What is Project Accounting? Definition, Methods, and Benefits

What Is Project Accounting?

Project accounting is a specialised branch of accounting that focuses on the financial planning, tracking, and analysis of a project's costs and revenues. It is a critical tool that enables project managers to monitor the economic health of their projects in real-time, ensuring that they stay within budget.

While traditional accounting looks at the overall financial status of an entire company, project-based accounting zeros in on the financial details of individual projects. It involves setting up a budget, tracking actual costs against this budget, and forecasting future expenses to keep projects financially viable.

This approach allows for a more granular view of where funds are spent and how they are being earned and is essential for managing complex projects with multiple moving parts. Using project-based accounting methods, you can identify which projects add value and improve your financial outcomes.

Project Accounting vs. Financial Accounting vs. Management Accounting

All of these are distinct branches of accounting with different focuses and purposes. Understanding the differences is key for businesses to allocate resources and make informed decisions.

• Project accounting is concerned with the financial transactions related to a specific project, tracking costs, billing, and revenue to manage a project budget effectively. It is characterised by having a start and end date, aligning with the project's lifecycle.
• Financial accounting deals with the overall financial health of an organisation, recording, summarising, and reporting financial transactions, typically a fiscal year. Moreover, financial accounting adheres to standardised principles and is used to provide information to external parties, such as investors or creditors.
• Management accounting is internally focused, and without the mandatory standardised principles of financial accounting is more flexible. Providing detailed financial and non-financial information to help strategic decision-making. It includes budgeting, forecasting, and analyses to support management in planning and performance evaluation.

Each branch is indispensable to strategic planning and the financial success of a business, but they differ significantly in their approach, purpose, and the audience they serve.

Common project accounting revenue recognition methods

Revenue recognition in project accounting is a critical aspect of financial management, ensuring that the income earned from a project is reported accurately.

Project-based accounting recognises revenue through a percentage of completion, completed contract, cost recoverability and instalments. Each method has its specific application and is chosen based on the nature of your project, industry standards, and the certainty of collection payment.

Percentage of completion

The percentage of completion approach allows for ongoing revenue recognition, matching income with the progress of a project. It suits long-term projects where you can compare the costs incurred to the estimated total costs, to determine the percentage of the project completed, allowing for revenue recognition that corresponds with the degree of completion.

This method ensures that company financial statements provide a realistic view of income and expenses throughout a project's life, rather than only on completion. It requires careful estimation and consistent tracking but offers a more accurate reflection of a company's financial status during ongoing projects.

Completed contract

The completed contract is exactly that, recognising revenue and profit only after a project is completed. It is useful where there is uncertainty about payment collection or project completion dates and is typically used when contracts are short-term, and the financial results would not differ significantly from other methods.

The advantage of this method is that it allows for the deferral of tax liabilities, potentially improving cash flow management, it can also result in irregular financial reporting, which might be challenging for stakeholders to interpret.

Cost recoverability

The cost recovery method is a conservative approach to revenue recognition often used when there's uncertainty about collecting receivables. It aligns with the prudence concept in accounting, which advises against the anticipation of income and encourages the recognition of all foreseeable losses.

Cost recoverability dictates that profit on a sale is not recognised until the cash payments received from the customer exceed the costs incurred for the goods or services provided. For example, if you sell goods on credit and are unsure about receiving payment, you will apply the cost recovery method to ensure that revenue is not overstated.

This approach provides a realistic view of your company's financial health, especially where the collectability of sales revenue is questionable.

Instalments

The instalment method recognises revenue as it is earned, often as a percentage of the total project revenue, aligning with the progress of the work completed. It allows revenue and expenses to be recognised over the lifespan of the project, as instalments are made or received.

This approach can be beneficial for long-term projects that span multiple accounting periods. It helps you to effectively manage budgets by tracking planned versus actual costs and making necessary adjustments to avoid overspending. It ensures financial reporting reflects cash flow and profit realisation, providing a realistic view of your project's financial health at any given point.

Top 3 project accounting benefits

Project accounting offers many benefits for businesses handling multiple, financially distinct projects. Implement project accounting software and you will gain a comprehensive view of your project finances, and easily track budgets, expenses, billing, and revenue to ensure financial viability and control.

With features for accurate and timely billing and invoicing, software tools help maintain compliance with financial standards, provide detailed financial reports and enable managers to adjust project strategies based on real-time financial data.

1. Managing project budgets separately, giving you flexibility

Managing project budgets separately gives you greater flexibility and control over financial planning because adjustments can be made in real time, to ensure that resources are allocated efficiently.

2. Tracking project expenses and performance more closely

Close monitoring of project expenses and performance helps identify potential issues early to facilitate quick responses to keep projects on track and within budget. Tracking expenses provides a granular view of financial transactions within a project, ensuring that all costs and revenues are accurately recorded and monitored.

3. Fighting scope creep, enabling you to deliver results on time

Project accounting helps to combat scope creep - the tendency for a project's scope to expand over time, usually due to changing requirements. By maintaining strict budgetary control and regular monitoring, project accounting helps manage scope creep in real-time, helping deliver projects on time and within budget.

The Role of the Project Accountant

A project accountant plays a crucial role in the financial management of projects. Responsible for creating project budgets and accounts, project accountants update contracts, maintain project-related records, and manage the transfer of expenses and revenues to ensure that all financial aspects are accurately monitored and reported.

Project accountants review and approve supplier invoices, time sheets, and overhead charges, investigating and reporting discrepancies to management. They work closely with receivables staff to manage unpaid contract costs and ensure project accounts are issued to customers and payments are collected. By fulfilling these responsibilities, project accountants contribute to the efficient financial management and overall success of projects.

What to include in a Project Accounting Annual Report

A project accounting annual report includes an executive summary that captures the essence of the project's financial health and progress. It presents detailed financial statements, a general ledger, a statement of corporate governance, an auditor's report, and any supplementary information that provides deeper insights into the project's performance.

The elements of a Project Accounting Annual Report help stakeholders understand the project's financial trajectory and guide future planning, decisions and investments. These include:

• Short summaries for each project
• Project names, objectives and key metrics
• Detailed financial summary for each project
• Budgeted and actual costs
• Cost overruns or savings
• Resource allocation
• Regulatory and compliance issues
• Risk mitigation strategies
• Supporting documents (e.g., financial statements, general ledger)

What to look for in project accounting software?

What sets project-based businesses apart? One factor is that project-based businesses have specific needs when it comes to managing budgets and costs associated with each project.

This is where specialised project accounting software excels (pun intended). Consider implementing a finance system that has been designed with project accounting in mind, and look for features such as:

• Project Tracking — This feature allows you to closely track and manage project-related financial data like expenses and other resources. Besides, it gives you a clear view of each project's financial health. Project accounting software can also help your finance team monitor the performance of different business units within your company.
• Budget Management — When managing multiple projects, it's essential to be able to create, monitor, and analyse project budgets separately, facilitating proactive budget control. This way, you can easily track the company's financial planning and budgeting processes, ensuring alignment with strategic objectives.
• Revenue Recognition — Try opting for software that enables you to accurate and timely recognition of project revenue based on milestones or completion. This allows you to ensure compliance with revenue recognition standards and to provide transparent financial reporting to stakeholders.
• Invoicing and Billing — When it comes to project accounting software, look for functionality that enables you to streamline the invoicing process by generating invoices based on project milestones, time, and expenses, facilitating efficient cash flow management.

Bottom line: What is project accounting?

The bottom line of project accounting lies in its ability to provide a detailed financial view of individual projects, to enhance the decision-making process for project managers and stakeholders. By creating accurate project forecasts, managing project budgets, and tracking expenses and performance, project accounting allows for efficient cost management.

Ultimately, project accounting best practices contribute to a company's overall financial health by ensuring projects are completed within budget and contribute positively to the net income.