Example of Commitment Accounting
Following is an example to illustrate the terms we've defined. All of the calculations described in this example are performed by the system.
Example
Sue, the manager in charge of human resources (HR) at the Acme Corporation, has to decide on a human resources budget for the upcoming fiscal year. She defines the budget, capping salary expenses at $200,000 and employer paid benefits and expenses at $40,000.
The Acme Corporation has 10 employees. Each employee earns $15,000 a year, and the employer paid taxes and benefits for each employee totals $3,000, for a total employee-related expense of $18,000 per employee. To ensure that there will be enough money to make payroll and cover the employee-related costs for the fiscal year, Acme's HR department must encumber $18,000 per employee, for a total of $180,000. By encumbering this money, this money is no longer a part of Acme's general operating budget and can't be spent on anything other than staffing-related expenses.
Sue would like to hire a new employee within six months (half way through the fiscal year), also with a $15,000 annual salary and $3,000 employer-paid expenses. To make sure that the new employee's salary is also encumbered, Sue decides to create the position and future date it for the date at which she anticipates filling the position. The total amount to be pre-encumbered for this yet-to-be-hired employee is $9,000 (because the new employee will be hired half way through the fiscal year, only half of the annual salary and expenses need to be pre-encumbered).
Acme's human resources budget is $240,000, and Sue has encumbered $189,000 of that amount.
| Item | Description |
|---|---|
|
Budgeted Employees |
10 for entire fiscal year and 1 for 1/2 of fiscal year. |
|
Total Cost Per Employee |
$15,000 + $3,000 = $18,000 |
|
Total Annual Cost for All Budgeted Employees |
(10 X $18,000) + (0.5 X $18,000) = $189,000 |
|
Total Amount Encumbered for the Fiscal Year |
$189,000 |
At the end of the first month of the fiscal year, Acme pays out a month's worth of earnings and employer paid expenses per current employee, totaling $15,000. When the payroll is run, the encumbrance is liquefied and becomes an expense, or actual. The HR department now has expenses of $15,000 and encumbrances of $174,000.
| Item | Description |
|---|---|
|
Expenses (Salary, Taxes, and Benefits for 1 month) |
(10 X $1,500) = $15,000 |
|
Updated Encumbrances |
$189,000 – $15,000 = $174,000 |
As defined above, an encumbrance is a projection of future expenses based on the present situation. Staffing situations can, and often do change, as most HR managers know. Two months later (three months into the fiscal year), two of Acme's employees resign.
Sue decides that one position must be filled immediately but that the other isn't as crucial. Sue wants to keep the staffing funds for position A encumbered, but not for position B. When Sue updates the HR encumbrances, the encumbrances for the remaining funds for positions A and B are reversed. Because Sue wants to keep the funds for position A encumbered, she needs to pre-encumber the remaining funds related to the position.
Of the $18,000 in salary and related expenses encumbered for each employee for the fiscal year, $4,500 had been liquefied at the time the employees resigned. The remaining salary and expenses for each position is $13,500. Before reversing the encumbrances, Acme's HR expenses were $45,000 and its encumbrances were $144,000. When updating the encumbrances, the balance of the employee related expenses for the two positions will be reversed and the value of one position pre-encumbered. Acme's encumbered amount is now $130,500.
| Item | Description |
|---|---|
|
Expenses (Salary, Taxes, and Benefits for 3 months) |
(10 X $1,500) X 2 = $30,000 |
|
Updated Encumbrances |
$174,000 – $30,000 = $144,000 |
|
Value of Reversed Encumbrances for Positions A and B (annual expenses – 3 months worth of expenses) |
2 X ($18,000 – $4,500) = $27,000 |
|
Pre-encumbered Amount of Position A |
$13,500 |
|
Update Encumbrances |
$144,000 – $27,000 + $13,500 = $130,500 |
After a month (four months into the fiscal year) of searching for a candidate to fill position A, Sue determines that the offered salary is too low. She decides to offer $24,000 and updates her encumbrances to reflect the salary change and the attendant change in tax and benefits expenses.
When Sue updates the encumbrances, only two-thirds of the salary and employer-paid expenses have to be encumbered to have sufficient funds encumbered for the year, for a total amount of $19,200. Money is already encumbered for position A at the old salary, so Sue has the system reverse the old pre-encumbrance and update with the new pre-encumbrance value. The total encumbered amount for HR expenses at Acme is 122, 700.
| Item | Description |
|---|---|
|
Expenses (Salary, Taxes, and Benefits for 1 month) |
(10 X $1,500) = $15,000 |
|
Updated Encumbrances |
$130,500 – $15,000 = $115,500 |
|
Value of Reversed Encumbrances for Position A (annual expenses – four months worth of expenses) |
$18,000 – $6,000 = $12,000 |
|
Pre-encumbered Amount for Position A With New Salary |
[($24,000 + $4,800) / 12] X 8 = $19,200 |
|
Update Encumbrances |
$115,500 – $12,000 + $19,200 = $122,700 |