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If a program director signs a $10,000 contract with a curriculum vendor in March but the invoice won’t arrive until June, encumbrance accounting lets the finance team record that $10,000 as “spoken for” the moment the contract is signed — not just when the bill finally posts.

This is standard practice in government and grant-funded nonprofit accounting, where knowing true remaining budget availability matters more than the strict accrual-basis timing of when an expense is technically incurred. Without encumbrances, a program could look like it has $50,000 left to spend when $30,000 of that is already committed to signed contracts.

When the invoice arrives and is paid, the encumbrance is reversed and replaced by the actual expense — so at any point, a budget report can show committed, spent, and truly available amounts side by side.

A donor who establishes a $500,000 endowment for scholarships isn’t giving the organization $500,000 to spend — they’re giving it $500,000 to invest, forever, so that the interest and investment gains can fund scholarships year after year. The principal itself is classified as net assets with donor restrictions (permanently restricted, under the older terminology), and touching it isn’t optional.

Most states have adopted a version of the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which governs how much of an endowment’s appreciation a nonprofit can prudently spend each year — commonly 4–5%, set by board policy — to keep the fund’s purchasing power intact over time even as inflation erodes it.

Endowments require their own sub-ledger tracking: original gift value, cumulative investment return, and cumulative spending, so the organization can always show a donor or auditor exactly how the fund has performed since inception.