Chapter 3: Commitment Accounting

CHAPTER 3: COMMITMENT ACCOUNTING

Objectives
The objectives are:

• Define an encumbrance.
• Create a purchase order encumbrance.
• Analyze a purchase order encumbrance transaction.
• Process year-end commitments.

Introduction
Commitment accounting is also known as Encumbrance Accounting.
Commitment Accounting allows the recording of a commitment in the general
ledger for future or planned expenses before the creation or collection of the
underlying documents. Examples of these documents could be purchase
requisitions or purchase orders before committed funds are paid out.

This allows the financial records to reflect the allocation of budgetary resources
when they are committed instead of when the actual expenditure is recorded,
providing financial information earlier than “budget to actual” reports.

Examples of commitments might include internal purchases or monthly utility

payments. Commitment accounting records the reservation of funds for future
payment obligations in the general ledger.

In Commitment accounting the accounting entries are made and the appropriation
is charged when a contract is started or when an order is placed for goods or
services. The entries record the amount to be reserved out of the unencumbered
balance that is remaining in an appropriation to honor the commitment.

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Defining Purchase Order Encumbrances

An encumbrance is a reservation of budget funds that are set aside to make sure
that actual expenditures do not exceed the available budget. If the encumbrance
process is enabled, you can create purchase order encumbrances that are recorded
in the general ledger when a purchase order is confirmed. Encumbered amounts
can then be spent when vendor invoices that reference a purchase order are
confirmed. Encumbered amounts on a purchase order are relieved when a vendor
invoice is confirmed to spend all or part of the encumbered amount. Relieved
amounts are subtracted from the amount of the purchase order encumbrance.

Budget Controls
Budget controls can be used to verify budget funds availability and to create
reservations of budget funds against the budget balances.

Commitment accounting only records the commitment of funds in the form of a

sub-ledger journal entry and subsequently in the general ledger.

For more information on budget controls, see the Use and Manage Budgets
training material in the Finance 2 collection.

Pre-Encumbrances
A pre-encumbrance is a request to reserve budget funds for planned expenditures.
The funds have been requested, but have not yet been approved for a purchase
order. If the pre-encumbrance process is enabled, you can create purchase
requisitions with a pre-encumbered amount for the planned expenditure. The pre-
encumbered amounts are then recorded in the general ledger.

When purchase requisitions are approved, you can create purchase orders for the
requested amounts. When you create and confirm a purchase order for the pre-
encumbered amount on a purchase requisition, a purchase order encumbrance is
created for that amount. The pre-encumbered amount is then automatically
relieved. This avoids having a budget reservation be counted two times in the
general ledger, as both a pre-encumbrance and an encumbrance.

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Setting Up Encumbrances
Posting definitions and Posting profiles are used when creating Encumbrances.
This allows the system to create sub ledger journal lines. To enable the
encumbrances or pre-encumbrances the General ledger parameter form is used.

Scenario: Purchase Order Encumbrances

A department manager in your organization creates a purchase requisition for
expected purchases for the department. One of the lines in the purchase
requisition is for 12,000.00 U.S. dollars (USD) in new office furniture. The
request is later approved and a purchase order is created that has a line to cover
the 12,000.00 USD cost. The 12,000.00 USD pre-encumbrance on the purchase
requisition is automatically relieved when the new purchase order is confirmed.
The relieved amount on the purchase requisition line is then replaced by a
12,000.00 (USD) encumbrance on the purchase order.

Creating Posting Definitions

Posting definitions and Posting profiles are used when creating Purchase Order
Encumbrances. This allows the system to create sub-ledger journal lines for
originating transactions that meet selected criteria. Posting definitions contain the
accounts or dimensions to generate when a posting definition is used.

After creating posting definitions, you must assign them to transaction posting
types. Transaction posting definitions identify which posting definitions to use
with a specific posting type.

NOTE: It is recommend to test all your posting definitions before you select any
Use posting definitions check boxes in the Microsoft Dynamics AX system (For
Encumbrances, posting definitions are found in the General Ledger Parameters
form in Accounting Rules section). When you select this check box in any module,
all posting definitions are active immediately. Posting definitions can be used
only for the transaction posting types that are shown in the Transaction posting
definitions form. Transaction posting types that are not shown in this form
always use posting profiles.

Procedure: Set Up Posting Definitions

To set up a posting definition, follow these steps:

1. Click General ledger, then Setup, then Posting, and then Posting
definition.
2. Click the New button to create a new posting definition.
3. Enter a name and description for the posting definition. You can
enter a longer description on the Memo tab.
4. Select the module for which the posting definition applies.

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5. Under Match criteria, click Add, and then enter the account number
that must be in the originating entry.
6. Optional: If you have multiple match account numbers, in the
Priority field, select a number to indicate the order in which the
transactions should be processed. Accounts marked 1 are processed
first.
7. Under Generated entries, click Add, and then enter the account
number where the system will generate a ledger line when a match
exists.
8. In the Generated debit/credit field, select the way to generate the
debit or credit.
9. Optional: To link to an existing posting definition, select the
definition on the Linked definitions tab. Linked posting definitions
must be associated with the same module. This tab is visible only if
the current posting definition is not linked to another posting
definition. If it is already linked to another definition, the Test tab is
visible.
10. Optional: To test the posting definition, click Test. A test allows you
to enter sample transaction data and then view the system-generated
ledger lines that will result when the posting definition is used.
11. Close the form.

FIGURE 3.1 POSTING DEFINITION

Procedure: Enable Purchase Order Encumbrances

To enable encumbrances or pre-encumbrances for purchase orders, follow these
steps:

1. Open General ledger, click Setup, and then select General ledger
parameters.
2. Click Ledger, and then click the Accounting rules fast tab.
3. Select the Use posting definitions check box. Click Yes if you are
asked to confirm the selection.

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4. Select one or both of the following check boxes:

a. Select Enable encumbrance process to create encumbrances
only.
b. Select Enable pre-encumbrance process to create both pre-
encumbrances and encumbrances. If you select this check box,
the Enable encumbrance process check box is automatically
selected.

5. Close the General ledger parameters form.

Purchase Order Encumbrance Transactions

A purchase order is a typical encumbrance transaction. It is a expenditure amount
for which there has been an expenditure of funds.

Verify Purchase Order Transactions

You can view encumbrances by ledger account for a selected purchase order, and
view any amounts that have been relieved. Encumbered amounts on a purchase
order are relieved when a vendor invoice is confirmed to spend all or part of the
encumbered amount. The relieved amount can include any invoice credits or
price adjustments to the encumbered amount. You can also view the remaining
amount of any encumbered amounts for a purchase order, if the whole
encumbered amount was not relieved.

Procedure: Viewing Encumbrance Transactions

To view encumbrances for a purchase order, follow these steps:

1. Select Accounts payable, then Common, then, Purchase orders,

and then All purchase orders.
2. Double-click a purchase order.
3. On the Action Pane, click the Purchase tab, and then click
Accounting, View subledger journal.

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Encumbrance Year-End Process

The purpose of this lesson is to establish policy and procedures to ensure that
year-end encumbrances are processed appropriately.

Encumbrance Year-End Overview

If you record encumbrances for purchase orders in the general ledger or have
budget control enabled for recording reservation of budget funds, you can
generate closing transactions to the general ledger and against budget
reservations at the end of each fiscal year.

NOTE: Use this process if using budget control only, commitment accounting
only, or both budget control and commitment accounting. If budget control is not
enabled, then this process does not impact budget reservations. Instead it only
creates general journal entries in accordance with the accounting rules (posting
definitions) for commitment accounting.

At the start of the new fiscal year, you can create opening transactions to
correctly record the encumbrances and budget reservations. These transactions
help make sure that the reservations for purchase order encumbrances are
correctly recorded on the year-end financial statements and in budget control.

Year-End Options
Closing purchase order encumbrances is a separate process from closing a fiscal
year, and is usually performed before a fiscal year is closed. There are two year-
end processing options to close purchase order encumbrances in the fiscal year
that is ending and re-encumber them in the new fiscal year.

The following table shows options and results for year-end close:

Option Process
Process and Do Closing Steps:
Not carry 1. The remaining encumbrances in the general ledger and
forward budget outstanding budget reservations for encumbrances are
year-end reversed.
2. Year-end closing transactions are generated in the
general ledger.
Opening Steps:
1. Closing transactions are reversed.
2. Encumbrances are re-established in the general ledger.
3. Budget reservations for encumbrances are created for
the purchase orders that are being processed against next
year's budget. NOTE: This step can only occur if Budget
Control is activated.

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Option Process
Process and IMPORTANT: This option is only available if budget
carry forward control is enabled.
budget year-end Closing steps:
1. The remaining encumbrances in the general ledger and
outstanding budget reservations for encumbrances are
reversed.
2. Year-end closing transactions are generated in the
general ledger.
3. Budget adjustments are created to reduce the budget in
the fiscal year that is being closed.
4. Budget adjustments are created in the new fiscal year
to re-establish the budget register entries that were carried
forward from the previous fiscal year and classified as
carry forward budget.

Procedure: Run Year-End Encumbrance

Perform the following steps to run a year-end encumbrance:

1. Open General ledger, select Periodic, select Fiscal year close, and
then click Purchase order year-end process.
2. Click Retrieve purchase orders in the lower pane to select purchase
orders for the year-end process. This opens a query form where you
can select purchase orders by criteria such as date, date range, vendor
account, purchase order type, purchase order balance, or financial
dimensions.
3. Click OK in the Inquiry form.
4. The results of the query are displayed in the lower pane of the
Purchase order year-end process form. Select the Include check
box for each purchase order to include in the year-end processing.
5. Encumbrances for those purchase orders will be reversed in the fiscal
year that is ending and the encumbered amounts will be made
available in the new fiscal year. You can click Include all to select
all of the purchase orders in the list or click Exclude all to clear your
selections.
6. In the Year-end option field, select how to process purchase order
encumbrances.
7. Select an original budget code, if you selected the Process and
carry forward budget year-end option. This code will be used for
budget adjustments that are made in the closing fiscal year. The code
that you select must not have a workflow selected, because the year-
end processing would stop for workflow approvals.

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8. Select a carry forward budget code, if you selected the Process

and carry forward budget year-end option. This code will be used
for budget adjustments that are made in the new fiscal year. The code
that you select must not have a workflow selected, because the year-
end processing would stop for workflow approvals.
9. Verify the default values in the Calendar and Fiscal year fields and
make any changes.
10. Verify the default values for the Closing parameters fields and
make any changes.
a. The default value for the Accounting date field is the last day of
the selected fiscal year.
b. The Type field is typically set to Operating for a period that can
be used to record accounting transactions. You can select
Closing if you are using a closing period to separate the closing
transactions.
c. If you selected a type of Closing, select the closing period that
you want to use.

11. Verify the default values for the Opening parameters fields and
make any changes.
a. The default value for the Accounting date field is the first day
of the opening fiscal year.
b. The default value for the Period field is the first period that has a
type of Operating in the opening fiscal year. This type of period
is used to record accounting transactions. You can select a
different period, but it must have a type of Operating.

12. Click Process when you are ready to run the purchase order year-end
process.
13. If any messages are displayed, make the necessary corrections and
run the process again for the affected purchase orders.

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Encumbrance Reconciliation Report

The Encumbrance Reconciliation Report identifies imbalances between budget
reservations for encumbrances and the corresponding encumbrances tracked in
the general ledger. It is possible to view a detailed version of the report, or view
only the differences. The detailed version shows totals by transaction or
document number for all encumbrances. The differences-only version shows only
instances where the budget reservation for encumbrances does not balance with
the corresponding encumbrance accounts in the general ledger.

To view the Encumbrance Reconciliation report open General ledger, select

Reports, select Reconciliation Vendor, and then click Encumbrance to access
the report.

NOTE: The commitment accounting ledger accounts need to be setup to use the
appropriate account category either pre-encumbrance or encumbrance for the
amounts to be reflected on the report.

Summary
This section described the setup and review of Commitment Accounting and how
it allows for future or planned expenses before the creation or collection of the
underlying documents.

Anyone who decides to use the functionality discussed in this section may help
his or her company in planning ahead to meet budgeted expenses.

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Test Your Knowledge

Test your knowledge with the following questions.

1. Define the term encumbrance

2. Can a purchase order be used as a encumbrance transaction?

( ) Yes
( ) No
( ) It depends on the setup in the general ledger parameters form

3. Is closing purchase order encumbrances part of the closing a fiscal year

process?
( ) Yes
( ) No
( ) It depends on the setup in the general ledger parameters form

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Quick Interaction: Lessons Learned

Take a moment and write down three key points you have learned from this
chapter

1.

2.

3.

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Solutions
Test Your Knowledge
1. Define the term encumbrance

MODEL ANSWER:

Encumbrances allow the recording of a commitment in the general ledger for

future or planned expenses before the creation or collection of the underlying
documents.

2. Can a purchase order be used as a encumbrance transaction?

(•) Yes
( ) No
( ) It depends on the setup in the general ledger parameters form

3. Is closing purchase order encumbrances part of the closing a fiscal year

process?
( ) Yes
(•) No
( ) It depends on the setup in the general ledger parameters form

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