Accounting Concepts Used with Project Initiation

It is important for project managers to have a good general understanding of the basic accounting principles that apply to their projects. Nearly all phases of the project life cycle require some type of accounting processes and valuation. Even initiation requires projects to be evaluated for the benefit to the organization. We discussed the two general categories of project selection methods earlier in this chapter. Both benefit measurement methods and constrained optimization methods require the application of some accounting methods.

You will need to understand several cost accounting concepts that are frequently used when performing the project selection process for the PMP exam. Of the two main project selection methods, the benefit measurement methods require more cost calculations. You are not expected to be an expert at cost methods for the PMP exam. However, you will have to understand all of these accounting concepts and know how to use them during the project selection activity. Table 2.2 lists the main accounting concepts you will need to know and how they relate to project selection.

Table 2.2. Project Selection Accounting Concepts

Accounting Concept	Description	Keys for Project Selection	Notes
Present value (PV)	The value today of future cash flow	The higher the PV, the better.	PV = FV/(1 + r)n
Net present value (NPV)	The present value of cash inflow less the present value of cash outflow	A negative NPV is unfavorable; the higher the NPV, the better.	Accounts for different project durations
Internal rate of return (IRR)	The interest rate that makes the net present value of all cash flow equal zero	The higher the IRR, the better.	The return that a company would earn if it invested in the project
Payback period	The number of time periods required until inflows equal, or exceed, costs	The lower the payback period, the better.
Benefit cost ratio (BCR)	A ratio describing the relationship between the cost and benefits of a proposed project	A BCR less than 1 is unfavorable; the higher the BCR, the better.
Opportunity cost	The difference in benefit received between a chosen project and a project that was not chosen
Sunk costs	Money that has already been spent and cannot be recovered	This should not be a factor in project decisions.

PMI also expects a project manager to understand other accounting concepts. Table 2.3 lists some of the most common accounting concepts you will need to know for the PMP exam.

Table 2.3. General Accounting Concepts

Accounting Concept	Description	Notes
Variable costs	Costs that change based on an organization's activity	For example, fuel costs
Fixed costs	Costs that remain constant, regardless of activity level	For example, rent and lease payments
Direct costs	Costs that can be directly associated with the production of specific goods or services	For example, labor and material costs
Indirect costs	Costs that cannot be directly associated with the production of specific goods or services	For example, legal costs, administration, and insurance
Working capital	Total assets less total liabilities
Straight-line depreciation	A depreciation method that evenly divides the difference between an asset's cost and its expected salvage value by the number of years it is expected to be in service	The simplest method
Accumulated depreciation	A depreciation method that allows greater deductions in the earlier years of the life of an asset	Double declining balance (DDB)
Life cycle costing	Includes costs from each phase of a project's life cycle when total investment costs are calculated

These accounting principles represent one area of project management (and general management) a project manager must understand. There will be several general management concepts on the PMP exam. Don't worry, though, because you will only be required to understand the basic concepts because they will affect projects.