Project Accounting Software

Archive for September, 2010

Estimating and Tracking Project Costs

 

During the execution of a project, procedures for project control, Percentage of Completion and record keeping become indispensable tools to managers and other participants in the Project Management process. These tools serve the dual purpose of recording the financial transactions that occur as well as giving managers an indication of the progress and problems associated with a project. The problems of project control are aptly summed up in an old definition of a project as “any collection of vaguely related activities that are ninety percent complete, over budget and late.”  The task of project control systems is to give a fair indication of the existence and the extent of such problems.

In this chapter, we consider the problems associated with resource utilization, accounting, monitoring and control during a project. In this discussion, we emphasize the project management uses of accounting information. Interpretation of project accounts is generally not straightforward until a project is completed, and then it is too late to influence project management. Even after completion of a project, the accounting results may be confusing. Hence, managers need to know how to interpret accounting information for the purpose of project management. In the process of considering management problems, however, we shall discuss some of the common accounting systems and conventions, although our purpose is not to provide a comprehensive survey of accounting procedures.

 

The Cost Control Problem

The limited objective of project control deserves emphasis. Project Cost control procedures are primarily intended to identify deviations from the project plan rather than to suggest possible areas for cost savings. This characteristic reflects the advanced stage at which project control becomes important. The time at which major cost savings can be achieved is during planning and design for the project. During the actual project execution, changes are likely to delay the project and lead to inordinate cost increases. As a result, the focus of project control is on fulfilling the original design plans or indicating deviations from these plans, rather than on searching for significant improvements and cost savings.

Finally, the issues associated with integration of information will require some discussion. Project management activities and functional concerns are intimately linked, yet the techniques used in many instances do not facilitate comprehensive or integrated consideration of project activities. For example, schedule information and cost accounts are usually kept separately. As a result, project managers themselves must synthesize a comprehensive view from the different reports on the project plus their own field observations. In particular, managers are often forced to infer the cost impacts of schedule changes, rather than being provided with aids for this process. Communication or integration of various types of information can serve a number of useful purposes, although it does require special attention in the establishment of project control procedures.

 

The management of project costs can be the most complicated, political, (and tedious) element of the project management process. But, costs have to be controlled, for the sake of IT credibility, and the overall fate of current and future projects.   There are three primary steps to project cost estimating:

To identify project cost factors.
To estimate cost values and create a budget.
To track costs and monitor variances.

Step #1 Identifying Cost Factors:

While cost factors will vary based on project characteristics and business circumstances, in general, project costs can be viewed from four basic perspectives:

Resource Costs:  the costs involved in staffing a project, which can include:

Salary
Benefits
Outsourcing Contracts
Temporary Staffing
Overtime

Asset Costs:  the costs of asset acquisition, usually involving tangible assets that are used to create or implement project deliverables, which can include:

Hardware
Software
Peripherals
Infrastructure
Telecommunications Equipment
Installation Tools

Overhead Costs:  the costs involved in maintaining the project environment, enabling project completion, which can include:

Office Supplies
Premises (rent, utilities)
Support Services

Project Specific Costs: costs of project execution, consumed in the completion of the project, which can include:

Travel
Meals
Meeting Costs
Print Production & Photocopying

Step #2 Cost Estimates and Budgets:

Project budgets quantify the expected costs associated with a project, and these budgets must be based on a reasonable, realistic estimate of likely project costs and expenses. The estimation of project costs is part science, and part logic, common sense and experience.

In fact, past projects can be the most valuable indicator of current project expenses. As project costs are estimated, the following factors should be considered:

The specific cost factors involved depending on the needs of the project.
The costs of similar projects in the past.
The opinions and feedback of project participants.  When estimating costs, it is important to get a broad spectrum of information, experience and opinion.

As you estimate costs, different tactics and formulas can be applied:

Since project cost estimates are just that …. estimates …., it is unlikely that related project budget, resulting from these estimates, can be etched in stone.  Projects have a pulse, and the circumstances and conditions under which projects occur can, and do change, impacting costs and expenses. To deal with this uncertainty, project managers often apply a “contingency factor” when preparing a project budget.  This contingency factor normally consists of a 5 – 10% boost of anticipated project expenses in order to uncover inexperience, as well as the “unknown” or the “unexpected”.

Depending on the degree of internal experience with a given type of project, contingency reserves may or may not be necessary.  In addition, there is a philosophy that says that contingency reserves are dangerous, leading to unwarranted project spending.

Contingency Pros:

The extra funds are in hand when needed, without seeking further approval.
Considering that project circumstances can change so frequently, contingencies readily acknowledge this fact, facilitating project completion.

Contingency Cons:

Contingency reserves make it easier to gloss over project costs, making budgets less precise.
Contingency reserves encourage cost overruns, by granting easy access to additional funding without a thorough consideration of alternatives..

Considering the duality of the contingency reserve issue, the prudent course of action may be the creation of a contingency/change control budget, which can be tapped only when specific circumstances are met.  In this fashion, project estimates are left whole, without any “fudge” factor, but contingencies are sufficiently addressed in order to facilitate project execution and completion.

Step #3  Tracking Costs and Cost Variances:

Once the project budget is created and approved, and the project is underway, costs and expenses must be tracked to ensure that budget utilization matches project progress (are you spending what you expected to spend based on how the project is proceeding?).

Budget variances can be tracked on a monthly basis, for a targeted project picture, as well as on the basis of the project as a whole, for a global perspective.

 

Calculating a Monthly Variance:

Monthly Budgeted Expenses – Actual Expenses = Variance
Variance Amount/Monthly Budget x 100 = Variance Percentage

Calculating a Total Project Variance:

Project Budgeted Expenses – Actual Expenses = Variance
Variance Amount/Project Budget x 100 = Variance Percentage

 

Once you identify any budget variances, you can look to the explanations…. is the variance positive or negative and what does it all mean?

 

A positive variance:  indicates that you are under budget, but appearances to the contrary not withstanding, this is not necessarily a good thing. When project expenses are less than expected, this may be a sign that the project is not proceeding according to plan, and may be behind schedule. In addition, a positive variance may be a sign of ineffective estimating.  On the other hand, this under budget condition may be the result of legitimate changes, discounts, or cost saving measures.

A negative variance: indicates that the project is over budget.  Depending upon whether the negative variance is at a monthly or overall project level, this variance may be the result of serious project problems, such as excessive changes, schedule delays or ineffective budgeting.  If the negative variance is on a monthly level, but the overall project is on track, there may not be an immediate cause for concern.

Project Accounting Terms Brief

 

Contract Value: Agreed price agreed between Seller & Customer on the Contract.

 

Revenue: Percentage of work done (cost x EBF), basis for PoC.

 

Gross Margin: Contract Value – Contract Cost

 

Deviation: Difference in the delivered & booked Gross Margin (BGM)

 

EBF (Earned Billed factor): Contract value ÷ Contract Cost.

 

Unbilled: ITD Revenue – ITD Invoicing. (Unbilled is the first thing to be observed in

PoC Report), (ITD is Inception to date)

 

Aged Unbilled: Aged unbilled means any unbilled which stays for more then 365 days (As per the accounting policy one have to provide for it)

 

Working Capital: Cash required to run a project.

Working Capital = unbilled + Account receivables – Account payable + Inventory – Advance

 

Project Cost: Seller’s Cost for a particular project (must be tracked through the

expenditure report in PoC)

 

AFDA (Allow for Doubtful account): When AR( Accounts Receivables) passes certain months( for eg.6 months) from the due date of then, it becomes AFDA.

 

Account Receivables: means current and aged/overdue receivables.

 

Account Payables: Is the amount which is payable to the Suppliers/Subcontractors

 

Backlog: Contract Value – ITD Revenue (ITD is Inception to date)

(YTD is Year to date)

Inventory: The material that we have in stores but is not charged/accounted for

any projects.

 

Receivables Balance: It is that amount which is invoiced to the client but is not

collected.

CTP: Contribution to Profit

CTP = Gross Margin – Selling & General Administrative Cost (SGA)

 

ROI: Return on Income

Operating Income ÷ working capital.

 

Project Manager’s Accounting Performance Matrix

ü  Revenue (Actual v/s Forecast)

 

ü  Invoice (Actual v/s Forecast)

 

ü  Variation (Actual v/s Forecast)

 

ü  Disputed Accounts

 

ü  Aged Unbilled

 

ü  AFDA

 

ü  Gross Margin Deviation

 

ü  Man Hours Utilization 90%

 

ü  Base Reports for the Project Managers

 

ü  PoC (Percentage Of Completion )

 

ü  Man Hour Utilization

 

ü  Gross Margin Deviation

 

ü  Orders Booking

 

ü  Aged Unbilled

 

ü  AFDA

 

ü  Billing Reconciliation

 

ü  Account Receivables

 

Each of the estimating methods used by the Project Manager described above require current information on the state of work accomplishment for particular activities. There are several possible methods to develop such estimates, including:

Units of Work Completed
For easily measured quantities the actual proportion of completed work amounts can be measured. For example, the linear feet of piping installed can be compared to the required amount of piping to estimate the percentage of piping work completed.

 

Incremental Milestones
Particular activities can be sub-divided or “decomposed” into a series of milestones, and the milestones can be used to indicate the percentage of work complete based on historical averages. For example, the work effort involved with installation of standard piping might be divided into four milestones: Spool in place: 20% of work and 20% of cumulative work.
Ends welded: 40% of work and 60% of cumulative work.
Hangars and Trim Complete: 30% of work and 90% of cumulative work.
Hydrotested and Complete: 10% of work and 100% of cumulative work.

Thus, a pipe section for which the ends have been welded would be reported as 60% complete.

 

Opinion
Subjective judgments of the percentage complete can be prepared by inspectors, supervisors or project managers themselves. Clearly, this estimated technique can be biased by optimism, pessimism or inaccurate observations. Knowledgeable estimaters and adequate field observations are required to obtain sufficient accuracy with this method.

 

Cost Ratio
The cost incurred to date can also be used to estimate the work progress. For example, if an activity was budgeted to cost $20,000 and the cost incurred at a particular date was $10,000, then the estimated percentage complete under the cost ratio method would be 10,000/20,000 = 0.5 or fifty percent. This method provides no independent information on the actual percentage complete or any possible errors in the activity budget: the cost forecast will always be the budgeted amount. Consequently, managers must use the estimated costs to complete an activity derived from the cost ratio method with extreme caution.

Systematic application of these different estimating methods to the various project activities enables calculation of the percentage complete and Project Budhet or the productivity estimates used in preparing job status reports.

In some cases, automated data acquisition for work accomplishments might be instituted. For example, transponders might be moved to the new work limits after each day’s activity and the new locations automatically computed and compared with project plans. These measurements of actual progress should be stored in a central database and then processed for updating the project schedule.

 

Example: Estimated Total Cost to Complete an Activity

Suppose that we wish to estimate the total cost to complete piping construction activities on a project. The piping construction involves 1,000 linear feet of piping which has been divided into 50 sections for management convenience. At this time, 400 linear feet of piping has been installed at a cost of $40,000 and 500 man-hours of labor. The original budget estimate was $90,000 with a productivity of one foot per man-hour, a unit cost of $60 per man hour and a total material cost of $ 30,000. Firm commitments of material delivery for the $30,000 estimated cost have been received.

The first task is to estimate the proportion of work completed. Two estimates are readily available. First, 400 linear feet of pipe is in place out of a total of 1000 linear feet, so the proportion of work completed is 400/1000 = 0.4 or 40%. This is the “units of work completed” estimation method. Second, the cost ratio method would estimate the work complete as the cost-to-date divided by the cost estimate or $40,000/$ 90,000 = 0.44 or 44%. Third, the “incremental milestones” method would be applied by examining each pipe section and estimating a percentage complete and then aggregating to determine the total percentage complete. For example, suppose the following quantities of piping fell into four categories of completeness:

complete (100%)
hangars and trim complete (90%)
ends welded (60%)
spool in place (20%)

380 ft
20 ft
5 ft
0 ft

Then using the incremental milestones shown above, the estimate of completed work would be 380 + (20)(0.9) + (5)(0.6) + 0 = 401 ft and the proportion complete would be 401 ft/1,000 ft = 0.401 or 40% after rounding.

Once an estimate of work completed is available, then the estimated cost to complete the activity can be calculated. First, a simple linear extrapolation of cost results in an estimate of $40,000/0.4 = $100,000. for the piping construction using the 40% estimate of work completed. This estimate projects a cost overrun of 100,000 – 90,000 = $10,000.

Second, a linear extrapolation of productivity results in an estimate of (1000 ft.)(500 hrs/400 ft.)($60/hr) + 30,000 = $105,000. for completion of the piping construction. This estimate suggests a variance of 105,000 – 90,000 = $15,000 above the activity estimate. In making this estimate, labor and material costs entered separately, whereas the two were implicitly combined in the simple linear cost forecast above. The source of the variance can also be identified in this calculation: compared to the original estimate, the labor productivity is 1.25 hours per foot or 25% higher than the original estimate.

Example: Estimated Total Cost for Completion

The forecasting procedures described above assumed linear extrapolations of future costs, based either on the complete experience on the activity or the recent experience. For activities with good historical records, it can be the case that a typically non-linear profile of cost expenditures and completion proportions can be estimated. Figure below illustrates one possible non-linear relationships derived from experience in some particular activity. The progress on a new job can be compared to this historical record. For example, point A in Figure below suggests a higher expenditure than is normal for the completion proportion. This point represents 40% of work completed with an expenditure of 60% of the budget. Since the historical record suggests only 50% of the budget should be expended at time of 40% completion, a 60 – 50 = 10% overrun in cost is expected even if work efficiency can be increased to historical averages. If comparable cost overruns continue to accumulate, then the cost-to-complete will be even higher.

 

Concluded Note:

As you can see, project estimating and budget control is more than a process of numbers.  As the project budget is tracked, the results of the tracking process can be used to monitor project success, and to highlight potential problem areas for further analysis and possible corrective action

Gautam Koppala,

POME Author