantly weaker budgetary control option.

 

If air-ticket expenses are defined to be controlled by the “Absolute” budgetary control option, any P.O. issued that would have exceeded the budget would not be granted until the budgeted amount or the acceptable tolerance level is increased.  Much stronger budgetary control but usually cause a lot of noises by users when budgets are set too low.

 

Budgets should be set using extreme caution and should be monitored frequently to minimize unnecessary disruptions in the procurement process.

 

Almost all items sourced using P.O. are maintained in the “Item Master” list (a.k.a. Master Item) which predefines the accounting entry for that particular item, which in turn is controlled by the budget.  To ensure a strong budgetary control, it is of utmost importance that the accounting treatment for each and every item in the “Item Master” is correctly defined and the right to maintain and change such settings be kept to a very limited number of rightful staff only.   

 

Useful Things to know about budget and encumbrance:

• Similar to actual book keeping, budget setting and accounting for encumbrance requires journal entries.
• Freeze budgets to disallow unauthorized changes
• To make changes to a frozen budget, unfreeze (reopen) frozen budget, make necessary changes and freeze budget again.

 

Selected set-up options:

• Summary budgetary control – whereby spending is controlled over a predefined group of accounts, such as total administration expenses.  Alternatively, ORACLE allows you to control spending by each natural account item line level as on the chart of account’s, known as “Detail Budgetary Control”.
• Tolerance set to zero - determines the allowable over-spending over budgeted amounts.  Could be set as a percentage or an absolute amount.
• Budget Amount Type and Boundary – below table shows the combination of amount type and boundary that system supports

In simple words, Amount Type controls when unutilized budgets expires and boundary controls the timing in which you could spend future budgets.  Initial budget requirement is that budgets are set and controlled quarterly and that there’s no restriction within that quarter on when you could spend that budget and hence initial system setting of Amount Type “QTD” and Boundary “Quarter”.

• ORACLE default setting does not carry forward any unutilized budget and encumbrances to the next fiscal year at year end.