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Explaining the major differences between the basis of accounting used in the budget document and the basis of accounting used in the GAAP financial statements helps stakeholders better understand and interpret the numbers presented in both documents. Likewise, providing a documented reconciliation of the two bases of accounting can help to prevent errors from occurring when the budget is prepared or interpreted. When it comes time to pay necessary encumbered funds, encumbrance accounting the “encumbrance” disappears in that amount and becomes an actual expense. As the company rolls through the budgeted year, the amount actually spent rises and the encumbered funds declines. If the projected spending declines (for example, when an employee quits), then an accountant can adjust the amount of encumbered funds downward. Salaries and benefits make up an important part of encumbered funds, suggests the cloud spend management system Purchase Control.

The term “basis of accounting” is used to describe the timing of recognition, that is, when the effects of transactions or events should be recognized. The basis of accounting used for purposes of financial reporting in accordance with generally accepted accounting principles (GAAP) is not necessarily the same basis used in preparing the budget document. Disparities between GAAP and the budgetary basis of accounting often occur because regulations governing budgeting (e.g., laws or ordinances of the state, county, city, or some other jurisdiction) differ from GAAP.

Basis of Accounting versus Budgetary Basis

Disparities may include basis differences, timing differences, fund structure differences, and entity differences. The description of the differences between the GAAP basis of accounting and the budgetary basis of accounting should be written in a manner that is clearly understandable to those without expertise in either accounting or budgeting. In cases where the use of technical accounting terms cannot be avoided, those terms should be clearly defined and fully explained. An understanding of the GAAP basis of accounting is critical to the proper budgeting of available financial resources.

An important factor in this calculation is encumbered funds, which is where the business ring fences the money and places a restriction on what the cash can be used for. Encumbered funds are most commonly used in government accounting to make sure there’s enough money set aside https://www.bookstime.com/ to meet specific obligations and purposes. GFOA recommends that the budget document clearly define the basis of accounting used for budgetary purposes. If the budgetary basis of accounting and the GAAP basis of accounting are the same, this fact should be clearly stated.