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 organization’s 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 today’s 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

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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

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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

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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

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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.

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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.

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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.