Monday, May 20, 2013

Basic Accounting Terminology for PMs

Professional service firms use accrual based accounting methodology, not cash-based, and once this is understood everything gets much simpler.

Revenue is recognized on an accrual basis when it is earned and when expenses are incurred without regard to the time of receipt or payment of cash. The determination of income and recognition of revenue rests upon the collection of cash and payment of expenses in a cash-based system. Taxes are calculated on a cash basis, regardless of the accounting methodology used for recognizing revenue.

Accrual-based accounting is best, as it more accurately measures real progress and work-in-place on projects while providing “real-time” profit calculations. You invoice and collect cash based on the terms in your contracts. You earn revenue based on the level of completeness of your projects, and the billing and earning schedules on a project can be different.

The most visible application for accrual accounting to project managers is setting-up and monitoring the project work plan. The work plan establishes the budget by phase by which the project will earn revenue, and it includes contingency amounts not visible on the billing/cash side to clients. Contingencies in themselves create differences in the amounts billed to clients and revenue earned internally.

In addition to understanding the difference between accrual-based and cash-based accounting, here are a number of other accounting terms with which all A/E project managers should be familiar:

• Gross Fee: Total fee paid to the firm for all services including consultants

• Consultant Fee: Fees paid to consultants by the A/E of Record

• Net Service Revenue (NSR): Gross Fee minus Consultant Fee

• Overhead: Fringe benefits, rent, utilities, management (including indirect labor) and marketing expenses.

• Direct Expenses: Expenses that are charged to a project or task and NOT billed directly to the client; the cost of these expenses must be absorbed by the project or task. They include supplies and unreimbursed travel.

• Reimbursable Expenses: Expenses that are charged to a project or task and billed directly to the client for payment. These are outside the scope of the Gross Fee.

• Billed/Invoiced Amounts: Amounts billed to clients based on contract compensation amounts and percent complete.

• Earned Revenue Amounts: Revenue recognized in the accrual accounting system based on subjective percent complete times Net Service Revenue.

• Percent Complete: Current, workin - place for the project, phase or task expressed as a subjective percent complete and not based on the percentage of labor hours or dollar amounts spent.

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