Project Accounting: Enhancing Enterprise Cost Management
The Economics
The current economic environment has mandated that companies enhance and renew their focus on the ability to effectively manage cost and cash flow. Gone are the days when lack of profitability and positive cash flow were ignored in hopes of rapid capital appreciation. Companies today are being evaluated more closely and frequently than ever before as the competition for capital has intensified.
In addition, even companies that enforce solid cost management philosophies are being required to push for more efficient operations to maintain margin profitability and sufficient cash flow to support operations.
As the leading ERPs have continued to enhance their core financial applications with Web-based capabilities and business analytics, one module has continued to be overlooked as a source of valuable insight and cost management capabilities project accounting. The core functionality has been available for the past 10 years, but few companies have recognized the true value and exploited the capability that they most likely have already licensed.
Many factors may contribute to an ERP implementation either omitting or partially utilizing the project accounting module, but the reasons are typically, and ironically, associated with those very issues the module attempts to manage project timeline and budget. Time-consuming and expensive ERP implementations have historically focused on core, operationally-critical transaction processing components and have only recently begun to focus on business insight and analytical capabilities.
Additionally, companies perceive their current rudimentary project management and tracking capabilities to be sufficient without fully exploring the value that a project accounting solution would provide. In some instances, the benefits of the capability to better manage hundreds of multimillion dollar projects alone may substantially justify the business case for the entire ERP implementation.
Capability Overview
Most general ledger applications support some very basic expense tracking capabilities either through an additional segment in the accounting code block or an additional user defined data element (in Oracle its the Descriptive Flexfield, in PeopleSoft its the Project Chartfields, and in SAP its the Account Assignment Element). However, each of the leading vendors supports a broad range of capabilities within their project accounting module.
The more traditional usage for project accounting is for capital projects. This capability is heavily utilized in industries, such as telecommunications, that have extensive property, plant, and equipment construction activities. Organizations use the project accounting capability to group or separate costs into the appropriate assets for capitalization in the fixed assets module.
A second capability is inventoried assets. This capability is prevalent in industries, such as manufacturing and oil and gas, that construct assets for inventory and resale. In these industries, robust construction accounting and revenue recognition capabilities are required to control and capitalize the appropriate cost over extended periods of time.
Finally, and the most overlooked capability, is expense projects. These include the noncapitalized component of fixed asset construction and, more importantly, special projects and initiatives that are embedded in and/or across the cost center structure of a company.
A prime example of this type of project that most companies face at one time or another is the implementation of an ERP package. This type of project typically involves capitalizable costs and expenses that are derived from multiple cost centers and purchases. Project accounting provides a comprehensive financial view and facilitates capitalization of the appropriate costs.
Enhanced Asset Management
For industries that create large volumes of self-constructed capital assets, the most common and valuable application of project accounting functionality is to enhance asset lifecycle management. Automating the asset lifecycle process with project accounting is not an easy task, but it is an achievable goal with proper organizational commitment to transaction processing fundamentals, such as collecting valid and complete source data, timely invoice processing, project milestone maintenance, and consistently applied asset capitalization policies.
Capture Quality Source Data
Similar to financial reporting processes, the success or failure of asset lifecycle automation is heavily dependent on the quality and proper classification of source transactions. This means that, in addition to basic accounting codes, all direct charges involved in constructing the asset must be recorded with the correct project and asset category information. Naturally, more detailed categorizations require additional effort from front-line employees, but strict compliance should result in efficiencies for downstream users and is critical to achieving automation benefits.
Expedite Invoice Processing
To comply with standard accounting practices an organization must capitalize fully constructed assets. As such, delays in collecting invoices related to asset construction are an oft-cited reason for an organizations inability to fully automate asset creation. In these cases, assets are placed in service using accrued costs that later become targets for auditors and a reconciliation issue for the organization. This problem, however, can usually be resolved through basic procurement process improvements that open the door for automation. One solution that minimizes the impact of invoice lag time is to take advantage of ERP functionality that allows purchase costs to be accrued upon receipt and automatically reconciled after the invoice is entered.
Maintain Project Milestones
The act of cost collection does not itself trigger the asset in-service process; rather, it is initiated by reaching critical project milestones. Depending on the duration and complexity of a project, this may occur once at the projects end or may take place on multiple occasions throughout the project. In either scenario, the process relies on project managers to maintain accurate milestone records.
Fortunately, this is made simple using tools available within the project accounting module. As projects are created, users establish milestones, statuses, and activities through the configurable work breakdown structure (WBS). A manipulation of these values, via online user interface or integration with popular third-party management tools like Microsoft Project, allows the project manager to effectively control the timing of asset capitalization.
Apply Consistent Capitalization Policies
Once capitalization is triggered, project accounting information will be transmitted to the fixed assets module so depreciation can begin based on the specified in-service date. Labor, freight, taxes, and other charges not directly attributable to a specific asset may also be captured in the assets cost basis using standard rates or algorithms. To further benefit from integration, the asset category/profile that defines each assets depreciation and accounting characteristics can be defaulted from reference data held in the ERP system item master (materials) or employee data (labor). Defaulting the asset accounting and depreciation characteristics requires standardization for similarly categorized items and some initial time investment. However, the result is improved accuracy and a more efficient process.
Two industries, telecommunications and utilities, frequently take advantage of project accountings enhanced asset management capabilities to process the thousands, or even millions, of new assets created annually. Telecommunications companies that constantly build and upgrade networks often use it to automate the process of placing construction in process (CIP) assets in-service. These companies often group similarly classified assets into a single depreciable unit, thereby minimizing the need to manage every individual piece of equipment while still maintaining sufficient supporting detail.
The utilities industry may use project accounting for unitization an asset management process virtually the opposite of that followed by telecommunications. The unitization process allows large expenditures to be split into many assets, thus arming the organization with information to request rate changes from regulatory bodies using the asset base.
These examples show that, despite different industry processing requirements, both types of organizations use project accounting to accurately capitalize large volumes of self-constructed assets. Taking full advantage of this capability, significant benefits can be realized through lower transaction processing costs and the ability to withstand intense scrutiny. Simply put, without this capability, either significant headcount is required to process the information or asset record accuracy suffers.
Inventoried Projects
Since the very first barter transaction took place, one fundamental principle has remained the foundation of successful business a company must collect more value from its products and services than it spends to produce them. The concept of positive cash flow generation, while seemingly simple, often proves difficult for organizations lacking the capabilities necessary to continually understand their costs. Traditionally, an organizations health has been analyzed in aggregate, through monthly/ quarterly reporting packages, but this is insufficient in todays complex business environment where the availability of initiative level profitability information can be a competitive weapon. Project accounting inventory construction capabilities, sales/ receivables integration, and reporting functionality provide the tools necessary for organizations operating in any industry to obtain this level of insight.
Construct Inventory
The first step in determining project profitability is to collect all direct expenditures for the initiative using project accounting integration capabilities. Depending on the type of project being delivered, direct costs associated with the effort may include labor, materials issued from inventory, expenses, and/or procured materials. Transactions associated with these items will reside in multiple source systems, none of which contain a holistic view of a projects cost. The project accounting module assimilates all this information by integrating the ERP data with required external data.
Direct expenditures, however, provide only a partial representation of a projects total cost. An accurate cost and margin calculation also requires the project to be fully loaded with the appropriate overhead and indirect expenditures. Organizations lacking the means to effectively charge overhead/indirect costs may attempt to do so manually, but are more likely to apply standard rates or forgo fully loaded cost calculations altogether. Project accounting offers multiple tools to automate this task, including:
- Allocation of general ledger balances across projects
- Allocation from one project to another
- Burdening projects to cover overhead
In the aerospace industry, for example, aircraft construction will contain direct cost components, such as centrally stocked inventory items, labor, and procured materials, that interface from various source systems. Assuming a facility is supporting multiple construction projects at any one time, the cost of that facility and its management may be shared by each project. Additionally, costs for marketing and centralized inventory may be applied to each unit under construction to produce the fully loaded cost.
Integrate With Sales and Receivables
Total cost data, combined with milestone and contractual information, may then be used to seamlessly integrate information into the sales module. Accommodating for unique contractual agreements, ERP packages will support multiple billing methods including fixed fee, labor rate, mark-up over cost, and milestone-based arrangements. To complete the process, integration with accounts receivable enables the application of collected revenue against the appropriate sale.
In service industries, the primary focus is on integrating time and expense information with specific projects. To recover these costs plus marketing and overhead expenses, the organization may use the project accounting module to achieve the appropriate profit margin through a markup of total labor cost. After producing customer invoices and collecting revenue, both the project and customer may be evaluated against performance targets.
This full-circle integration facilitates project/customer profitability reporting, the key to understanding which initiatives and customers an organization should direct focus toward. Those companies with strong project accounting capabilities should realize true bottom-line benefits through improved decision-making and the ability to proactively take corrective actions where necessary.
Cost Management Capabilities
No company or business unit, regardless of its current financial health, can afford to overspend on internal initiatives. So, even if project accounting is never used to produce an invoice or create an asset, it can play a critical role in every organizations financial systems architecture as an internal cost management tool. In this capacity, project accounting usage may be as broad and varied as the organizations it supports. The application offers the flexibility to manage and collect costs for projects of any size anything from large, multiyear programs to minor, single cost center activities.
Control Costs With Budgets
Controlling expenditures with the aide of an integrated budget management component is the foundation of project accounting cost management capabilities. When managing smaller projects, the budget may be designed to cover the entire project lifecycle, whereas larger programs may require a budget for each specific phase or activity.
As transactions are entered in source systems, such as accounts payable, purchasing, inventory, and payroll, each is appended with a project identifier(s) directing it to the appropriate project. By linking these transactions with a project budget, the ERP system can provide both proactive remaining budget indicators and immediate feedback showing that a particular entry will cause an overrun.
Major marketing campaigns, for example, may span multiple years and delivery mediums but must stay within a predefined budget. The external cost of the campaign will contain accounts payable transactions for the advertising agency, newspapers, radio stations, and television networks. Internally, all personnel working on the campaign will charge their time to the project. Assuming the campaign is organized by media, timeframe, and type of expenditure, costs may be actively managed at every step along the way.
Controlling expenditures with the aide of an integrated budget management component is the foundation of project accounting cost management capabilities. |
Analyze Results
Both elements of cost management, the budget and actual transactions, combine in the project accounting module to provide powerful reporting. At the most basic level, budget versus actual reports can be created for each project or phase of a project having a budget. This information can be delivered via ad-hoc query tools, packaged reporting solutions supported by the ERP, and advanced multidimensional reporting applications. Additionally, joining these reporting tools with a standardized WBS allows the organization to report the costs of particular activities across multiple projects.
Information technology projects represent a prime illustration of how this capability can apply to nearly every organization. If a standard methodology is adopted, each project would contain similar project phases and activities. This permits budgets to be established following standard percentages relative to a phase or the overall project (e.g., the design phase is 30 percent of the total budget). Phase budgets can then be enforced and comparisons may be drawn across projects. Valuable insights may be gained from understanding how and why a particular task or activity was completed under or over budget.
Conclusion
Every company, regardless of its size or business, can benefit from the integration, analysis, and control mechanisms offered by project accounting. Of course, each organization will have its own specific set of requirements ranging from basic, single project expenditure tracking to profitability reporting for large revenue generating programs. The project accounting module provides both the tools and flexibility to meet the varying demands of each unique situation.
In all cases, the types of projects executed by an organization, along with its cost management disciplines, will dictate the functionality implemented. Despite the capabilities that may be in place today, many organizations have learned over the past few years that maintaining status quo is insufficient for long-term success. Project accounting is an essential tool for monitoring and improving the most intimate operational details.
The simple fact is that cost stewardship has taken on a new role in the management and profitability of a company, which ultimately drives the value it earns in the market. Efficiently managing a broad base of expenditures using project accounting helps remove uncertainty and surprises from the market valuation equation. For organizations seeking an advantage in the marketplace, leveraging the enhanced capabilities of project accounting can be a powerfully competitive weapon through the insight and management capabilities it provides.
