Project Accounting – Introduction and Value

In the world of accounting, project accounting is a subset of financial accounting. Many folks believe it is a form of cost accounting and it is not. Cost accounting is more formally a function of manufacturing and deals with large quantities of identical products. Project accounting is generally ineffective with homogenous types of jobs but is extremely effective with larger more subjective ventures i.e. highly complicated extended functions. If utilized properly, it is a tool that can generate immense value to the owner of a small business. It is designed to provide a feedback loop of information to management in order to make changes that will generate greater profits.  

This article is written to introduce the reader to project accounting and explain the value management gains from its implementation. Future articles will cover cost drivers and characteristics of production that warrant project accounting. Another article will follow up with creating a project accounting format and how to implement project accounting using common accounting software like QuickBooks or Sage. For now, you need to understand why and how project accounting is an effective management tool. 

I implore upon my readers to understand that this is business. This is the real world and I do not offer any quick solutions to your problems. Nobody can and if somebody says they can; well, they don’t know what they are talking about. And to be honest, you are a fool to believe them. Becoming a great business operation takes time and real commitment. This article and the ones that follow are in-depth and yes, they will take more than 5 minutes to read each one of them. Take your time and do this the right way. 

This article is broken out into two sections. The first introduces project accounting and explains the different forms of accounting as a function of production or sales. The second section explains the value of project accounting and some of the benefits with using this type of accounting.  

What is Project Accounting? 

In the traditional accounting presentation an owner of a company looks at his profit and loss statement to see if he has made money over a given period of time. The most common time period is quarterly and for the smaller businesses it is presented monthly. Typically, the profit and loss is split into three sections: revenue, cost of goods sold and overhead (general expenses). The term ‘Gross Margin’ refers to the amount of money earned when the cost of goods sold is subtracted from revenue. It will look something like this:

                Profit and Loss Statement
                     ABC Company
      For the 30 Day Period Ending Z/XX/2017 

Revenue                                                 $ZZZ,ZZZ
Cost of Goods Sold:
  Materials                                ZZ,ZZZ

  Labor                                     ZZ,ZZZ
  Supplies                                   Z,ZZZ
  Other                                       Z,ZZZ
  Subtotal Cost of Goods Sold                    ZZZ,ZZZ
Gross Margin                                             ZZ,ZZZ
Overhead (Expenses)                                   Z,ZZZ

Net Profit                                                 $ZZ,ZZZ 

Looks pretty straight forward and it’s easy to understand. The problem is that it doesn’t tell me HOW ABC Company made its money. You see, the P&L is all inclusive, so several products or lines of products or jobs were completed and each had materials and labor assigned. Thus, the report only tells us that we did OK in the aggregate but not HOW we made money. What department or product line made us the money? Was there a particular job that was more effective than another? Is there a particular manager that ran a job that is better than the others? 

Since I can’t figure out where we made the money, I need some other form of accounting to help me figure this out. Remember, accounting is a system of recording economic activity and reporting this activity to management in a format that is easy to understand and aids management in making good decisions.  

The world of accounting created other sub types of accounting to help management see HOW the money was made. These other subsets of accounting include:

  • Cost Accountinggeneral used in manufacturing where a line of products is produced and the volume of the production is large per line of product;
  • Retail Accountingutilizes bar codes to aggregate to groups of products sold or it can use specific identification method (serial numbers) to identify the more lucrative sales;
  • Class Accountingbreaks the company up into divisions and each division reports on their respective revenues, costs and margins;
  • Project Accounting customarily required in contractual situations whereby the business must track the costs to be reimbursed or vouch for its work. 

Value Using Project Accounting 

How can project accounting be more beneficial than the traditional accounting presentation? The key is in the details. Project accounting provides value because it breaks out the sources of revenue and the associated costs to assist management in identifying HOW the profit was earned. Let’s take a look at simplified project accounting based Profit and Loss Statement for the same ABC Company.

                                          Profit and Loss Statement
                                                 ABC Company
                              For the 30 Day Period Ending Z/XX/2017

                                      Project ‘A’      Project ‘B’      Project ‘C’      Project ‘D’         Totals
Revenue                        $ZZ,ZZZ          $ZZ,ZZZ           $Z,ZZZ           $ZZ,ZZZ         $ZZZ,ZZZ

Cost of Goods Sold:
  Materials                       ZZ,ZZZ            ZZ,ZZZ             Z,ZZZ                Z,ZZZ             ZZ,ZZZ

  Labor                            ZZ,ZZZ            ZZ,ZZZ             Z,ZZZ                Z,ZZZ             ZZ,ZZZ
  Supplies                          Z,ZZZ               Z,ZZZ                ZZZ                    ZZZ               Z,ZZZ
  Other                                  ZZZ                  ZZZ                   ZZ                    ZZZ               Z,ZZZ
  Subtotal COGS            ZZ,ZZZ            ZZ,ZZZ             Z,ZZZ              ZZ,ZZZ           ZZZ,ZZZ
Gross Margin                 Z,ZZZ          ZZ,ZZZ                ZZZ               (Z,ZZZ)          ZZ,ZZZ
Overhead (Expenses)                                                                                                           Z,ZZZ

Net Profit                                                                                                                         $ZZ,ZZZ 

Note how each project’s respective revenue and cost groups add up to the total. But this format tells management that something went wrong with Project ‘D’. It lost money. If the project accounting system is set up correctly management can review the detail reports to identify specifically what drove the loss with Project ‘D’. But more importantly, you can now see the value of having project accounting in the financial reporting system. With the general financial reporting format, there is no way management can deduce which project if any project caused a problem with margin. Actually management wouldn’t even know they had a problem. 

Another value project accounting brings to the table is that it IS NOT a time period reporting function. It is strictly tied to the project no matter how long the project takes or even if it extends into future accounting periods. Project accounting is tied to a particular goal such as construction of a home or commercial facility, installation of an assembly line, completion of a design/build project, or the delivery of a specialized product (ships, planes, transportation equipment etc.).  

It is often referred to as job costing. This is OK, but in reality jobs are considered sub functions of projects. Imagine a large construction project like a hospital. Jobs are subsets of the project. Example, one job might be pouring the concrete floors and another job might be the emergency backup power systems. Just be careful when you use the term ‘Job Costing’ in place of ‘Project Accounting’. On a smaller scale they can be the same, but with larger complex situations, jobs are a subset of a project. 

Now that you understand the value project accounting can bring, how do you know if you need project accounting? Specifically, what characteristics of business warrant the use of project accounting? My next article explains the characteristics of production that merit project accounting. Act on Knowledge.

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