Why Cost Engineering shall be D-E (Dual-Entry Accounting)
This article describes advantages resulting from utilizing Double-Entry Accounting in Project Cost Planning and Control.
Before we proceed, let us clarify the definition of D-E Cost Engineering. Namely, it shall comprise activities of cost planning and control related to EPC (Engineering, Procurement, Construction) projects, expressed mainly from the point of view of project accounting, executed by the Cost Engineer. This excludes activities of man-power & man-hour planning and control occurring on Engineering-only projects, where Cost Engineers are not dealing with the related $-costs (usually considered as confidential).
If you are a professional Cost Engineer or a Project Manager you know the current methodology of Project Cost Control, and you may wonder why Cost Engineers should learn something new, so far unproven, and apparently complex such as DEBIT=CREDIT.
There are three (3) good reasons why:
To change the mentality of Cost Engineers so that they can think and do their calculations like all finance people do.
To involve Cost Engineers in all aspects of Project Cost Engineering, inclusive of the major part that presently is handled by Project Accountants only.
To make Cost Engineers able to discover project-cost overruns immediately when they see related project invoices, without waiting for Project Accountants to supply data on bills already paid.
1. To change the mentality of Cost Engineers
Presently Cost Engineers are using the Single-Entry Accounting (C = A + B) method when creating and maintaining cost accounts of their projects. This method of accounting is simple and appears natural. It is being used almost by everybody, for example, by housewives for planning and recording household expenses, and by any person for updating his/her bank check-book. However, only all finance people - such as accountants, bankers, loan managers, real estate officers, stock-market brokers - since over 500 years use the Double-Entry (DEBIT=CREDIT) accounting. Click here to refresh your understanding of Single-Entry and Double-Entry accounting methods.
However, this single-entry accounting methodology has a negative impact on the mentality of Cost Engineers. Although cost magnitude of their projects may reach billons of dollars, they neither think nor execute their calculations the way finance people do, ignoring the powerful concept of DEBIT=CREDIT of Double-Entry Accounting. Where even the most complex operations of a manufacturing plant, or a any big business, can be managed by only one Accountant, today every large engineering project must employ both the Cost Engineer and the Project Accountant. The reason is that: by using the single-entry accounting methodology, Cost Engineers are unable to handle alone all cost aspects of EPC projects. They need help, now provided by Project Accountants who handle the important part of EPC project cost accounting, comprising accounts of involved contractors, suppliers and engineering firms.
2. To involve Cost Engineers in all aspects of Project Cost Engineering
Presently Cost Engineers are using the Single-Entry accounting methodology when creating and maintaining cost accounts of their projects. They maintain many separate accounts, each covering some project cost element, such as one construction object, one material, or one engineering task. However, all accounts related to contractors, suppliers, and engineering firms are maintained by the Project Accountant and not by the Cost Engineer. In this accounting system, there is no network that could bind all accounts and yield logical project financial cost statements, the way possible in Business Accounting. Current progress is being measured by Earned Value figure, representing some percentage of work advanced or materials supplied. This Earned Value figures (supplied by Project Engineers, Field Engineers, and Procurement Engineers), plus the related Current $-Expenditures (supplied by the Project Accountant) are used by the Cost Engineer to calculate the current cost overrun or under-run. Click here to read the pertinent Single-Entry formulas of the current Cost Control methodology. For comparison, click here to see the Dual-Entry formulas of D-E Cost Engineering, and click here for one example proving validity of the D-E formulas.
The D-E Cost Engineering utilizes the Dual-Entry accounting methodology, similar but not the same as that of Business Accounting. Click here to compare the leading equations governing Business Accounting versus Project Accounting. Click here to see the comparison of Business Accounting versus Project Accounting. There exist always an active cost network: click here. There are four journals, that must always balance: DEBIT=CREDIT. In the Forecast Journal cost estimates and change orders mean FORECAST (CREDIT), and they are offset by the funds required REQUEST (DEBIT). In the Expense Journal the cost of work advanced in CONSTRUCTION and ENGINEERING (assessed by Earned Value), or in MATERIALS (assessed by issued purchase orders and requisitions and expressed as Earned Work) means ACTUALS (DEBIT), and it is offset by the equivalent dollar amounts credited to Contractors, Suppliers, or Engineering Firms EARNED (CREDIT). In the Booking Journal invoices issued by Contractors, Suppliers and Engineering Firms mean PAID (DEBIT), and they are offset by the corresponding funds identified as Direct Costs or Indirect Costs, BOOKING (CREDIT). In the Commitment Journal funds supplied by the Project Sponsors AVAILABLE (DEBIT), and they are offset by the corresponding funds identified as COMMITTED (CREDIT), always expressed as Direct Costs or Indirect Costs. In all journals the sum of DEBITS must be always equal the sum of CREDITS. There are four (4) types of accounts. Cost Account contains records of cost forecasted FORECASTS (DEBIT) versus costs reported ACTUALS (CREDIT). Expense Account contains records of costs earned EARNED (DEBIT) versus costs paid PAID (CREDIT). Booking Account contain records of invoices and bills paid BOOKED (DEBIT) versus funds used to pay COMMITTED (CREDIT). Commitment Account contains records of funds requested REQUEST (CREDIT) versus funds available AVAILABLE (DEBIT). During the project progress, the sum of Credits and the sum of Debits generally will remain unequal within each account. Analyzing these differences, Project Management can have good picture about the current status of any account. At the project completion, all accounts should balance (DEBIT=CREDIT), except for those accounts where is an overrun or under-run. On complex projects gWbs Accounts are used to summarize cost of various project objects, and to calculate and to supply the current Global Earned Value and Global Earned Work to the corresponding Cost Accounts and Booking Accounts, via the Expense Journal. Finally, D-E Accounting supplies also various Ledger Reports, Project Cost Financial Statements , Cash Flow with Commitment Report, and Time-Cost Reports with histograms and S-Curves.
3. To make Cost Engineers able to discover project-cost overruns immediately
The Cost Engineer is the first one who knows what invoices and what purchase orders must be paid and when. These documents are checked by him, approved by the Project Manager, and only then forwarded to the Accountant. However, the single-entry accounting methodology does not permit the Cost Engineer to maintain accounts of all (often more than hundreds) involved contractors, suppliers and engineering firms, as necessary to get the current balances needed to calculate overrun or under-run of each account, as well as that of the total project. The Project Accountant - who handles (easily, using the dual-entry accounting) accounts of the Project Participants - supplies the Cost Engineers with the balances of these accounts, but usually with some delay (even as long as 90 days, required by rules of Accounts Payable). Therefore, in cases of cost overruns, it is often too late for the Project Management to take any remedial action. Click here to read about some examples - EXAMPLE #1 and EXAMPLE #2 - demonstrating the Cost Engineer's problems and how they can be resolved.
Implemented in the current Cost Control, the single-entry accounting method makes Cost Engineers unable to handle all cost aspects of engineering projects, making them dependent on Project Accountants. Only the dual-entry accounting method, fully proven in Business Accounting, can make Cost Engineers fully capable to plan and to control easily and efficiently all aspect of engineering project costs.
Yet today, many experienced Cost Engineers - of whom perhaps more than 95% are unfamiliar with Business Accounting - may still see the Dual-Entry Accounting as complex and useless, something that could only complicate their current way of doing job. They do not see the Project Cost from the point of view of Project Sponsors or General Contractor ("watching each dollar transaction"), but rather from the narrow perspective of the Project Scheduler. Thus today, Cost Engineers concentrate on tracking project work progress and incorporating the best practice of Cost Loaded Scheduling and Earned Value Management (EVM) Principles, making necessary the employment of Project Accountants for handling the other half (BOOKINGS and COMMITMENTS) of the Total Project Accounting. Although this arrangement reduces the Cost Engineer's work load, yet it makes him unfamiliar with accounts of Project Participants, and thus it makes the Project Accountant - and not the Cost Engineer - knowledgeable and responsible for handling all important monetary transactions related to accounts of participating contractors, suppliers and engineering firms. Missing the instant knowledge of the status of these accounts - because depending on Project Accountants, today Cost Engineers are unable to discover dangers of cost overrun as soon as they see the submitted invoices.
Of course, Cost Engineers can become fully knowledgeable to the degree to make Project Accountants redundant in the future. Therefore, if you are the Cost Engineer, you should learn Business Accounting too, as this would allow you to think and to act in the DEBIT=CREDIT terms, the same way as all finance people think and act. Learning first the Project Accounting can make your learning Business Accounting easier, and vice versa. Fortunately, the first Project Accounting computer program (TECA) is already available. Nevertheless, considering the mentality of many Cost Engineers today, it is possible that only future generation of Cost Engineers - already familiar with Business Accounting and supported by TECA or other similar computer programs - will utilize the D-E Accounting principles worldwide.