🎯 Purpose

This article explains whether nonprofit organizations receiving federal grants are required to use encumbrance accounting and, if encumbrances are used as an internal control, whether they must match actual payments exactly.

❓ Question 1: Are nonprofits receiving federal grants required to record encumbrances?

Short Answer

No. Nonprofit organizations are not required to use encumbrance accounting, even if they receive federal grants. Encumbrances are primarily a governmental accounting requirement, not a nonprofit GAAP requirement.

Explanation

• Nonprofits follow Financial Accounting Standards Board (FASB) guidance, primarily ASC 958, Not-for-Profit Entities.

• Government entities follow Governmental Accounting Standards Board (GASB) standards, which emphasize budgetary compliance and often require encumbrance accounting.

• Receiving federal funds does not change a nonprofit’s accounting framework from FASB to GASB.

Federal Grant Requirements

Federal grants are governed by Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (Uniform Guidance), codified at 2 CFR Part 200.

Uniform Guidance requires nonprofits to:

• Track obligations and expenditures

• Ensure costs are allowable, allocable, reasonable, and consistently treated

• Maintain effective internal controls over federal awards

However:

• Uniform Guidance does not require encumbrance accounting

• Federal definitions of “obligation” do not require general ledger encumbrances

• Obligations may be tracked through contracts, leases, subaward agreements, or administrative schedules

💰 Question 2: If encumbrances are used, must they match actual payments exactly?

Short Answer

No. Encumbrances are budgetary estimates, not final accounting measurements, and do not need to match actual payments penny-for-penny.

Explanation

Encumbrances are used to:

• Reserve available budget

• Prevent over-obligation

• Provide visibility into anticipated future spending

Because encumbrances are estimates:

• Minor differences between encumbrances and actual expenditures are normal and acceptable

• Precision to the cent is not required under GAAP or Uniform Guidance

🏢 Example: Rent Allocated Across Multiple Grants

Scenario

• Monthly rent allocation: $1,006.33

• Allocation across 12 grants

• 12-month lease period

Acceptable Practices

• Encumber rent using a reasonable annual estimate

• Encumber the total lease obligation and allocate costs to grants administratively

• Adjust or release encumbrances periodically as actual costs are incurred

Encumbrances do not need to equal each monthly payment or final allocation amount exactly.

🛡️ Internal Control Expectations (Best Practice)

If encumbrances are used as part of internal controls, the organization should ensure:

1. Authorization
   Lease agreements and cost allocation methodologies are formally approved

2. Reasonableness
   Encumbrances reasonably reflect known contractual obligations

3. Monitoring
   Periodic review of encumbrances versus actual expenditures

4. Resolution
   Encumbrances are adjusted or cleared timely when obligations are fulfilled or change materially

🔍 Audit Perspective

Auditors and grant monitors typically:

• Verify that obligations were incurred within the grant period

• Confirm costs are allocated in accordance with the approved cost allocation plan

• Ensure encumbrances (if used) are cleared or adjusted appropriately

They generally do not expect:

• Exact cent-level matching between encumbrances and expenditures

• Government-style budgetary accounting for nonprofits

• Zero variance between encumbrances and actual payments

📌 Summary

• Encumbrances are not required for nonprofits, including those receiving federal grants

• Federal regulations require tracking obligations, not encumbrance accounting

• Encumbrances, if used, are estimates, not exact measurements

• Minor variances between encumbrances and actual payments are normal and acceptable

• The focus should be on reasonableness, monitoring, and timely resolution

📚 References

1. FASB Accounting Standards Codification (ASC) 958 – Not-for-Profit Entities

2. 2 CFR Part 200 – Uniform Guidance

   • §200.302 — Financial Management

   • §200.403 — Factors Affecting Allowability of Costs

   • §200.405 — Allocable Costs

3. 2 CFR §200.71 — Obligation

4. GASB Codification, Section 1100 – Budgetary Accounting
   
   
   Example: Monthly Rent Distribution with Rounding

   Monthly Rent Invoice: $1,006.33
   Allocation Method: Percentage-based allocation across grants
   Rounding Rule: Amounts rounded to two decimal places per grant. When costs are allocated across multiple grants using percentages, individual grant amounts maybe rounded to two decimal places when encumbering funds. As a result, the sum of the rounded allocations may differ slightly from an original invoice total. In this example, rounding results in a $0.01 difference, which is considered immaterial and is adjusted through manual reconciliation or is liquidate upon final payment if invoiced amount is less than the encumbered balance. 

   Grant	Allocation %	Monthly Amount (Unrounded)	Allocated Amount (Rounded – 2 Decimals)
   GrantA1	3%	30.1899	30.19
   GrantA2	4%	40.2532	40.25
   GrantA3	3%	30.1899	30.19
   GrantA4	1%	10.0633	10.06
   GrantA5	1%	10.0633	10.06
   GrantA6	15%	150.9495	150.95
   GrantA7	30%	301.8990	301.90
   GrantA8	13%	130.8229	130.82
   GrantA9	10%	100.6330	100.63
   GrantA10	12%	120.7596	120.76
   GrantA11	3%	30.1899	30.19
   GrantA12	5%	50.3165	50.32
   Total	100%	1,006.33	1,006.32