COST REPORTING VERSUS COST CONTROL

Cost reporting is where the accounting system provides management with the accounting data after the opportunity has passed for management to respond to and correct the problems indicated by the data. When companies wait to enter the cost of their purchases until the bills are received, management does not know if they are under or over budget until the bills are entered, at which time the materials purchased have been delivered to the project and may have been consumed. The extreme case of cost reporting is where companies only look at the costs and profit for each project after the project is finished. Cost reporting is typified by the accounting reports showing where a company has been financially without giving management an opportunity to proactively respond to the data.

Cost control is where the accounting system provides management with the accounting data in time for management to analyze the data and make corrections in a timely manner. Companies that enter material purchase orders and subcontracts, along with their associated costs, into their accounting system as committed costs before issuing the purchase order or subcontract allow management time to address cost overruns before ordering the materials or work. Committed costs are those costs that the company has committed to pay and can be identified before a bill is received for the costs. For example, when a contractor signs a fixed-price subcontract he or she has committed to pay the subcontractor a fixed price once the work has been completed and, short of any change orders, knows what the work is going to cost. Accounting systems that track committed costs give management time to identify the cause of the overrun early on, identify possible solutions, and take corrective action. Cost control is typified by identifying problems early and giving management a chance to proactively address the problem. A lot of money can be saved by addressing pervasive problems—such as excessive waste—early in the project.

If a company’s accounting system is going to allow management to control costs rather than just report costs, the accounting system must have the following key components:

First, the accounting system must have a strong job cost and equipment tracking system. The accounting system should update and report costs, including committed costs and estimated cost at completion on a weekly basis. Having timely, up-to-date costs for the project and the equipment is a must if management is going to manage costs and identify problems early.

Second, the accounting system must utilize the principle of management by exception. It can be easy for managers to get lost in the volumes of data generated by the accounting system. The accounting system should provide reports that allow management to quickly identify problem areas and address the problems. For example, as soon as bills are entered into the accounting system, management should get a report detailing all bills that exceed the amount of their purchase order or subcontract. Problems that are buried in volumes of accounting data are often never addressed because management seldom has time to pour through all of the data to find the problems or if they are found they are often found too late for management to address the problem. Providing reports that flag transactions that fall outside the acceptable limits is a necessity if management is going to control costs. By having reports that flag items that fall outside acceptable limits, management can make addressing these items a priority.

Third, accounting procedures need to be established to ensure that things do not fall through the cracks. These procedures should include things such as who can issue purchase orders and what to do when a bill is received for a purchase order that has not been issued. The procedures should also identify the acceptable limits for different types of transactions. Procedures ensure that the accounting is handled in a
consistent manner and give management confidence in the data that it is using to manage the company.

Finally, the data must be easily and quickly available to management and other employees who are directly responsible for controlling costs. It does little good to collect cost data for use in controlling costs if the data cannot be accessed. Where possible the reports should be automatically prepared by the accounting software. This eliminates the time and effort needed to prepare the reports manually. Additionally, frontline supervisors who are responsible for control costs should readily have access to their costs. Holding supervisors responsible for costs at the end of a job while not giving them access to their costs throughout the project denies them the opportunity to proactively control costs.

The accounting system for many construction companies consists of three different ledgers: the general ledger, the job cost ledger, and the equipment ledger. The general ledger tracks financial data for the entire company and is used to prepare the company’s financial statements and income taxes. The job cost ledger is used to track the financial data for each of the construction projects. The equipment ledger is used to track financial data for heavy equipment and vehicles. All construction companies should have a general ledger and a job cost ledger. Companies with lots of heavy equipment or vehicles should have an equipment ledger.