Financial Accounting Systems and Cost Accounts
The cost accounts described in the previous
sections provide only one of the various components in a financial accounting
system. Before further discussing the use of cost accounts in project control,
the relationship of project and financial accounting deserves mention. Accounting
information is generally used for three distinct purposes:
z Internal reporting to project managers for day-to-day
planning, monitoring and control. z Internal reporting to managers for aiding
strategic planning.
z External reporting to owners,
government, regulators and other outside parties.
External reports are
constrained to particular
forms and procedures
by contractual reporting requirements or by generally accepted
accounting practices. Preparation of such external reports is referred to as
financial accounting. In contrast, cost or managerial accounting is intended to
aid internal managers in their responsibilities of planning, monitoring and
control.
Project costs are always included in the system of
financial accounts associated with an organization. At the heart of this
system, all expense transactions are recorded in a general ledger. The general
ledger of accounts forms the basis for management reports on particular
projects as well as the financial accounts for an entire organization. Other
components of a financial accounting system include:
z The accounts payable journal is intended
to provide records of bills received from vendors, material suppliers,
subcontractors and other outside parties. Invoices of charges are recorded in
this system as are checks issued in payment. Charges to individual cost
accounts are relayed or posted to the General Ledger.
z Accounts receivable journals provide the
opposite function to that of accounts payable. In this journal, billings to
clients are recorded as well as receipts. Revenues received are relayed to the
general ledger.
z Job cost ledgers summarize the charges associated
with particular projects, arranged in the various cost accounts used for the
project budget.
z Inventory records
are maintained to identify the amount of materials available at any time.
In traditional bookkeeping systems, day to day
transactions are first recorded in journals. With double-entry bookkeeping,
each transaction is recorded as both a debit and a credit to particular
accounts in the ledger. For example, payment of a supplier's bill represents a
debit or increase to a project cost account and a credit or reduction to the
company's cash account. Periodically, the transaction information is summarized
and transferred to ledger accounts. This process is called posting, and may be
done instantaneously or daily in computerized systems.
In reviewing accounting information, the concepts
of flows and stocks should be kept in mind. Daily transactions typically
reflect flows of dollar amounts entering or leaving the organization.
Similarly, use or receipt of particular materials represents flows from or to
inventory. An account balance represents the stock or cumulative amount of
funds resulting from these daily flows. Information on both flows and stocks
are needed to give an accurate view of an organization's state. In addition,
forecasts of future changes are needed for effective management.
Information from the general ledger is assembled
for the organization's financial reports, including balance sheets and income
statements for each period. These reports are the basic products of the
financial accounting process and are often used to assess the performance of an
organization. Table12-5 shows a typical income statement for a small
construction firm, indicating a net profit of $ 330,000 after taxes. This
statement summarizes the flows of transactions within a year. Table 12-6 shows
the comparable balance sheet, indicated a net increase in retained earnings
equal to the net profit. The balance sheet reflects the effects of income flows
during the year on the overall worth of the organization.
In the
context of private construction firms, particular problems arise in the
treatment of uncompleted contracts in financial reports. Under the
"completed-contract" method, income is only reported for completed
projects. Work on projects underway is only reported on the balance sheet, representing
an asset if contract billings exceed costs or a liability if costs exceed
billings. When a project is completed, the total net profit (or loss) is
reported in the final period as income. Under the
"percentage-of-completion" method, actual costs are reported on the
income statement plus a proportion of all project revenues (or billings) equal
to the proportion of work completed during the period. The proportion of work
completed is computed as the ratio of costs incurred to date and the total
estimated cost of the project. Thus, if twenty percent of a project was
completed in a particular period at a direct cost of $180,000 and on a project
with expected revenues of $1,000,000, then the contract revenues earned would
be calculated as $1,000,000(0.2) = $200,000. This figure represents a profit
and contribution to overhead of $200,000 - $180,000 = $20,000 for the period.
Note that billings and actual receipts might be in excess or less than the calculated
revenues of $200,000. On the balance sheet of an organization using the
percentage-of-completion method, an asset is usually reported to reflect
billings and the estimated or calculated earnings in excess of actual billings.
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