Project Accounting Methods

The ultimate guide to simple project accounting

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Project cost accounting creates, collects, and reports project data that reflects financial transactions and their implications on a client engagement level.

Since accounting is a technical discipline with highly standardized systems, the methods used in project accounting are often similar to those implemented in financial accounting -- except in the demand for greater detail, more frequent reporting, and tighter resource allocation practices.

Managing resources is at the core of project accounting.

To be able to achieve the highest level of profitability, project resources need to be apportioned, monitored, and controlled as efficiently and effectively as possible.

Project accounting and resource management

A project budget is created to set the parameters for the costs incurred by project resources, and to track how they are managed and allocated throughout the project lifecycle. Project management accounting recognizes that there is a financial component attached to every resource -- basically categorized as either time, labor, or materials. The inability to monitor, capture, or control how these resources are utilized is a surefire recipe for project failure.

Monitoring large and complex projects carries its own set of unique challenges. One of the ways to improve efficiency in such cases is by creating a work breakdown structure (WBS), which establishes the deliverables at the onset, then divides the project scope, costs, and schedules into smaller, simpler, more manageable tasks.

Project components are broken down into progressively smaller pieces until they are reduced into very basic and fundamental tasks to which cost, risk, and other values can be assigned. Once the costs are determined, they can be easily tracked at every stage. This makes it easier for project leaders to analyze the profitability of the project in real time and to make adjustments in resource allocation when necessary.

One of the most important benefits to using work breakdown structure in project cost accounting is that every resource involved in completing the project can be defined, documented, and analyzed, allowing project accountants to generate accurate invoices for billing purposes, as well as to leverage government incentives and other tax benefits in support of the project.

Revenue recognition methods in project accounting

Revenue recognition is an essential accounting function for any organization because it tells you whether or not revenue has actually been earned by your business.

There are several ways to do revenue recognition in project based accounting. In order to meet the standards of generally approved accounting practices (GAAP), businesses should account for their revenue by choosing from a specific selection of project accounting methods.

It is necessary for project managers and project accountants to fully understand the method they are choosing, as each one has a different way of reporting income and expenses, as well as handling matters concerning taxes.

For consistency, once a company has chosen a particular method and begins to use it in their financial reports, it should continue to do so.

There are five basic methods used for revenue recognition.

1. Percentage Of Completion Method

Typically applied to large or long-term projects (like in construction and engineering services), the percentage of completion method involves the ongoing recognition of revenue and profits to demonstrate that the service providers are already generating revenue even though the projects are not yet complete.

It is important to note that the percentage of completion method can only be used if there is a long-term contract enforceable by law, and if the project financials are set up in such a way that accountants can estimate the percentage of completion in order to allocate both revenues and expenses.

Using this method helps to identify certain amounts of gains or losses related to a project in its regular financial reports as long as the project continues to be active.

Percentage of completion can be computed based on specific milestones (like how many pages have been completed on a website design project) or calculated based on cost incurred. For best results, you need a fair amount of certainty that you can estimate the stages of project completion on a real time basis, or be able to predict the remaining time and cost to complete a project.

2. Point Of Sale Or Sales Basis Method

Under the point of sale or sales basis method, revenue is recorded at the time of sale, which is the point where goods or services are exchanged. It should be noted, however, that payments are not necessarily made during the point of sale.

Widely used for most types of retail sales, accountants using the point of sale method would record revenue at the time of sale or delivery. For instance, if a customer pays in advance, the payment will not be recognized until the product or service has been successfully delivered.

3. Installment Method

In the installment method, the seller or service organization collects payment from the client for goods or services delivered throughout a number of years. This is typically used for large purchases, such as real estate or automobiles, when collecting the entire purchase amount in cash is improbable.

Using the installment method, a company will recognize and record the revenue only after the payment is received – such as when a customer makes a down payment or remits the agreed partial payment on a specified date.

4. Completed Contract Method

As the name suggests, in the completed contract method, all of the revenues and expenses associated with a project are only recognized only after all deliverables are fulfilled and the project is complete.

This method is typically applied when the requirements for the percentage completion method cannot be met, like if there is no contract that can be enforced or if the percentage of completion cannot be estimated.

5. Cost Recoverability Method

Cost recoverability is the most conservative of all revenue recognition methods. It is used when the organization cannot make a precise estimate of the entire project budget. Revenues are recognized only when payments made have recovered the seller or service provider’s costs.

This method is normally used when transactions are approved but repayment is not guaranteed. In these situations, net profit is not reported until the cash collected exceeds the cost of the item or service delivered. Cost recovery enables companies to better recognize profit and defer taxes in uncertain situations.

Simplify the process with project accounting software

As resource and project management become more complex, keeping track of project financials can also become strenuous, complicated, and susceptible to accounting inaccuracies. Instead of relying on archaic and often disparate tools, many professional services are turning to project management solutions such as Mavenlink to track their time and expenses with more accuracy and consistency.

Like many service organizations, Big Bang relied on several different legacy systems for project management needs during its first years as a boutique consultancy firm. However, as the company grew, the need for a more effective and far-reaching professional services automation (PSA) solution became more apparent.

The real challenge for Big Bang was to improve time allocation of varied skill sets with the ability to allocate resources in detail or for tasks in progress, combined with having the visibility in the forecast to better prepare for future task demands on its workforce.

"We didn’t have visibility into availability," shares Nicolas Urena, Director of Business Innovation and Solutions at Big Bang. "As a result, we were managing projects with a flat rate for each resource on a single project and how we billed for professional services. It was difficult to determine gross margin and forecast availability and revenue for each project."

The need to upgrade from legacy systems to a modern integrated system that could support their needs as a services business led them to Mavenlink.

"Mavenlink gave us a vision that matches our overall system architecture and satisfies both our financial and our professional services departments," relates Nicolas. "This new system of record helps us improve our project lifecycle by focusing on the important areas of resource management, project management, collaboration, project accounting, and Business Intelligence."

By linking the team’s time, expenses, and invoices to their tasks and projects, Mavenlink offers quick and real time visibility into project financials, helping leaders make more informed decisions in raising the profitability of each project.

Mavenlink also supports project accounting through a variety of features, including rate cards, project financials, currencies, roles, audit logging, and more. Aside from providing greater control over timesheet processes and workflows to improve time collection, utilization, and billing, Mavenlink also helps streamline the invoicing process, speeding up payment on completed work.

As experienced by Big Bang, forecasting and planning become a breeze with Mavenlink Insights Business Intelligence, Margin Reports, and Work In Progress (WIP) Reports, which fuel data-driven decisions for more reliable financial performance.

And for those who are not yet ready to let go of their favorite tools and applications, Mavenlink M-Bridge makes it easy to connect information and processes in financial systems like Netsuite, Microsoft Dynamics, Quickbooks, Oracle, SAP, Intacct, and Concur.

Mavenlink M-Bridge -- the industry’s only OpenAPI-based, services-centric integration platform – helps streamline your project accounting procedures by enabling you to connect and extend your tech stack to the extent of your imagination.

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