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
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
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
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
d) Analyzing project cost break-up.
e) Analyzing personpower time break-up and
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
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
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
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.
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.
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 that are largely independent of the line
function activity. These include Support Staff function
expenses, establishment expenses and depreciation
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.,
Difference of revenue and variable costs (direct costs)
which intend to cover the fixed costs (indirect costs).
A report giving costs incurred in the project, revenue
earned and contribution achieved.
A Sample IT Organization Chart:
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)
4.2 Expense Related Components:
--- a. Direct Costs:
2. Material /Spares/ Services
5. Direct Line Function Overheads
--- b. Indirect Costs:
1. Staff Function Overheads
2. Establishment Expenses
3. Cost Center component of Corporate Overhead
5. Othei Overheads
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
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
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
project, hence, employee time is recorded project-
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:
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.
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
(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-
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.
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
7 Project Contribution:
b. Advances Received
c. Collections Received
d. Personpower Costs
e. Material I Services
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
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.
7. Exception reporting.
10 Management Reports:
The following reports can be obtained from the
1. Project Cost-Sheet.
2. Project Cash Flow Analysis.
3. Overheads Analysis.
4. Personpower Time Analysis.
5. Cost Center Performance.
6. Regional Performance.
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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.