By Santosh Behar
Image Courtesy: Gerd Altmann at Pixabay.com
Standard Accounting for a firm deals with the accounting for a company as a whole, usually within a fixed time period (i.e. quarterly or annually). On the other hand Project Accounting monitors the financials of individual projects.
These days more and more companies are earning significant revenues through project implementations. Mostly, such companies have Projectised or Matrix organisational structures and the majority of the organisation’s resources are involved in project work. The project work is generally completed for the benefit of an external customer and in such organisations, Project Managers have greater autonomy to run the projects. Nevertheless, the project financials are coupled with organisational financial considerations. Therefore, it is important for Project Managers not only to have an in-depth understanding of project accounting but also to have a reasonably good understanding of Standard Accounting.
In recent past, many Financial Accounting Experts have done analysis on Toshiba's Accounting Scandal (year 2015). Going through following compilation of some of findings of this scandal can be interesting for project management professionals. They may find it useful to link the significance of day to day project accounting with larger perspective of standard accounting.
So, the story in short is that the global economic crisis in the year 2008 and an earthquake that triggered a tsunami in the year 2011 had a significant impact on the operations and businesses of Toshiba. Despite this, Toshiba’s performance improved and was profitable from the year 2010-11. Later on, it was revealed on investigation by Securities and Exchange Surveillance Commission (SESC) that Toshiba inflated earnings by at least $1.2 billion during the period 2009-2014.
The rest of the blog is an attempt to illustrate some of the points on the scandal that could be relevant for Project Management:-
Faulty use of the percentage-of-completion method of accounting - A large part of the problem stemmed from improper use of an accounting method called “percentage-of-completion”, which is commonly used in long-term projects. More specifically under this non-cash flow method, the accounting treatment for contract work in a fiscal year is estimated and the income and cost of the contract for the current accounting period is reported on that basis. Toshiba claimed that the problem was caused by work in electricity generation, railways and related projects; these groups had focused too much on attaining their profit targets by improperly lowering expenses in the near-term periods. Managers did this in the knowledge that it violated the principles of the percentage-of-completion approach. (Reference - Global Advanced Research Journal of Management and Business Studies (ISSN: 2315-5086) Vol. 5(4) pp. 088-101, April, 2016)
Related Points to Note for a Project Manager - Complex projects may have multiple inter-dependent parts or certain aspects involving organisational change management, engineering work, process re-engineering or automation related work (or all of these complexities). For such projects, at many instances, it becomes extremely difficult to assess the extent of completion of work (and forecasting on following related pieces of work), even with data available through reasonably good project management metrics. In addition, quite often Project Managers have to take a judgement on percentage of completion of work for a certain duration of time (Quarter, Annual). These time periods are not always in sync with the project delivery timelines or project milestones. Moreover, any project manager will tell that the applying accounting principal of conservatism for financial reporting is strongly contested by increasing expectations of the client and senior management (of the organisation responsible to execute the project) to see the project going perfectly as per estimated cost, time and quality.
Therefore, a Project Manager must take cognizance of the fact that an accurate and well-judged reporting of percentage-of-completion (by most of the projects) becomes basis for correct accrual entries ensuring certainty of realization of revenue.
Padded Accounts for Accommodating Stopgap Measures - The Company (also) padded accounts by adjusting the inventory records of its semiconductor business. However, stopgap measures implemented for the sake of temporarily boosting profits had to be accounted for in subsequent accounting periods. And as a result, Toshiba found itself in the position of needing to continue padding its books. (Reference- www.nippon.com/en/in-depth/a04802)
Related Points to Note for a Project Manager - A project is a Temporary Organisation with a definite beginning and a definite end but the point to note is that the organisations having stake on the project are not temporary (in nature). Many times these organisations have their own interest on different outcomes of the project and they exert pressure to see the outcome of their own interest getting realized without giving heed to fulfilment of overall objective of the project. In such a circumstances, a Project Manager should avoid getting lured to stopgap measures as an arrangement to manage powerful stakeholders.
In this regards, it is observed that many a times, contrary to expectations of a Project Manager, even cautiously manipulated project accounts for stopgap measures get difficult to do away with over the due course of time (the assumption of either getting space to hide the stopgap measures in future accounting entries or to garner a relevant justification to justify stopgap measure does not always succeed).
Carryover to delay Expenditure - Toshiba’s television manufacturing unit put off booking losses by using “carryovers,” requesting vendors, for example, to postpone issuing invoices for advertisement, distribution, or other services until the next quarter, while moving up projected discounts on parts to the current accounting period. In addition, it inflated profits by boosting prices of products sold to overseas affiliates. (Reference- www.nippon.com/en/in-depth/a04802)
Related Points to Note for a Project Manager - Financial accounts are assumed to portray the reality of financial transactions. A deliberate attempt to manipulate different component of transactions to make the project financial look healthy by many project managers of an organisation can always lead to inflated financial statements of the organisation. Adherence to accounting principal of matching must be observed to the best possible extent.
Inappropriate Recording of Outsourcing Transactions - In its personal computer business, the company inflated revenues through transactions with manufacturers producing Toshiba-brand computers under contract. Toshiba sells the manufacturers key parts for the computers and then buys the finished products from them. To avoid revealing the actual prices of its parts to competitors, the company sells them at an inflated “masking price” to the manufacturers and it buys the finished computers from them at a price that adds production and other costs to this inflated amount. Since the high masking price for the parts is offset by a correspondingly inflated price for the finished product, the gains on these sales of parts cannot properly be booked as profits. But that is what Toshiba did. Over the years, the company raised its masking prices until they were almost five times the actual cost of the parts. And by forcing manufacturers to buy more parts than they needed, Toshiba was able to make its profits for the current accounting period look bigger. (Ref- www.nippon.com/en/in-depth/a04802)
Related Points to Note for a Project Manager - Project Managers dealing with turnkey projects have to depend on external entities for executing project. It is not very common for a company to have specialization on the whole gamut of product, services, skills and expertise required for any turnkey projects. Project Managers must ensure principals of accounting (like conservatism, matching) are followed while recoding transactions with external vendors. Appropriate controls and checks and balances should be put in place to ensure that the business relationship with vendors remain in strict conformance to the contractual obligations. Where ever deemed appropriate reasonability of rates and appropriate quantity of product and services must be verified.
Business Environment and Work Culture - In the Japanese business community, subordinate employees are expected to demonstrate a deep level of commitment and loyalty to their corporate managers. Under the (Japanese) principles of makoto, it is disrespectful for an employee to speak or act outside the scope of his or her prescribed position. This belief system prevents many individuals from challenging the decisions of their superiors, and discourages them from disclosing any problems that may arise. In return, superiors will often reward their most loyal employees with respect, appreciation, and even promotions. Thus corporate managers are able to consolidate their power by surrounding themselves with employees who are committed to following their orders. In addition to the values of makoto, Japanese ideas of cultural harmony also play a big role in facilitating corporate misconduct. At its core, cultural harmony can be best described by the Japanese proverb, “the nail that sticks out gets hammed down,”—meaning that its better to follow the group than to stand out. Thus, “groupthink” dominates Japanese corporate culture.
Related Points to Note for a Project Manager - It may be noted that time and again cases of corporate governance failures have provided evidence that good corporate governance structure does not necessarily lead to good corporate governance. But, regional business culture and organisational culture is a critical determinant of the quality of corporate governance.
Within organisations, it’s the People, who follow processes. It may be noted that when it comes to following the accepted processes in true spirit, it has been widely observed that among so many tempting and directive forces trying to influence an employee to deviate from adherence to processes (or regulations), usually most employees eventually end acting in accordance to cultural norms. Project Managers therefore must be empowered for promoting a culture of ethical corporate values.
In addition, an independent and sensible internal audit team may be given adequate powers to conduct independent audit. Very experienced and senior experts must become member of audit team. Internal audit can function independently only if the audit committee is capable, independent and effective, and but more importantly, the internal auditors should report to an independent body of audit committee. Project Managers must be open for audit and advice by audit team on critical decision making.
About Santosh Behar
Santosh works as a Sr. Manager in the IT and eGovernance sector at IPE Global Limited. He is an Information Technology (IT) professional with Masters in “Entrepreneurship & Innovation Management” from Royal Institute of Technology, Stockholm. He is a PMP (Project Management Professional) and has more than seventeen years of experience in IT industry. He is an Engineering graduate from BIT, Durg and in addition to Development Sector, he has also served in Telecom Sector in his professional career.