Final answer:
An encumbrance is recorded when a government commits to a purchase, like the $750 million for road maintenance equipment. Once the actual cost is determined ($745 million), the encumbrance is relieved, and a voucher payable is issued. The process helps ensure spending does not exceed budgeted amounts.
Step-by-step explanation:
Understanding Encumbrances in Government Accounting
The term encumbrance is used in governmental accounting to represent funds that have been committed for a particular purpose but have not yet been spent. When the state contracts to purchase equipment, an encumbrance is recorded for the amount of the purchase order, which is $750 million in this case. Once the actual cost of $745 million is known and the state issues a voucher payable, the encumbrance is relieved for the contracted amount, and an expense is recorded for the actual cost. The difference of $5 million would typically be returned to the fund from which it was encumbered, unless there are other outstanding encumbrances that it could apply to.
An encumbrance is an important tool for budget control in governmental accounting. It helps in ensuring that the amounts committed for spending do not exceed the budgeted amounts. The process begins with recording an encumbrance when a contract is signed or an order is placed. Subsequently, when the goods are received or a service is performed and the actual cost is known, the encumbrance entry is reversed, and an actual liability is recorded.