What Is Project Accounting? (With Benefits And Principles)
Updated 23 September 2022
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Project accounting is a type of accounting that organisations might use when they work on a project-to-project basis. Typically, companies in the construction industry or other similar industries use this type of accounting. Learning about this accounting procedure and how it differs from general financial accounting can help you plan a new career path involving project finances. In this article, we discuss what project-based accounting is, learn why it is important, explore its key principles and review the difference between general and project-based accounting.
What Is Project Accounting?
Project accounting is an accounting practice that keeps track of costs and financial benefits associated with a project. It primarily involves tracking costs, cash flows and expenses across the entire life of a project. As many projects might start in the middle of the fiscal year, it might be helpful to record finances rather than look at expenses incurred in a specific financial year. This accounting allows an organisation to assess the financial implications of completing projects and planning them to meet contract parameters.
It is important for a business to track the money they spend over time, learn how to allocate resources and ensure payments occur on time. Project-based accounting is a valuable and effective tool for project management because it provides a detailed overview of the project's progress and financials. The construction industry uses this accounting to keep track of finances that might span several years. In the construction industry, an organisation can track wages, building materials costs and equipment over the length of the project.
Related: 11 Important Accounting Concepts And What They Mean
Why Is Project Accounting Important?
Project-based accounting provides many benefits for those who employ it in their business. This practice is desirable for businesses with operations across various industries and sectors. Here are some reasons a business might want to use this type of accounting:
Provides visibility: A project runs better when managers track expenses and revenue because it helps make better managerial decisions. Tracking cumulative and per-day expenses and revenue can help plan labour, materials and other resources involved.
Ensures accuracy: This accounting tracks every aspect of a project, which means organisations can get an overview of everything related to the project. It ensures accuracy in billing, revenue, expenses and accruals.
Helps track fiscal differences: Project-based accounting tracks every project, so even if two projects fall under different fiscal years or belong to different departments, this accounting can keep track of the fiscal differences.
Identifies issues: Accounting can help leaders identify potential issues with the project and empower them to make quick decisions to track and reduce costs.
Educates project team: Project-based accounting can help and educate a team on factors that can affect cost and profitability.
Sets reasonable budgets: Apart from improving resource management, this accounting can help establish a reasonable budget for a project.
Helps determine the price: Project-based accounting can help identify scope and pricing by understanding the estimated project costs.
Related: What Are the Functions of Accounting? (Definition And Types)
What Are The Principles Of Project-Based Accounting?
Accounting might involve different principles, which provide information, insights and calculations to ensure timely completion of projects. Some principles of project-based accounting are:
The cost principle of accounting focuses on recording the project's cost at the original value. This value tells how much material, machinery and equipment might cost instead of the market value they might hold. For instance, if you purchase materials at a discount of ₹7,000, but the actual cost is ₹10,000, the cost principle records the amount you paid for buying the material.
Related: Basics Of Accounting - Terminology, Principles And Concepts
The matching principle is a concept that conveys that a company reports expenses at the same time as the revenue. It primarily involves matching expenses to specific milestones and project process points. This principle helps you assign expenses incurred during the production process to the period in which a team incurred the expenses. This ensures that revenue and expenses match the reasonable cost and activities. For example, assigning the cost of raw materials to the stage where the organisation might use it can provide managers with insights into the project's cost.
This principle combines work and processes over time to ensure the project's cost remains consistent. This principle typically uses a process to identify the revenue and cost and merge the project's relevant financial activities into a single account. For example, an accountant might consolidate the labour cost into one account that contains details about the project's total cost.
The liability principle allows an accountant to recognise costs related to the project's future obligations. This principle might provide protection and information on liabilities that a company might face. For example, an accountant might provide a document that lists possible costs when a company is incapable of completing a project within the specified period of the contract.
Related: 8 Steps Of The Accounting Process (With Key Terms)
The control principle of project-based accounting states you follow processes and procedures to ensure regulation in tracking financial activity. This principle allows a manager to track a project's performance after making the desired adjustments. It can even help in tracking performance when a company lacks financial information.
Related: What Is FIFO Accounting? Definition, Example And Advantages
The prudence principle focuses on determining the expense and revenue of a project based on the manager's estimate or advice. This information might help align budgets and understand the project cost associated with ongoing projects. For instance, the prudence principle might provide an idea of future revenue and expenses based on insights from professionals and experts.
The full-disclosure principle records and displays the financial costs incurred during a project. Recording everything increases accountability and transparency for senior management and stakeholders involved in dividing a project's budget. For example, an accountant might provide a disclosure statement of costs incurred during project completion.
Resource allocation principle
The resource allocation principle states that organisations can allocate resources to different projects. This implies that project managers might allocate the same resources to different projects, depending upon the financial risks and benefits, preventing the requirement of financial allocation of resources. For example, a manager might assign machinery resources to various projects at the same time.
Related: 9 Commonly Accepted Accounting Principles
Project-Based Accounting Best Practices
Some best practices for project-based accounting are:
Using a separate accounting system: You cannot club project-based accounting with the typical accounting process because project-based accounting is more detailed.
Identifying key performance indicators (KPIs): Identifying KPIs like cost performance and schedule performance helps ensure the project's critical aspects are on track.
Running reports frequently: As project-based accounting tracks progress and budget, running financial reports frequently is essential. Regularly running financial reports might help in monitoring the project's status and potential issues that might incur.
Creating budget forecasting: To ensure accounting delivers the desired result, create a budget before starting a project. This is a starting point to work from and helps measure the progress and determine whether the project is a success or a failure.
Difference Between Project-Based Accounting Vs General Financial Accounting
The primary difference between project-based and financial accounting is that the former focuses only on the cost of a particular project. Some differences between these accounting types are:
Usage and purpose
General financial accounting might support different activities in a business, including recording expenses, filing tax returns and creating financial reports and financial statements. Project-based accounting is integral to individual projects and focuses on project finances. Project-based accounting works with other accounting, but general accounting considers every financial information for filing taxes.
Standard accounting tracks transactions for every month. Project-based accounting monitors and tracks financial information from the start to the end of the project. Depending upon the project's lifecycle, the time frame might be one month, one year or several years. The lifecycle can be shorter or longer depending on the project's nature.
Adaptability and involvement
General accounting is a requirement for businesses that do not change or require adaptation. Project-based accounting might meet the project's demand and develop as the requirement changes. It ensures greater flexibility and adaptability. For instance, frequent reviews might lead to changes in the projected budget.
Revenue and expense recording
General financial accounting focuses on expenses already incurred by the company and money that has already left the business account. Project-based accounting might focus on business costs throughout the length of the project. It might even include examining already incurred expenses and tracking future projected costs. Project-based accounting ensures an easy correlation between milestones and costs.
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