When do generally accepted accounting principles (GAAP) require that fund balance be reserved for encumbrances?

Generally accepted accounting principles (GAAP) stipulate that fund balance should be reserved for encumbrances when a lapse period is utilized. This is important because a lapse period allows for the reversal of encumbered funds at the end of a fiscal year, which can lead to a situation where the government entities must ensure that those funds are accounted for properly in the subsequent fiscal period. By reserving fund balances for encumbrances, the entity acknowledges its obligation to honor the commitments made through contractual or purchase orders, even if those obligations are not settled by the end of the fiscal year.

In the context of GAAP, reserving ensures there is a clear understanding of financial resources and liabilities, aiding in transparency and proper financial management. This practice helps in maintaining accountability and ensuring compliance, particularly when future budgetary considerations are being made.

While encumbrances that lapse and are automatically reappropriated can lead to budget adjustments, the core principle under GAAP emphasizes the necessity of reserving funds during a lapse period specifically.