The Beginner’s Guide to Project Accounting (Including Calculations)

Updated Aug 3, 2022.
project-accounting

Businesses rely on projects to generate revenue and achieve specific outcomes. Some projects require your business to spend more resources than their actual worth. 

Weighing the costs of an individual project to its actual benefits helps you determine if the project is worth your business' limited resources. This process is called project accounting. 

You can use project accounting to evaluate projects to find out if the projects are worth spending resources on or not. With project accounting, you can find out which projects add value to your business and the best ways to improve your profit margin per project. 

Project accounting shares the same fundamentals as other accounting methods such as cost accounting. However, there are certain aspects of project accounting that differ from traditional accounting methods. 

In this article, you will learn everything you need to know about project-based accounting, including the best project accounting tips and best practices, and the differences between project accounting and financial accounting,  

What is Project Accounting?

Project accounting is a form of managerial accounting which involves keeping track of all costs and other financial implications of running a project. This is an accounting process that involves the tracking, reporting, and analysis of every financial component of a project, with the aim of keeping project delivery in line with financial budgets and also in anticipation for future projects’ costs.

Financial elements like project budgets, cost estimates, expenses, and project invoicing are essential areas that attract the attention of project accounting. Reports are generated on these areas and used by stakeholders to maintain proper visibility into the financial progress of the project.

Overall, project accounting is a managerial accounting technique used to achieve and maintain the most proper and appropriate cost management on projects. 

Project accountants play the role of consistently tracking projects, measuring variance compared to budgets, reporting on project finances, and giving advice on the implications of certain activities on the project finances. 

Project Accounting vs Financial Accounting

Project accounting and financial accounting are two different types of accounting methods that follow the same accounting fundamentals. 

1. Scope of Operation

While project accounting is tied to a single project, financial accounting takes a wider scope of the company’s operations into consideration. This means that in addition to the multiple financial components that relate to a single project, financial accounting also covers other areas of your business.

2. Timeframe

Another notable difference between these two accounting methods is in the time frame over which they operate. Project accounting considers a single project, meaning all relevant accounting processes start and end with the project management life cycle

Financial accounting, on the other hand, is done over an entire accounting period, which typically spans one fiscal or non-fiscal year. 

3. Limitation

While project accountants and their activities are specific and limited by a project, financial accountants have no limits and play a more general role in the financial management of a company.

4. Objective

The objective of financial accounting is to track and improve financial performance and position in an organization, while the objective of project accounting is to ascertain cost and cost control as it relates to specific projects.

5. Costs and Profits

Project accounting shows cost and profit details for every product, contract, task, and process relating to the project while financial accounting reveals overall costs and profit/loss.

6. Types of Report

Financial accounting generates general reports such as the balance sheet and income statement while project accounting generates project management reports such as project status reports, project health reports, team availability reports, project risk reports, variance reports, and time tracking reports.

Importance of Project-based Accounting

Just as every project within an organization remains unique, project accounting plays a unique role in the overall financial and business management of companies. 

Through regular project accounting processes, data on every financial component relating to a project is documented. This includes data on overall revenue, costs, and eventual profits from the project.

1. Shows the Cost-Benefit of a Project

With project accounting, you know how beneficial the project is to your business. Thanks to reports on the financial implication of going through with a project, which could either be a profit or loss, you know just how much effect that single project has on your entire business’ financial health.

2. Helps Optimize Your Project Management Processes

Project accounting reveals the areas of the project that bring in the most money and the areas that generate losses for your business. With this, you optimize your project management operations down to the specific tasks you engage in and make sure that unnecessary costs are gotten rid of. 

3. Positive Effect on Future Projects

Project accounting does not just help with fine-tuning and getting the most out of a single project but has effects on future projects. 

With it, you create a financial management framework that remains actionable in keeping future costs of related projects in check. Project lead time remains as relatively short and productive as you need it to be. 

Where executed correctly, project accounting undoubtedly improves the financial performance of every single project you take on.  

Project Accounting Tips & Best Practices

1. Resource Management Is Key 

The usage and availability of resources determine whether the project gets completed as well as how efficiently and productively managed it is. Resources are key to any project, with financial resources used to purchase other resources or fund your company’s operational, labor, and material costs. 

What this implies is that as labor and material resources are used or mismanaged, financial resources are inevitably used up and you eventually have to spend more than initially budgeted. 

With project accounting, you ensure that every resource is assigned a cost. This helps with proper cost tracking and management. As resources are used up, they immediately translate to costs. 

Project accounting evidently has a close relationship with your resource management processes. Closely tracking resource consumption levels and optimizing resource usage has a direct effect on the number of financial resources used. When optimized correctly, it keeps your financial resource usage in check.   

2. Integrate Time Tracking

Every project is measured against time constraints. The time spent on a project defines how well the project has gone and how feasible ending it on the scheduled deadline is. 

Why is tracking time important to your project accounting? Where more time is spent on a project than planned for, more resources are expended on the project which equally translates to more cost.

Constant time tracking helps you keep everyone in check and ensure tasks are completed at their appointed time. Through timesheets, you know which tasks consume more time as well as the tasks each team member completes faster than others. 

Tracking time also helps you determine the exact time spent on non-billable work on the project and you are able to cut down on this. These types of work are better left automated where possible.

Through proper time tracking, you make adjustments to your appointments and schedules and ensure all tasks are completed before the project due date. You need this to keep your project finances under budget.

3. Maintain Proper Change Management

Tracking every element of your project and how they change due to the effects of external factors is important to your project accounting operations. 

A change in a task and related variables may have you spend more on it. Quickly identifying this type of change and making quick adjustments in relation to it helps you save on your project finances. 

4. Remain Flexible for Changing Situations

Project changes such as scope creep are situations that every project accountant has to prepare for and understand early. Changes to your projects usually increase your project costs. 

The best way to prevent project changes from affecting the project cost is to have a say in the change control process. This helps you stay abreast of changing project situations. 

5. Use Project Management and Accounting Software

Project accounting can be tasking and time-consuming if you use manual methods and spreadsheets to track the cost of every project. You can save time and eliminate administrative tasks by automating the project accounting process.

Use project management software like Monday.com, ClickUp, and Wrike, and accounting software like NetSuite, Intuit QuickBooks Online, and Sage 50cloud for your project accounting needs. These software tools help you keep up-to-date financial records. 

Most used project management software features
Source: Clockify

Project Accounting Checklist Along the Project Process

The process of project accounting is not entirely complete or even feasible except when certain actions are taken. These actions are spread across the different stages of your project for better identification.

Project Initiation   

The project initiation stage for project accountants is where they carry out cost estimates and basic cost analysis on the project in relation to available resources.

Checklist

  • Is It Right to Take on a New Project? Project accountants determine whether the company can take on another project. Company finances are put into consideration in addition to the schedule or availability of team members.
  • Are There Similar Projects to Model? Having similar projects with similar budgetary allocations helps with your current budget estimates. So you check for these or implement the analogous estimation technique to forecast time and cost in case there is not much information on the past projects.  

The initiation phase is majorly concerned with whether available financial and time resources are enough for the new project to be taken on.

Project Setup and Planning

This is the stage where you create or make all the plans and allocations for the project. The project plan takes into account the estimates from the initiation stage and creates a detailed framework through which you can manage the project.

Checklist 

  • Are The Start and End Dates Feasible? This is important for creating the project scope. You want your project’s available finances to be in line or enough to cover the length of time needed to run the project.
  • How Detailed Are Assigned Costs? For your project accounting to be effective, you need the exact cost of each task and project deliverable. With this, you easily track each task and know how much effect they have on your finances.
  • Do You Have a Budget Contingency Reserve? Admittedly, keeping your expenses below or within your budget is easier said than done. To keep your project moving forward, you ensure you have that extra reserve of financial resources to satisfy your extra costs. 
  • What Are Your Sources Of Data? Have your project scope, task list, statement of work, the scope of work, and schedule down for quick reference. 

Project Execution

Project execution is where you put all the project plans to practice. This is where you get involved in activities that make or break your project’s success. Project accountants apply their skills to maintain the financial health of your project required for it to be successful.  

Checklist

  • Is Financial Data Trackable? To properly keep your expenses in check, you need data that represents them. Here, you want to ensure that you do not just have data sources, like digital journals, but also that your data sources are accurate and reliably present you with real-time financial data. 
  • Are Expenses Compared to Budget Allocations? For this, you make sure that all expenses are tracked and compared to the budget allocation set down for each workflow or task. 
  • What Is Your Level Of Profitability? Profitability from projects depends drastically on your actual cost, revenue, and eventual profit from the project. You want to always look into these.

The project execution phase is also the stage where time tracking workflows are implemented, so you pinpoint the exact rate of progress your project is making. You need to write an effective project execution plan to maximize the project execution stage. 

Scope Creep

Scope creep is what you call a project correctional phase, a stage common with poorly planned projects with the sole aim of bringing the project back on track. 

Checklist

  • Are Numbers Updated In Real-Time? One reason a lot of financial accounting operations have failed is stale numbers, with accountants not having access to the actual state of financial accounts. You want to ensure these numbers are consistently and accurately reported on.
  • How Much Is Being Expended? You want to ensure you know the actual amount being expended on tasks, and not just inaccurately represented data.
  • What Project Elements Take The Most Cost? Ensure that you have visibility of the exact roles and tasks taking the most financial resources. This helps with making the required changes.

All these are aimed towards identifying areas where financial resources are leaking through and making adjustments to curb these leaks.

Project Closing

This is the final stage where your project is rounded up and delivered.

Checklist

  • Was The Accounting Process Satisfactory? Here you check to see if your project accounting processes were effective enough to gain profits and keep your expenses within the project’s budget.

This stage helps you know which processes were efficient and which require more optimizations.

The 9 Primary Elements of Closing a Project
Source: The Project Management Blueprint

Project Accounting Revenue Recognition Methods

The percentage of completion of a project is a measurement assessed by a project manager, program management officer (PMO), or project accountant to identify the project status and progress towards completion. 

One particular importance of this measurement to project accounting is the fact that the entire revenue of the project is taken into account. There is recognition of the project’s revenue and profits or losses are easily identified.

To come up with your project’s percentage of completion, three methods are used.

1. Cost-to-Cost Method

The cost-to-cost method pays particular attention to your estimated cost and the number of expenses already incurred during project execution. This method is not feasibly implemented except there is constant and accurate reporting as additional financial resources are expended on the project. 

With this method, you record the highest amount of cost from the early stages of the project because it is when you make material investments. 

The formula for calculating the percentage of completion is: Percentage Complete = (Cost Incurred) / (Total Estimated Cost) x 100

Consider a project for the construction of a building with an estimated cost to be $50,000 and a contract to sell the building for $70,000. Where materials are bought for $28,000, you have your percentage complete to be:

Percentage Complete = (Cost Incurred) / (Total Estimated Cost) x 100

Percentage Complete = ($28,000/$50,000) x 100 

Percentage Complete = 56%.

You have 56% of your project complete. 

Now, to calculate your current revenue from the project, you use the formula: Current Revenue = Percentage Complete x Contractual Quote

The total revenue is then: 56% x $70,000 = $39,200.

You have generated $39,200 in revenue through the project.

The cost-to-cost method may be used to calculate the revenue for each period the project is broken down into, which could be weeks, months, or years. 

Here, after revenue for the initial period is determined, you then use the formula: (Percentage Complete x Contractual Quote) – Revenue from Previous Period(s)

To put this into full view, let us assume the project from the previous example is split into three periods of 4 months each. Where a revenue of $39,200 is recorded from the first period and the next general calculation in the second 4-month period shows a revenue of $56,000, your revenue from the second period is then:

$56,000 – $39,200 = $16,800.   

2. Efforts-Expended Method

The efforts-expended method takes your estimated project time and total time currently spent on your project into account. This is feasibly implemented where the required project time is estimated from the beginning and constant time tracking is maintained. It includes time used by external contractors and even machines for task automation.  

This method is particularly important or useful to project accounting where labor costs majorly determine how much is expended on the entire project. Costs are also directly associated with work hours. 

The formula to calculate the percentage complete is: Percentage Complete = (Hours Completed / Estimated Labour Hours) x 100 

For instance, when labor hours are estimated to be 200 hours and 60 hours have been completed, the percentage complete is then:

(60 hours/ 200 hours) x 100 = 30%.

To calculate the current project revenue, you then use the formula: Current Revenue = Percentage Complete x Contractual Quote

Using the example, where a quote of $60,000 is placed on the project, revenue becomes:

30% x $60,000 =  $18,000.

Additionally, to calculate the revenue generated for subsequent project accounting periods, you use the formula: (Percentage Complete x Contractual Quote) – Revenue from Previous Period(s) 

3. Units-of-Delivery Method

The units-of-delivery method is preferred by the GAAP as it is direct and easily verified. This considers your output, as well as the cost for each unit delivered. 

As straightforward as it gets, to recognize revenue, you consider the price of each delivered item. To recognize the cost, you calculate the cost of each unit delivered. This method is more accurate in calculating your project revenue than cost.  

However, to calculate your percentage of completion, you take into account the number of units delivered in comparison to the number of units to be delivered under the contract. 

You use the formula: Percentage of Completion = (Number of Units Delivered / Number of Units to be Delivered Under Contract) x 100

The units-of-delivery method is useful in the construction, production, and manufacturing industries as units of production and sale are easily quantified. 

For instance, where a company sells off 4 units of telecommunication systems worth $2 million each, the total revenue is calculated to be $8 million. Where the cost of each unit is $1.5 million, the total cost is calculated to be $6 million.

Where there are 6 units contracted to be delivered, the percentage complete is then said to be:

Percentage of Completion = (Number of Units Delivered / Number of Units to be Delivered Under Contract) x 100

Percentage of Completion = (4 units / 6 units) x 100 

Percentage of Completion =  66%

For this, however, the contractor must accurately set prices for each unit of items for profits to be derived from them.

Martin Luenendonk

Editor at FounderJar

Martin loves entrepreneurship and has helped dozens of entrepreneurs by validating the business idea, finding scalable customer acquisition channels, and building a data-driven organization. During his time working in investment banking, tech startups, and industry-leading companies he gained extensive knowledge in using different software tools to optimize business processes.

This insights and his love for researching SaaS products enables him to provide in-depth, fact-based software reviews to enable software buyers make better decisions.