What Is an Encumbrance?

An encumbrance is a much broader term, referring to any sort of claim against a property. A mortgage is an obvious encumbrance; if a homeowner doesn’t keep up with mortgage payments, the lender has the right to foreclose on the property. Zoning laws and environmental restrictions are also examples of encumbrances. A lease is an agreement to rent something, like a car or an apartment, for a specific period of time and at a specific rate. A lease is a kind of encumbrance because it limits the borrower’s ownership of that car, or other piece of property. For instance, if you lease a car, and you really love it, you must return it by the agreed-upon date, as directed in the lease.

When interest rates are low, a homeowner might take out a line of credit as an emergency source of funds. Even if the account is closed without ever being used, the homeowners must still record a release of the lien. An easement refers to a party’s right to use or improve portions of another https://1investing.in/ party’s property, or to prevent the owner from using or improving the property in certain ways. For example, a utility company may have the right to run a gas line through a person’s property, or pedestrians might have the right to use a footpath passing through that property.

Consequently, it ensures accounting for the anticipated expenditure is done. This article explores the practice of encumbrance accounting, its importance, and how a typical encumbrance accounting process works. Lenders and buyers require a clear title, so it’s best to resolve involuntary encumbrances quickly. In some cases, such as a line of credit, there might be no exchange of money until the homeowner actually taps the line of credit and borrows money.

  1. An entry is made in the journal with a debit to the encumbrance account and transferred to the general ledger.
  2. If the underlying obligation is not satisfied, the creditor may be able to seize the asset that is the subject of the lien.
  3. Encumbrances allow organizations to recognize future commitments of resources prior to an actual expenditure.

To illustrate how the complete encumbrance accounting process works, let’s take a typical example of an encumbrance transaction — a purchase order. A lien is a legal right granted by the owner of a property, by a law, or otherwise acquired by a creditor. A lien serves to guarantee an underlying obligation, such as the repayment of a loan.

Encroachment is an encumbrance because it provides an obstacle to a property owner’s enjoyment of his own property. A negative easement, on the other hand, prevents a property owner from using or improving upon his property in a way that might negatively affect others. For instance, a negative easement would prevent a property owner from modifying his property in such a way that it restricts the amount of sunlight on his neighbor’s property. This is a kind of negative easement that prevents a company from developing on certain areas of land that are protected for the purpose of conserving the environment.

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Encumbrance accounting, therefore, ensures that a business does not overspend its budget. The encumbrance concept is also used in real estate, where it is a claim against a property. It is difficult to transfer an encumbered property, so the property owner has a strong incentive to settle the underlying claim. An encumbrance can also restrict the uses to which property can be put, such as zoning laws that limit the types of construction on a plot of land.

Translations of encumbrance

A restrictive covenant is an agreement that is made wherein a seller writes a clause into a buyer’s contract that restricts how the buyer can use the property he is purchasing. For instance, if a buyer is purchasing an office building, there might be a clause in the contract that specifies he cannot alter the building in any way. So long as it’s not illegal, anyone can make a restrictive covenant for anything they choose with regard to how a property that is being sold is ultimately used. A restrictive covenant is a type of encumbrance because it affects the use of the property by the current owner, and must be transferred to a new owner. A lien represents a monetary claim levied against property to secure payment—the settlement of an obligation from the property owner.

Financial statements indicate how budgetary resources are allocated to payment commitments before the actual expenditure incurs with encumbrance accounting. An encumbrance is a claim against a property by a party that is not the owner. An encumbrance can impact the transferability of the property and restrict its free use until the encumbrance is lifted.

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For example, unsightly power lines can lower the visual appeal of a piece of land. Easements are often purchased by public utility companies for the right to erect telephone poles or run pipes either above or beneath private property. A mechanic’s lien is generally filed by a contractor or encumbrance meaning subcontractor for work or materials that remain unpaid. All involuntary liens must be paid off for a title company to issue a title policy without naming the encumbrances as exceptions to the title insurance. Others, like zoning laws, have minimal impact when you buy or sell property.

When an organization creates a new purchase order or adds a new line item to an existing purchase order, the new items are encumbered to the journal. An entry is made in the journal with a debit to the encumbrance account and transferred to the general ledger. Encumbrance accounting involves recording encumbrances in the general ledger when the organization is certain about the time and amount of the anticipated expense. This is done before creating and collecting the underlying documents, such as purchase requisitions and purchase orders. Typically, there are two ways of using encumbrances to monitor overspending.


This information should not be considered complete, up to date, and is not intended to be used in place of a visit, consultation, or advice of a legal, medical, or any other professional.

A restrictive covenant is an agreement that a seller writes into a buyer’s deed of property to restrict how the buyer may use that property. There might be a provision that requires the buyer to leave a building’s original facade intact, for example. As long as they do not break the law, restrictive covenants can be as specific and arbitrary as the parties are willing to agree to. An example of encumbrance that proceeded to litigation can be found in the case of Green v. Ayres from 1975.

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Restricted cash is a type of business encumbrance requiring unique accounting. The FASB gives guidance for reporting restricted cash on the balance sheet and in cash flow statements. Organizations use budgetary controls to minimize maverick spending and avoid overspending.

A mortgage is a loan that is provided to a borrower by a bank, so that the borrower can purchase a piece of property. The bank is then the owner of the property until the borrower has paid off the mortgage. If the borrower decides to sell the property before the mortgage is fully satisfied, then he must pay back what he owes before claiming any of the profits for himself. A lien is a contract that a property owner, or borrower, makes with a creditor that allows the creditor to seize the property if the borrower stops making payments as agreed on the lien. If the creditor does seize the property, the company can then sell the property to make back the money it is owed. In some cases, businesses may enter into a large contract or have debt or loan repayment that results in restricted cash balances held aside for specific purpose expenditures.

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