[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

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  • 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

    C...

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