Because of lax tax collections, the City of Bliss has run out of money on several occasions. Upon reviewing this situation, the new finance director noticed that most purchases of goods and services are actually for less than amounts encumbered for these purchases. As a result, he requested that, when removing encumbrances, only the actual amount of the purchase be reversed out, not the entire amount encumbered. Using this method, he reasoned, will provide a “cushion” that can be used to make up any shortfall that might arise by the end of the year.
Do you think this accounting practice is sound?