Author: Municipal Finance Law Bureau
This month's Ask DLS features frequently asked questions concerning encumbrances. Please let us know if you have other areas of interest or send a question to cityandtown@dor.state.ma.us. We would like to hear from you.
What is an encumbrance?
Encumbrances are an accounting device to ensure that municipalities do not close out operating appropriation balances against which vendors and employees may have enforceable contractual claims at the end of the fiscal year. Appropriations, whether for operating purposes or special purposes, constitute a delegation of the municipality's power to make contracts. Without an appropriation or other funding source such as a grant, municipal officials generally do not have the power to incur obligations that will bind the city or town. G.L. c. 44, § 31. The determination of what constitutes adequate documentation for an encumbrance may depend upon local practice, bylaws and the allocation of responsibilities among various town officials.
What are the differences between an encumbrance and a special purpose appropriation?
Special purpose appropriations are not confined to a particular fiscal year, and therefore, remain open until the purpose is fulfilled or abandoned. There is no need for encumbrances against such an appropriation because the appropriation has no predetermined expiration date. Operating appropriations in the annual budget are limited to spending for the operation of the city or town department in that fiscal year and must be closed out at the end of the fiscal year. G.L. c. 44, §§ 56 & 56A. If the municipal accounting officer closed out the undisbursed balance of an operating appropriation against which the department had already incurred an obligation, the city or town would still be liable for that obligation. The closed-out appropriation balance would in the ordinary course of things be certified as part of its free cash; if that free cash were spent, the result would be a deficit. To avoid such deficits, operating budget appropriations need to be encumbered to the extent that the department has already entered into binding contractual arrangements in reliance upon the appropriation.
Encumbrances should not be based merely on a department's planned or intended expenditures. No encumbrance is tenable unless another party had acquired enforceable rights to payment under a municipal contract. Thus, the amount of an outstanding purchase order that has been placed with a vendor by June 30 should be encumbered. However, the amount of a prospective purchase that has gone out to bid by June 30 but for which no contract exists cannot be encumbered.
Please see the December 2nd, 2021 issue of City & Town for more information on special purpose appropriations.
How can a municipality encumber funds for periodic charges, such as utility bills?
Periodic charges such as utility bills, whose billing periods overlap the end of the municipal fiscal year, raise awkward problems. Such liabilities arise for a particular billing period not by virtue of any separate purchase order or contract entered into by the department, but merely because of the volume of service used in that period. Theoretically, the departmental appropriation could be encumbered based upon the cost of services provided through June 30th, and the bill paid partly from the encumbrance and partly from the succeeding year's appropriation, in the same way salaries for a pay period that includes parts of two fiscal years are paid. However, such an approach is administratively impractical for charges such as utility bills, which unlike salaries cannot simply be pro-rated between different fiscal years based upon the number of days of the billing period in each year.
It is reasonable in our view to pay such bills for periods that overlap the end of the fiscal year either by encumbering the prior year's appropriation and paying the bill from the encumbrance, with any surplus in the encumbered amount reverting to the general fund, or by charging the bill to the following year's appropriation. But we believe that whichever practice is adopted should be followed consistently, so that no more than a year's worth of bills are paid from any given fiscal year's appropriation. In the case of monthly bills, that would mean no more than twelve bills paid from any given annual budget. A rule allowing a department discretion to pay thirteen months of bills from one fiscal year's operating budget would in effect allow that department to transfer appropriations between fiscal years. The power to transfer appropriations between different spending purposes is reserved to the municipal appropriating authority under G.L. c. 44, § 33B.
Do school funds have to be encumbered?
G.L. c.71, § 34 does not by its terms have any direct bearing on the issues raised by encumbrances. §34 constrains the power of a municipal appropriating body to prescribe the details of school spending through the annual budget process. Cities and towns can generally appropriate departmental budgets other than the schools' budget in as much detail as they wish, and such details will be binding on the departments, but any details within the school department's operating budget are no more than a recommendation to the school committee. The limitation on spending from one fiscal year's appropriation for purposes of another fiscal year derives not from the details of any municipality's budget, but from the principles of municipal finance established by the General Laws and, in particular, from the provisions for annual operating budgets.
One provision of Education Reform is relevant to encumbrances. G.L. c. 70, § 11 provides that to the extent a school district underspends its net school spending obligation, the balance of the appropriation (up to 5% of the required net school spending) is automatically carried forward to the following year. No purchase orders are necessary for such carry-forward amounts. But for unspent school budget balances in municipalities that have met their net school spending obligation, this automatic carry-forward rule is inapplicable. The normal rules governing encumbrances based on purchase orders apply.
Other provisions of Education Reform have an indirect bearing on the issue of encumbrances. The entire elaborate apparatus of financial formulas in G.L. c. 70, which sets out the calculation of schools' spending requirements and municipalities' school funding obligations, rests on the premise that each fiscal year's school budget provides for the spending of that school year, with the one exception referred to above that derives from §11. This presupposition in c.70 highlights the significance of the language of G.L. c. 71, § 34, which says that municipalities "...shall annually provide an amount of money sufficient for the support of the public schools..." These general provisions and statutory exceptions make it clear that each fiscal year's school budget is a distinct spending authorization, within which the school's line-item fiscal autonomy under §34 is operative.
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| Date published: | June 22, 2022 |
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