[IEEE Engineering Management Society Conference on Managing Projects in a Borderless World - New Delhi, India (17-18 Dec. 1993)] Proceedings of Engineering Management Society Conference on Managing Projects in a Borderless World - Use of cost accounting concepts in managing IT projects
Use of Cost Accounting Concepts in Managing IT Projects Sandeep Verma Sr. IT Engineer C.M.C Ltd.1, Eastem Avenue, Maharani Bagh, N.Delhi -1 10065, INDIA Abstract: Project Costing is about accounting of costs incurred on a project for the purpose of controlling them and planning the optimum utilization of resources. Cost centers in an organization are identified. All projects executed belong to one of the cost-centers. Direct costs of an IT project such as people and material are identified. Cost of organizations support services and other overheads is prorated to cost- centers and from there to the projects within the cost- centers, using direct method of costs allocation. - 1. INTRODUCTION: There is an increasing need for cost-consciousness in executing projects in todays competitive IT environment. Project Costing is about accounting of costs incurred on a project for the purpose of controlling them and planning the optimum utilization of resources. Managing a project in IT industry involves Time Scheduling, Resource Allocation, and Cost Management. Most of the standard software packages for Project Management emphasise time scheduling and resoure allocation. Some packages which deal with cost management have the limitation that they work in a stand-alone manner and are not integrated with the financial system of the organization. Expenses incurred by the project are 119 entered manually into the system by the project manager alongwith the budgeted figures. The Project Management software then calixllates the variances. In most of the standard packages, only direct costs attributable to projects are taken into account. But, an organization operates with office-overheads such as establishment expenses, staff-function expenses which include office maintenance and rent and salary and other perks of the employees belonging to Administration , personnel, Marketing, and Accounts departments. These overheads should also be shared by projects and only then, a true picture of their viability will emerge. There are corporate expenses and R&D investments also. As projects are revenue generating activities, they should also contribute towards covering these expenses. An organization has many centers of activity. Each center has many projects going on. It also has overhead expenses. Cumulative performance of all projects in a cost center gives performance of that center. Thus, costs associated with a project cannot be seen in isolation, but in conjunction with those of the center and the organization as a whole. In brief, project management cannot be a stand-alone activity, rather it should be integrated with the Financial system of the organization, so that a more accurate assessment of projects performance can be made. This paper treats this Project Costing aspect of the Project Management and is experiential in nature. It is based on an actual implementation of Costing system for IT projects. 2. The Proiect Costinq Svstem: The concept of Cost Accounting can be applied to IT projects . The primary purpose of Project Costing is to ascertain the project profitability, to create cost - consciousness among project managers and other staff of the organization. An accurate cost analysis of projects helps in the following: a) Assessment of profitability of project. b) Performance evaluation of projects. c) Arriving at better estimation standards and procedures. d) Analyzing project cost break-up. e) Analyzing personpower time break-up and - personpower costs. In the context of IT industry, there are different kinds of projects undertaken and depending upon the nature of activity involved, these projects can be grouped under the following heads: 1. Hardware Maintenance 2. Turnkey Projects 3. Equipment Supply 4. Software Projects 5. Software Products 6. Systems Consultancy 7. Education & Training 8. Environment Engineering Services 9. Facilities Management The above can be called revenue heads or revenue cost centers or profit centers or Lines of Business (LOB). Company personnel can belong to one of these activities or LOBs. Similarly, each project that the organization takes up also belongs to one of these centers. Cost Accounting principles can be applied to cost an IT project. A cumulation of these costs for all projects of an activity center or LOB can yield costing for that center. Similarly, enterprise-wide cost comparisons of different regional offices of the organization or of different LOBs can be obtained. 3. Certain Cost Accountinq Terms & Definitions: Before further discussing the project costing, a few cost accounting terms and definitions are given below: Cost Accounting: Accounting of costs incurred by a unit or project for the purpose of controlling costs and planning the optimum utilization of resources. Financial performance can be evaluated and controlled only when a comparison between the costs actually incurred and the costs that should have been incurred is made. Cost Center: When costs are accumulated for an organizational unit or department, it is called a cost center. The examples for an IT organization could be the maintenance department or tumkey projects. Direct Costs: Are those cost items which can be traced logically and conveniently, in their entirety, to a cost unit (e.g. a project or a cost center). Indirect Costs: Are those cost items which cannot be traced or identified with a cost unit. Overheads : Include all costs except those that are direct such as direct material and direct labor costs. Direct Over heads: Directly linked to a cost unit (project or cost center) and varies directty and proportionately with the volume of line function activity. These costs are travel, senior management expenses and other cost unit expenses. Indirect Overheads: Expenses that are largely independent of the line function activity. These include Support Staff function expenses, establishment expenses and depreciation etc. Corporate Overheads: Corporate expenses and management salary and benefits comprise corporate overheads. These are not controllable by the operational level managers, hence they cannot be prorated to revenue-generating projects or cost-centers. Rather, projects or cost- centers must generate enough profits to provide towards covering such expenses. Marginal Cost Accounting: Marginal Costing or variable costing is a system of segregating project costs between fixed and variable components and charging the project with only variable costs. It brings in 'contribution margin' - excess of revenue over variable costs. Contribution margin is intended to recover fixed costs before contributing towards operating profits., Contribution: Difference of revenue and variable costs (direct costs) which intend to cover the fixed costs (indirect costs). cost Sheet: A report giving costs incurred in the project, revenue earned and contribution achieved. A Sample IT Organization Chart: Corporate Office I I I I North East West South Region Region Region Region I __---___-_________ I I ..... I cost center1 ... 1 . 1 Project1 Project2 ...... - 4. Proiect ComDonents: There are two major financial components of a project, namely income and expense. A record of income and expense of a project is kept for a quarter, for a financial year or for the entire period of the project. At the start of the project, expected income and expected cost figures are arrived at and these are later compared with actual figures. 4.1 Income Related Components: 1. Revenue (Bills Raised) 2. Collections 3. Advances 4.2 Expense Related Components: --- a. Direct Costs: 1. Personpower 2. Material /Spares/ Services 3. Travel 4. Training 5. Direct Line Function Overheads --- b. Indirect Costs: 1. Staff Function Overheads 2. Establishment Expenses 3. Cost Center component of Corporate Overhead 4. Depreciation 5. Othei Overheads 121 The above project components are explained below. 5. Project Income: Bills raised are revenue for the project. Collections are money realized. Advances are adjusted against bills. Collections and advances are counted in cash flow of the project. 6. Project Expense: Project expense will be accounted for in the following manner: 1. All expenses directly attributable to a project will be booked to the project. 2. All expenses not directly attributable to a project, but attributable to a cost center or LOB will be booked to the center and prorated to all projects within that center. The proration will be done in ratio of personpower costs in each project. 3. All expenses not attributable directly to a cost center or LOB but attributable to a regional office as a whole, will be prorated to all cost centers or LOBS of that region and further prorated to projects. Following are the types of expenses involved in an IT Project Costing: 6.1 Direct Costs: 6.1.1 Personpower Cost: IT industry is largely service industry. It is people intensive at operational level. Therefore, the time spent by IT professionals on a project needs to be recorded. This can be captured from daily time record of programmers, analysts and hardware engineers. A small software package can be developed and used by IT people to record the time spent activity-wise. A person may be spending time on more than one 122 project, hence, employee time is recorded project- wise. Person Power Rate: An organization has people working at different levels. For each level, a standard per hr. rate can be calculated depending upon the average salary, pay raise or revision and perks for that level. The senior management staff who do not spend time directly on a project, instead spend it on managerial or supervisory activities, cannot record time project- wise, so their cost is part of direct overheads which should be prorated over different projects. The following costs are also project specific and are to be taken from the accounting system of the organization. A project-specific financial voucher entered must have a project code . The accounting system must be integrated with the costing system, so that all the project-related expenses can be picked up. 6.1.2 Material Cost: Following material costs are involved in an IT project: - Equipment Supply. - Software (OS, RDBMS, and utilities). - Environmental Engineering related expenses and vendor payments. - Spares consumption for maintenance projects. - M/C time usage bought out. - Internal M/C usage costs. - Consultant and others technical service charges. Such costs must correspond to a project. 6.1.3 Other Direct Costs: Any other costs directly attributable to a project. 6.1.4 Direct Overheads: (a) Travel: Another component of expenses is project related travel expenses. Cost of any travel concerning more than one project can be divided among projects in ratio of time spent on each. (b) Training: IT industry is skills oriented and IT people need to be trained very often to keep abreast with the latest in technology. Project specific costs are directly attributed to the project (c) Other Direct Overheads: (i) Expenses of management (salary & perks) in a LOB (Line of Business) which cannot be directly attributed to a project. (ii) Other LOB expenses which cannot be directly attributed to a project such as general training or travel expenses on IT professionals belonging to that LOB. (iii) Other expenses related to IT department of the organization, but not specific to a project or a LOB. (iv) Interest cost on a negative cash flow of a project. Net Cash flow of a project = Advances + Collections - (Material + Personpower + travel + Training + Direct Overheads) Interest can be calculated periodically , say every month. For the period, i f the cash flow is positive, interest cost calculated will be taken negative giving benefit to the project by reducing the cost. 6.2 Indirect Costs: These costs are overheads and should be prorated to all Projects. 6.2.1 Staff Function Overheads: Marketing, Ad ministration, Accounts, Personnel departments are support function in an IT organization. Salary and perks are expenses of the support staff and are overheads for IT projects. 6.2.2 Establishment Expenses: Such expenses include office building rents, office- maintenance etc. 6.2.3 Cost Center Component of Corporate Overheads Any corporate expense which can be directly attributed to a cost center or a LOB is identified and is io bt Drorated to all projects belonging to that LOB. 6.2.4 Depreciation: Depreciation of major assets of the organization such as computer systems, buildings etc. is treated as Indirect Overhead cost. 6.2.5 Proration of Overheads: 1. All regional level overheads can be prorated to cost centers or LOBS on the basis of percentage of the use of the establishment or support staff by the LOB. 2. LOB component of aforesaid regional overheads are then prorated further to projects within the LOB and form part of the project costs. 3. Any other costs directly attributable to a cost center or a LOB can be further prorated to all projects within that cost center or LOB. The cost center overheads as in 2 and 3 above can be prorated on the projects on the basis of personpower costs spent on each project. 4. Corporate overheads are not prorated to projects as these are not under the control of the regional management or the operational management. The projects are expected to earn revenue and contribute towards the corporate overheads and towards the organization profits. 7 Project Contribution: a. Revenue 123 b. Advances Received c. Collections Received d. Personpower Costs e. Material I Services f. Travel g. training h. Direct Overheads i. Contribution (a-(d+e+f+g+h)) j. Indirect Overheads k. Net Contribution (i-j) The above shown in tabular form is also called the costsheet of the project. 8 Data Collection Methodology: 8.1 Personpower Time Record: To collect data related to time spent on a project by the concerned people, a time recording system can be developed and used. Time is recorded project-wise and activity-wise. 8.2 Financial Data: Revenue and expense vouchers in the financial system must have related project code, so that project specific data can be collected. Expenses not directly attributable to a project must have relevant cost center code. 9 Role of a Cost Accountant in an IT Organization: 1. Codification of projects /activities. 2. To ensure person-power time recording. 3. To identify components of direct costs and ensure use of relevant project code on financial vouchers. 4. Proration criteria for Indirect Overheads. 5. To determine standard costs. 6. Analysis of results. 124 7. Exception reporting. 10 Management Reports: The following reports can be obtained from the Costing System: 1. Project Cost-Sheet. 2. Project Cash Flow Analysis. 3. Overheads Analysis. 4. Personpower Time Analysis. 5. Cost Center Performance. 6. Regional Performance. it A- I&rDfc1 ?*id t ~ a d g - ~ f sy&: ST. t4mWybmd bjd Hayer // REFERENCES 111 Fundamentals of Financial Management by J.C. Van Horne, Stanford University. [21 Budgeting: Profit Planning and Control by Glenn A.Welsch, University of Texas. [31 Management Accounting by I.M.Pandey, Indian Instt. of Management, Ahmedabad.