Project Accounting Concepts and Business Calculations

author — Project Accounting Concepts and Business Calculations

Lisa Schwarz | Product Marketing

Essential Guide for Accountants, Business Managers, and Project Managers

This guide provides students and professionals everything they need to know to understand project accounting. Our accounting experts explain definitions, formulas, examples, practical expert advice, visuals and guidance that will help you master project accounting.

Included on this page:

How project accounting differs from standard accounting
Calculate percentage completion
What to look for in project accounting software
How to learn project accounting

What Is Project Accounting?

Project accounting focuses on the financial transactions related to managing a project including costs, billing and revenue. Professionals such as project managers and accountants use this method to integrate key financial tasks on a project-by-project basis and report their progress and success to management.

Project managers rely on project accounting to inform them of the status of direct costs, overhead costs and any revenues in a specific project. Project accountants generate these figures in financial reports. A project manager uses these reports to determine if they need to adjust the project’s budget and work breakdown structure (WBS).

Project accountants often develop a project accounting plan to ensure the projects they manage are completed on-budget and on-time. This plan delineates every cost element in the project and includes regular—even daily—checks. Managers can track the expenditure of resources, such as people, via their timesheets and adjust allocated hours, if necessary.

A subspecialty of project accounting is production accounting, which is what a film or television project uses. Project accountants turn each production into a unique project accounting opportunity.

Project accounting also includes internal projects such as construction builds, new product launches, advertising campaigns, research or clinical research, long-range purchases and company strategic planning. These are capital projects with discrete beginning and end periods that are not business-as-usual type work.

Project control is another essential accounting procedure. Any deviations from the project plan affect the project’s bottom line. Project control can achieve significant cost savings during the planning and design phase, as well as in the advanced stages of the project. Therefore, it is the project manager’s main role to help achieve the best setup and development of the project plan. It’s the project accountant’s role to ensure the project financials such as billing and revenue are set up correctly to match the contract terms for the project. They need to fulfil this plan before they start to identify and mitigate changes later.

Len Holm (pictured, middle), author of “Cost Accounting and Financial Management for Construction Project Managers” and owner at Holm Construction Services, helps not just the construction industry but also other businesses and individuals set up their projects. He explains the importance of understanding project accounting from a practical perspective:

“Most construction companies do not have specific accountants working for them, but instead they have cost engineers. These are people in-house using the tools and who are better at math than most,” Holm says. “At the end of the year, we hire a project accountant to go through the books and prep the taxes. Therefore, everyone needs to understand these project accounting principles.”

Project Cost Accounting

Although project cost accounting principles have a different intent and scale than standard financial or management accounting in business accounting, they are the same concepts. Project accounting (project cost accounting) tracks costs to the project in addition to billing and revenue recognition for project profitability.

Standard business accounting tallies expenses, revenues and budgets across an organisation. Business-as-usual accounting focuses on revenue and expenses by department and looks at the revenue stream. The project accounting methods are the same whether they are for business-as-usual or specific projects and whether accountants use an accrual, cash-basis or some hybrid accounting method. Accountants have a wide variety of calculations to choose from to meet the methodological requirements.

Project accounting sets itself apart from standard accounting by using different systems, processes and reporting standards. The method should include:

Separate System of Accounting: This process is more detailed than overall company finance tracking, and accountants may want to use more granular accounting. In some cases, the company’s financial application may let them complete all accounting processes in one program.
Reporting Frequency: Projects require frequent reporting to ensure they are on track financially and meeting deliverables. Accountants may want to increase their report frequency, especially when the project and its contract are coming to an end.
Simplified, Specific Reports: Project managers and accountants should determine the key performance indicators (KPIs) specific to the project. For example, when staff is not meeting a KPI such as budget variance, the dashboard could show the figure in red. When the project manager sees the red number, they know quickly they must adjust either the budget projection or their plan to meet it.
Transaction Identification Processes: Accountants and project managers should work together to set up processes that identify project-specific transactions. This way, they can allocate these transactions to the appropriate cost centres.
Forecasting: Project managers should forecast the project budget and update this forecast as the project progresses and through completion. Stakeholders are often concerned about the ongoing financial progress and completed cost, as well as the required deliverables. Initially, these project costing activities develop a forecast with a defined scope that completes the overall cost estimate.

Project accounting also focuses on resource management. Every project requires internal resources, external resources and in some cases, third-party material costs. Project managers should track their resources closely to avoid spiraling costs, which is known as time and materials or T&M. Here’s what you should consider for each element:

Typically, the most expensive cost is the labour worked by resources on a project. There are a variety of costs and billing rates based on services provided, expertise, location, etc. Materials, such as third-party costs or pass-through expenses, have initial and subsidiary costs. Materials may incur additional costs for a late delivery or if installers miss a scheduled appointment.
Time relates to labour. Resources must track their time accurately and regularly, identifying when they are either short allotted hours or over the budgeted amount. They should also notify project managers when they complete their work or will use additional hours to complete it, exceeding the budget.

Project accountants break down the project accounting process flow into six main areas: initiation, budget, administration, allocation, maintenance and analytics and reports.

Initiation: Before starting a project, project managers should decide who is responsible for each task and how those resources will code their time. They can set up roles in their software using different levels of permission, as necessary.
Budget: Project managers should confirm the overall budget is broken down into categories or groups. A software solution should support defining the budget and offer varying budgets, such as versioning that includes an initial baseline budget. These budgets should be based on the business’s required reporting.
Administration: Project accountants process the transactions by recording and processing costs and revenues as well as tracking financial commitments, running billing and invoicing, recognising revenue and generating project profitability reports.
Execution: During this phase, the project managers assign costs, revenues and measurements to activities. Accountants can base allocations on fixed percentages, specified factors, percentage and factor combinations, computations or a list of parameters.
Maintenance: Project staff should have a process to continually review and validate the data and have a way to identify inconsistencies.
Analytics and Reports: Regular access to the accounting data on the project helps project accountants and managers create user-defined reports. They can use this information to perform analyses and make accurate and timely business decisions.

Project accounting techniques and processes also support project billing. Many businesses develop standards to bill either by time and materials (hourly, daily, weekly or monthly), by project, by emphasising the deliverable or by Fixed Fee (as determined by a deliverable or milestone, percent complete or fixed amount). Many companies also charge a set scoping or discovery fee for project inception.

Project Accounting Revenue Recognition Methods

Accountants choose project accounting revenue recognition methods based on a particular industry, circumstances of the project and the method’s effect on taxes. Generally accepted accounting principles (GAAP) require accountants to perform revenue recognition (acknowledging income) consistently and according to an approved methodology. These revenue recognition methods differ with each industry and with the circumstances of the agreed upon deliverables or performance obligation the firm makes with its customer for the services being delivered.

Here’s a list of the different revenue recognition methods businesses can use and examples of when to use them:

Sales Basis: Accountants record revenue of the time of sale, sometimes referred to as billed (time and materials), which occurs when companies exchange goods or services. The receiver of these may not have made a payment yet. For example, if a customer pre-pays for a service, the company will record the payment when it delivers the service.
Instalment: This method takes into consideration customers who need to pay in instalments. Therefore, companies record revenue when customers make a payment. For example, the company records when a customer makes a down payment, hits a milestone or a specific date. When the customer makes each subsequent payment, the company records it as revenue.
Percentage of Completion (hours or cost-based): The requirements of this method stipulate that accountants can only use it if there is a long-term contract in place enforceable by law. Additionally, the project setup should enable accountants to estimate the percentage of completion to allocate revenues and expenses. Regardless of the level of completion, service providers should be able to show they are generating revenue. Typically, construction and engineering firms use this method.
Completed Contract: Once a project is complete and the company fulfils its deliverables, accountants recognise the revenue and expenses. Companies use this method when they cannot meet the requirements of the percentage of completion method.
Cost Recoverability: This method records revenues only when accountants account for all project expenses. Cost recoverability means that accountants understate revenue early in the project and have overstated it for the company in future years.

In May 2014, the Financial Accounting Standards Board (FASB) released Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers. This update removed inconsistent revenue recognition practices between industries and enabled some consistency in those practices, regardless of industry.

This update added a five-step process to revenue recognition requirements:

Why Use Project Accounting

Use project accounting to drill down to details often found at the micro-level in projects. The method ensures that the company meets the overall project financial goals through close monitoring of project costs, material expenses, billing and revenue.

Project Accounting Benefits

Project accounting, the practice as well as the software, has several benefits. Since you are tracking the project so comprehensively, you have information about exactly where it is succeeding and where management needs to make changes. Thus, management has an idea of true project profitability. Other benefits include:

Oversight: You can see incremental, day-by-day expenses and revenues, enabling management to adjust labour, materials, personnel and payments quickly.
Contract Tracking: Since project accounting tracks everything, billing and contract delivery are exact and prompt.
Alignment: Some contracts fall into different departments or fiscal periods. Using project accounting enables the project accountant to create reports that help track progress through varying departments and reconcile through different financial periods.
Predict Growth: Having a detailed handle on projects helps businesses predict their futures. Companies will understand hiring needs, see their pipelines with more clarity and foresee their cash flows.

Sometimes project accounting has other challenges, such as staff in disparate geographical or functional departments. Project accounting procedures can enable everyone in your organisation to view the status of their project tasks based on their assigned role. This structure helps accountants and managers monitor projects that span several years because they don’t have to generate reports on an annual or another accounting period basis.

Finally, project accounting techniques enable companies who have the additional challenge of cross charging. Cross charging occurs when resources are shared to work on a project in a different department, cost centre or subsidiary. Some staff may be charging codes and departments outside of their normal ones on their timesheets, and their managers may not see their coding. The project’s accountant must keep a close eye on these hours billed. This way, the project manager has a handle on the project’s total billed hours.

Project Accounting Best Practices and Tips

Project accounting best practices focus on the project management process, controls and procedures and activities when issues arise. The decisions you make at the beginning of a project, the pricing, the bidding and contract process and the contract provisions influence how you develop the controls and documents.

Project managers should periodically review the following items when they determine and update the controls and documentation when necessary:

The Schedule of Values (SOV): Maintain a detailed schedule where the contract cost delineates the portions of work.
Meeting Minutes and Progress Reports: Reviewing meeting minutes and regular progress reports can signal when the project is veering from the original agreement.
Cost Reports: Regularly reviewing the cost reports ensures there are no unsupported costs.
Requests for Information (RFIs): Companies sometimes use RFIs when there are information gaps in the plans, contracts, documents or specifications.
Change Orders: Particularly in construction, a change order often signals a change in the original statement of work presented to the customer. Manage the potential delays before they happen by ensuring there is a change order plan.
Labour Hours: Review the labour hour documentation regularly (even weekly) to ensure that labour hours track with the project forecast.
Subcontractor Bills: Ensure that all the subcontractor bills are for approved charges.
Project Schedule: A regular recalculation of the project schedule that starts down at the task level, then elevates to the overall project, then elevates to the macro-level can ensure the timeline is running as expected.

Do the following work before a project kicks off to work more effectively.

Define Scope and Expectations: Once the project manager defines the project scope and sets expectations, they can gauge opportunities for improvement and cap the spending amounts by project phase.
Be Flexible: Give portions of the project some financial flexibility, so there’s room for adaptation should new requirements or issues arise.
Track Often: Regularly tracking transactions provides awareness of the project’s financial health.
Choose Simple Software: When starting with project accounting, simple and straightforward software is best. Look for software that has less functionality and simple flows so you can adapt to processes before adding in a complex layer.
Maintain Current Financial Reports: Frequent financial reporting and analysis can ensure success—especially near a project’s completion. Financial reports show risks to the project budget. The details of these reports help create a targeted plan of mitigation, where necessary, with up-to-date financial data.

Projects fail regularly. The Standish Group studied the failure rate of projects from 2005-12, and 29-39% of projects undertaken were successful—meaning on-time and on-budget. The report reveals that many projects fall apart due to lack of management support (33%), unskilled project managers (44%) or the lack of a clear link between the project’s goals and the company’s strategic plan. The biggest project challenge is the inability to capture time and cost accurately initially. Poor project accounting practices only make these challenges even more striking.

Project managers develop an annual report for their projects to show the earnings, investments and any other notable figures from the year. The report should also tell the project’s story and share the big picture for stakeholders. The project manager may include financial statements and figure verification in these reports, as well as project accomplishments, letters from the CEO, case studies and other highlights.

What to Include in a Project Accounting Annual Report

Here’s an example of what a project accounting annual report includes:

Table of Contents and Executive Summary: Develop a clear report outline with the corresponding page numbers. If you have a digital format, let readers jump from the table of contents directly to the specific entry. The executive summary should hit the big-picture numbers and findings of the report. This way, executives have the bottom-line upfront and can explore if they want more details.
Key Performance Indicators (KPIs): KPIs should outline the balance and financial progress of the project over the year. Examples of what to include are the project-specific total earnings, balance sheet, income statement and cash flow statement.
Graphics That Show the Data: The annual report will have lots of numbers. Add flow charts, graphs and charts to help the average reader understand these details, and highlight the key takeaway figures and report findings.
Data Interpretation: The language you use in the report should explain the data and depict what happened over the year. Writers should highlight any cause-and-effect to the financial picture.
Strategy: If this section has sensitive and proprietary information, the project manager may omit it or designate it for internal purposes only. However, if they are not giving away trade secrets, showing the strategies alongside the results helps design the future roadmap. Managers can highlight poor decisions as well as good ones and how they would do things differently or similarly the following year. Managers can also reveal expectations for the project and the refinements they will make.
Projections: Finally, project managers should work with the accountants to develop a forecast from the historical reports. They can combine multiple years, if appropriate, to analyse trends and set projections. This detail can show the direction of the business and the logic behind it.

What Is a Project Accountant?

A project accountant is responsible for helping a project manager monitor progress and transactions, including tracking financial variances, expenses and any revenues. They oversee client invoicing and payments to suppliers. Anything finance-related on a project is in their purview.

Project accountants must understand the management accounting and financial accounting of their company and apply these concepts to the projects that management assigns them. Often, project accountants need knowledge of the business’s entire financial function to manage their projects effectively. They are a business’s gatekeepers of information about how their projects are doing and advise project teams on how their decisions affect the project finances.

They act as a translator between the project staff, the high-level managerial staff and the different finance and accounting functions. Salaries vary widely for the position and are dependent on how deeply the company embeds the accountant in its agency and whether they function in other roles. A project accountant can be in a strategic or tactical position, regardless of their specific project duties.

Primary project finance duties include:

Invoicing
Reconciling expenses
Reporting project financials
Project asset management (financial only)
Tracking all project resource’s hours
Projecting revenue recognition

Holm recommends that project accountants understand as much as possible about the field they are serving.

He says his industry, construction,

“is unique. Accountants need to understand the terminology. I would hire an accountant, as well as an attorney or a banker based on their experience with construction because they need to understand our language and rules.”

How Does Project Accounting Work?

Project accounting uses proper financial management techniques to enable the oversight of projects. The practice allows project managers and their teams to see the cost, schedule, resources and progress of their projects at a detailed level. In project accounting, only one accountant manages a project.

Revenue Recognition in Project Accounting

One method, the percentage of completion method, allows companies to record their profits while a project is ongoing. This method works best when the project manager can reasonably estimate the project in stages. To measure the percentage of completion, accountants can use the cost-to-cost method, the effort-expended method or the units-delivered method.

Cost-to-Cost Method

To determine the amount of revenue recognised, accountants can use the cost-to-cost method. The method is only valid if the accountant performs a regular review and reconciliation of the total estimated project cost. Since most of the direct material expenses occur at the beginning of a contract, this method recognises the largest amount of revenues in the early stages.

For example, a construction company is building a $20,000,000 complex, charging its customer $32,000,000. The company bought the bulk of the materials, worth $4,000,000, in the first quarter. At the end of this first quarter, its total incurred costs are 20% of the total cost of the project, enabling the accountant to recognise 20% of the projected revenues, or $6,400,000.

Cost-to-Cost Calculation
The calculation of the cost-to-cost method of percentage of completion is straightforward. The formula is:

From this, companies can also calculate the cumulative revenue recognised for the month:

For example, project manager Edwin has a contract to build a highway abutment for the city. The estimated cost of the project is $10,000. Edwin’s company has a policy that dictates he adds 18% onto the cost estimate. The final quote agreed upon by both parties is $11,800. The company also estimates it can complete the project within two months. In the first month, the company incurred $2,000 in costs and completed 40% of the project. In the second month, the company incurred another $1,200 in costs and completed the remaining 60% of the project. The total cost incurred was $3,200.

The breakdown of the cost-to-cost method of percentage completion for the two months is:

table-cost-to-cost-method-of-percentage-completion

Using the formula for January’s data (as shown in the image above), the company reports:

Using the formula for February (as shown in the image above), the company reports:

This formula could work for any period—month or year. If the company recognised revenue in other periods from this contract, it must subtract it. For example, if the company completed 40% of the work in January but recognised $2,000 from the scoping process that it did not bill separately, the new revenue recognised total for January would be:

cumulative-revenue-recognised-for-january

Efforts-Expended Method

This method acknowledges the amount of effort expended or hours worked to date as compared to the total projected effort for the project. These hours can be direct man-hours, machine hours or material consumed quantities. This way of determining the percentage of completion would also include any subcontractor or temp-worker hours. Accountants can only use this method if the project manager can estimate the required project hours in advance (at the beginning of the contract period).

The method is also useful for a project in which the labour hours are the main cost for completion. For example, the ABC Cleaning Company bid for a contract to prepare a new building for its inhabitants. It estimates it will take about 400 hours of labour over three months to complete. The total estimated cost of the project is $60,000.

Efforts-Expended Calculation

Using the efforts-expended method, the accountant uses the hours logged in timesheets to calculate:

From this, companies can also calculate the cumulative revenue recognised for the month:

formula-cumulative-revenue-recognised-for-the-month

The breakdown of the effort-expended method for percentage completion for the three months is:

Using the formula for April (as shown in the image above), the company reports:

Using the formula for May (as shown in the image above), the company reports:

Using the formula for June (as shown in the image above), the company reports:

This formula could also work for any period—month or year. Accountants should subtract any revenue reported before the period and labour hours worked from this contract, like in the cost-to-cost method calculation.

Units-of-Delivery Method

Units-of-delivery is the GAAP preferred accounting method for the percentage of completion calculation because it is direct and easily verified. Preferably measured by counting output, this method allows accountants to count input for cost or production. Accountants should set this method up carefully to measure the appropriate figures. For revenue recognition, accountants use the contract price of the units delivered. For expense recognition, accountants use the costs allocated to the units delivered.

This method is useful in construction, production or manufacturing environments because a company can easily count units produced and delivered and calculate it against the contract requirements. Companies can split a long-term contract into multiple smaller units to deliver to the customer and include the prices, units and delivery schedule of each in the agreement.

As an example, the Better Building Construction Company has the following figures built into a contract:

table-better-building-construction-figures

Below is the actual units delivered from the information in the contract above.

better-building-construction-delivered-units

The Better Building Construction Company can recognise $19,870,000 in revenue for the year, based on what it managed to accomplish in that accounting period.

As a side note, the contractor must decide when creating the contract what a reasonable allocation is for each unit they will deliver, meaning they should decide how much over the expense of the materials and installation they will charge. Every material has its own cost and installation (or build) fee. The contractor still must levy an additional fee for getting the material into the building project on time and completed.

For example, each eyewash station from above costs the customer $2,000 per unit. If the actual expense with materials and expert installation is about $1,600, then the Better Building Construction Company has added 25% over this cost standard to ensure its profit. For each line item in the contract, the customer can assume a percentage fee over the actual material and installation cost.

Project Accounting Software for Small Business

Project accounting software for small business is automation for project-specific financial needs. Often included in professional services automation (PSA) solutions or enterprise resource planning (ERP) solutions, project accounting software manages costing, billing and revenue for a project-based business.

Small businesses can occasionally find project accounting-specific options embedded in regular accounting software, making it scalable. Companies also purchase a project accounting system because it’s more customisable, saves time (and money) and can help improve their profit margins. All this results in lower business costs, a good return on their software investment and happier clients.

Invoicing and communication with other departments and geographic locations can be time-consuming and cause workflow issues. Further, projects can have problems with inaccurate revenue recognition reporting. Project-specific accounting solutions can solve these issues with communication, profit margin and utilisation tracking and comprehensive reporting.

More benefits of project accounting software include:

Tracking the revenue and budget across all project stages
Project manager empowerment
Executive access
Availability on mobile devices
Data and project encryption security
Real-time financial visualisation
Reports
Tracking of time and schedules

Small businesses have different needs than large organisations and require simple, cost-effective solutions. They do not need products that have complex tools they will never learn but rather something that works on command and is easy to set up and run.

Small businesses should look for software with an affordable price tag and various pricing plans. Some products have features they can scale up for a growing business. Integration with other software systems should also be an option and compatible with existing tools. The program should reduce manual data entry and some of the more tedious processes such as automated billing. Since small businesses need the flexibility that mobile apps provide, the solution should have robust mobile capabilities.

How to Buy Project Accounting Software

When researching project accounting software, keep in mind your company and your budget. You should also make a list of features you need currently and in the future. Key features that fall under professional services automation (PSA) platforms include what is necessary for project accounting. These features enable companies to see all cost, resources, schedule and finance transactions in one place.

Essential project accounting software features are:

Timesheet Views: Integration with the system your company uses for timesheets is crucial. Labour hours worked equals money spent on the project. These timesheets tell managers how many hours employees coded to their projects and keeps the budget and timeline up-to-date.
Resource Management: The resource information tells the project manager the availability and skills they have for their projects. They use these details to adjust which resources they use on the project based on where they are in the project timeline and its needs.
Budgeting: The budget is based on what the business determined it can achieve and what it plans to achieve.
Forecasting: Project managers should have the ability to quickly and easily update the forecast to ensure there is consistent communication about the budget, milestone dates and completion date.
Earned Value Management (EVM): EVM is a project management best practice metric that comes from the project manager’s policies. EVM basics are planning, execution, performance assessment and project monitoring. At the task level, project managers should assess the completion of the work and calculate EVM regularly.
Billing: The bid-to-bill lifecycle is a metric that all companies want to shorten and improve. Revenue recognition and billing should be hand-in-hand procedures. You should be able to share the details of these two functions. For example, bills should automatically generate with all the customer details intact and accurate instead of requiring the accountant to fill them in manually.
Metrics and Reports: The software system should provide the KPIs that the project manager selects early in the project. The project accountant needs regular access to these KPIs. Dashboards, where the stakeholders can see KPIs quickly and easily, provide visually appealing information.

Some software suites for project accounting also include options like customer relationship management (CRM), a module that captures all customer interactions. Others contain opportunity management features that help companies visualise their sales pipeline and plan for resources, growth and the revenue course.

How to Learn Project Accounting

Both professionals and students can take project accounting training formally or informally. There are many courses offered on the principles and methods, both standard accounting courses and specialty ones. Further, employees can learn on the job, if given the opportunity.

To work as a project accountant, many companies require a bachelor’s degree in the field of accounting, along with licensure as a Certified Public Accountant (CPA) or Chartered Accountant (CA). Many programs that teach project accounting focus on the GAAP and the difference between tracking and billing cycles in a project versus standard accounting.

Other main principles of project accounting include:

How to initiate accounting projects
How to perform the planning and setup with metrics and software
How to execute contracts
How to avoid scope creep
How to close out projects

All of these are critical and unique to working with multiple projects as compared to standard accounting practice.

Automate Project Accounting With NetSuite’s Accounting Module

Effective project accounting can make or break a project and is a vital tool for project managers. Finding the right tool that can streamline accounting processes and provide project visibility to all who need it is essential. NetSuite’s PSA module lets you manage costs across currencies and organisational boundaries. Project managers will appreciate that they can use Oracle NetSuite to store project plans and transactions, process project costs and create corresponding accounting entries.

Learn more about how you can use NetSuite to automate project accounting.