Project-based accounting: How it works + examples

Struggling to keep track of every dollar spent on your projects? You’re not alone. Every project-based business has multiple moving parts, and sometimes, their projects feel like individual businesses within the organization. 

Project-based accounting simplifies accounting for construction companies by accurately tracking costs, revenue, and profits on a per-project basis. In this article, we explore how it works and how you can use it to make smarter, more profitable decisions.

How does project accounting work?

Components of project-based accounting

Project-based accounting methods

Why project-based accounting is important

How to implement project-based accounting

Overcome obstacles, drive growth in your midsize business

Project-based accounting FAQ

How does project accounting work?

Project-based accounting helps prevent costly mistakes by closely monitoring each project's financial performance. It’s common in industries such as construction, consulting, and engineering. 

While traditional financial accounting focuses on your company’s overall financial health, project-based accounting narrows the scope to the financial performance of individual projects. By treating projects like mini-businesses, you can track their costs, revenue, and resources. Simply put, financial accounting takes a broad view of your finances, while project-based accounting is more granular.

When to use project-based accounting

Project-based accounting is especially useful when you take on large, complex jobs with multiple phases and substantial budgets. If you want to make sure that each project remains on budget and profitable, you need to break down each stage to determine your budget, timeline, and resources. These projects often span months or years and require close financial monitoring throughout the project life cycle.

Let’s say your construction company just landed a contract to build a new office complex, and it includes multiple phases like:

• Site preparation
• Foundation work
• Building construction
• Interior finishing 

Each phase requires its own budget, timeline, and resources. Project-based accounting helps track every dollar spent on the office complex. It also lets you monitor the costs of materials, labor, and equipment for each individual phase so you can stay on budget and ensure resources are used efficiently. This approach also lets you identify any financial issues before they become bigger problems.

Components of project-based accounting

Project-based accounting has a lot of moving parts, and tracking project progress and costs means thoroughly understanding them.

Job costing

Job costing involves detailed estimates of material quantities, labor hours, and equipment usage in construction. By comparing these estimates to actual costs throughout the project, you can identify variances and make adjustments as needed. 

Estimate, track, and analyze all project costs, including your direct and indirect costs. Direct costs include labor, materials, and equipment, while indirect costs cover overhead and administrative expenses. To set a realistic budget and timeline, you should try to account for every cost you might incur.

Project forecasting

Based on your current data, project forecasting helps you predict future costs, forecast revenue, and estimate timelines. Project forecasting helps project managers prepare for potential challenges and determine how best to keep things on track. Like project costing, this is an ongoing process, and you should update it regularly when data becomes available. 

For example, project forecasting was especially important during the pandemic when bottlenecked supply chains caused delays in material deliveries. In addition, the materials themselves became more expensive. With project forecasting, construction companies were better prepared to adjust their budgets accordingly.

Resource management

Resource management can help you save time and money on your project. By using labor, materials, and equipment efficiently, you can better ensure that resources are allocated effectively, reduce waste, and minimize delays. 

On a construction site, resource management may involve scheduling workers in shifts to help ensure the project progresses steadily without downtime or bottlenecks. You may also have time blocks to be mindful of. For example, if you’re repaving a busy road, you might be limited to late nights and weekends and must plan to use your resources accordingly. 

Revenue recognition

Revenue recognition refers to when and how revenue from a project should be recognized in your company’s financial statements. You’ll usually receive payments in stages for long-term projects like a new office complex. Identifying what these stages are will help you budget for them. 

You may recognize revenue during each completed milestone, like finishing the foundation or installing the roof. When done well, revenue recognition ensures that your company’s financial statements accurately reflect the project’s progress and economic health.

Project-based accounting methods

There’s no one right way to recognize revenue and track financial performance. What project accounting best practices you choose depends on the nature of the project and your company’s accounting policies. Here are a few to consider:

• Completed contract: This method is often used during shorter projects where costs and revenues are challenging to estimate accurately. If you’re contracted to build a small residential home, it may make sense for you to recognize all revenue and costs after the property is fully constructed and delivered to the buyer. 
• Cost Recovery: The cost recovery method is a more conservative approach that recognizes revenue only after recovering all project costs. You might consider using this method for high-risk projects where the final cost is difficult to predict due to challenging environmental conditions or really complex designs. 
• Percentage completion: This method recognizes revenue and costs proportionally as the project progresses. For example, if your company is building a whole neighborhood of similar homes, you might recognize revenue and costs based on the individual completion of each home or after reaching a certain milestone across all homes (e.g., completing the foundation, constructing each kitchen, etc.). 
• Sales basis: With this method, you recognize revenue only once the project is sold or delivered to the client. For example, if you’re working on a home development, it may make sense to recognize revenue only when each home gets sold.
• Installment: The installment method recognizes revenue when you receive payments from the client. Typically, the method is preferable when you have long payment terms or where the client pays in installments over time. Often, the installments include a down payment, additional percentages after milestones are achieved, and a final payment upon project completion. 

To effectively keep track of your project’s finances despite the method you choose, make sure you’re following these key principles.

Why project-based accounting is important

When you have multiple projects going on simultaneously, you need an accurate account of each one. Each project can significantly impact your company’s overall financial well-being.

Here are the benefits of project cost accounting:

• Accurate expense tracking: Precise tracking of all project-related expenses, ensuring that costs are allocated effectively and budgets are adhered to. 
• Improved project profitability: Companies can monitor each project's revenue and expenses closely. Adjustments can be made as the project progresses to help maximize returns. 
• Enhanced resource management: Reduce waste, minimize delays, and ensure efficient use of labor, materials, and equipment.
• Better decision-making: Forecast future costs, set realistic budgets, and identify potential financial challenges before they become bigger issues. 
• Improved financial control: Get a clear picture of the financial health of each project you have under contract. The better you understand each project’s financial status, the easier it is to maintain better control over projected revenue and avoid surprises at the end of the project.

How to implement project-based accounting

Here’s how to successfully build out and maintain a project-based accounting system for your business: 

1. Set your project structure: Define the types of projects your company undertakes. Create a structure that includes project phases and sub-ledgers for tracking expenses and revenues. 
2. Create a budgeting system: Develop a system for budgeting labor, materials, overhead, and other project-related costs, and make sure you’re accurately tracking all of these costs against the budget.  
3. Set up cost codes for tracking: Assign cost codes for different categories within a project, like labor, materials, and equipment. Creating these codes will help you track costs more accurately and identify any budget variances. 
4. Implement expense management: Define expense policies and use expense tracking tools to monitor project-related expenses. Then, double-check to ensure that you’re properly documenting and tracking all of these expenses. 
5. Create financial reports: Determine what metrics and regular reporting periods you’ll use to monitor project progress and financial health. These financial reports will provide insights into each project’s performance. 
6. Monitor and analyze projects: Track key performance indicators (KPIs) like resource utilization and budget variance. KPIs will help you identify trends, make data-driven decisions, and improve project performance.

Overcome obstacles and drive growth in your midsize business 

Managing multiple projects simultaneously while also staying profitable is no small feat. Project-based accounting provides the tools you need to navigate these challenges by offering detailed insights into each project’s financial performance. 

Getting started with project accounting isn’t easy, but an all-in-one enterprise resource planning system like Intuit Enterprise Suite can help you manage your finances with precision and ease.