There is a good maxim that every form should be as much use to the person completing it as the person who gets it. Good forms are the keystone of any system and one can never spend too much time on their design in order to get the most effective result.
The form used to set the budget is called a 'budget setting form'. It should be arranged so that it helps the manager to prepare the budget and be useful for reference later. Although he can group items into cost centres as he wishes, in most industries there are some fairly conventional ways of grouping costs and it is perhaps best to adhere to these conventions whenever possible. It is particularly important to try to be consistent and keep the same groups and cost centres from year to year in order that useful comparisons can be made. With this in mind, budget setting forms should be pre-printed to ensure standardisation, not only of groups and cost centres but also oflayout.
To avoid excessive detail on the budget setting forms it is preferable if small items grouped into cost centres are listed in a separate manual for easy reference. Thus the form should be as uncluttered as possible and only contain relevant detail.
On examining the cost centres of each department it will be found that some departments e.g. Supplies, have many while others e.g. Insurance, have few. In order to be able to summarise the costs easily on the form, they are grouped together as follows:
Cost centres are desil\Dated 3 rd category costs.
Groups of3rd category costs are designated 2nd category costs.
The swn ofal! the 2nd category costs is the 1st category or department cost.
As stated earlier, ifthe cost centres, or 3rd category costs, are composed of a number of items, these are not shown on the budget setting form but are listed in a manual. In departments where there are very few cost centres, they will be designated 2nd category costs.
It should be noted that in addition to the need to group large numbers of cost items, there are requirements for different levels of information.
Whereas top management may only want to know the total ship costs, or the ship costs broken down into departmental totals, the ship manager will want more detail and the departmental manager will want even more, to be able to highlight fluctuations in the cost centres. The significance of this will be seen when the aspects of control are considered.
One cost centre which should be carefully avoided is that of miscellaneous, a convenient dustbin into which staffcan place costs rather than take the trouble to seek the appropriate allocation. There should never be a miscellaneous section in any budget as every item of any significance should be accounted for.
Each cost centre is usually given a code number which forms part of the overall coded company accounting system and these are printed on the budget setting form. Codes simplify the allocation of costs, and adapt well to computer and other accounting equipment. It is usual to arrange the codes into numbered groups and sub groups for easy identification of departments and categories; for examp le, crew costs may be arranged into a 3000 series, technical costs into a 4000 series and supplies costs into a 5000 series. Taking this one step further, 2nd category 'crew wages' may be arranged in the lOO group of the 3000 series (3100), 'crew travel' may be arranged in the 200 group (3200) and 'crew other costs' into the 300 group (3300). 'Ten' groups are arranged for 3rd category costs. These groups are usually preceded by a code to identifY the ship and followed by other code groups used by the accounts departmentto identify suppliers, items to be recharged, etc.
Although the budget is for a whole year, it is usual to show costs for each quarter year on the budget setting form, in order to highlight exceptional changes compared with other quarters. To provide for this the budget setting form is usually arranged with columns
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Head Code: ,1. Series 5000
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for costs for the four quarters and a total column for the year, Finally, each budget form should have space to show in writing all assumptions used and estimates of out-of-service time for dry-docking, crew changes and any other items of importance,
During the preparation ofthe budget anumber of notes and calculations will be made in order to arrive at the figures and data entered on the budget setting forms, These should be kept carefully on file for reference and future use, The importance of these notes should not be underestimated,
There should be only one budget. The draft or proposed budget being only a draft is not a budget until properly approved, Once approved it should remain unchanged, Ifth is rule is ignored, terms such as revised budget, first budget and second budget arise and staffbecome confused as to which budget people are actually referring, This causes considerable difficul tieswhen explanations of differences between the budget and actual figures are required, Adherence to the 'one budget' rule will ensure that the yardstick against which results arc measured remains the same, Budgets have an additional use in that the infonnation contained in them can be of considerable use in research and development projects, The data can save considerable time when a quick idea of costs is required and can be adapted to suit a particular project.
Once the background notes and calculations are finished the next step is to transfer the data and fill in the budget setting forms, Providing one's writing and figures are reasonably neat and legible it is preferable for the fonns to be handwritten for the following reasons: if copied by a typist errors may occur: and the figures will be transferred to a computer or other
124 THE NAUTICAL INSTITUTE
business system and thus it does not matter whether they are typed or handwritten, In other words, the less the figures are copied the better.
To summarise
A budget is a plan in financial terms,
It is based on the plans and policies of the company or organisation and on good infonnation,
Its creation and implementation is the responsibility of management with the approval of senior or top management.
It must be both realistic and challenging,
It must be meticulously prepared and produced in accordance with an agreed tim e table,
It should consider every factor and each factor or group offactors should be given a cost centre labeL It should never have a miscellaneous cost centre, It should be prepared on a standard fonn which should aid managers before and after the budget is approved,
There should only be one budget.
Accounting practices
One of the difficulties experienced by ship managers when dealing with accounts and accountants lies in reconciling the financial datapresented to them to events which they know have occurred, This is largely because accountancy is based on anumber of philosophies regarding the arrangement of business accounts whi ch appear strange to those not initiated into the mysteries oftheir conventions and practices, Fortunately the development of management accounting has resulted in data which is much easier for non-accountants to comprehend, but there is, like many professions, a certain amount of professional jargon which needs to be understood, For example certain computer output sheets may be referred to as 'journals' or 'ledgers' which they are not, in the sense of bound books, but are so called because they contain the information which used to be contained in ledgers andjournals when infonnation was recorded by hand, Accounts are prepared for three reasons: to show the financial position of the business; to allow tax calculations to be made; and to provide management with the information it needs to exercise proper controL
Accounting is the method of recording the money value ofbusiness transactions, sales, purchases, receipts and paym ents,
FlnanclaJ accounting or reporting analyses the income and expenses(costs),by the type oftransaction - e,g, cash, stock, creditors, debtors, assets, liabilities etc,
Cost accounting provides analyses ofthe costs of a business by function or activity, It is most effective in m anufacturing and similar in dustries,
Management accounting or reporting presents relevant, up to date and accurate information to management to assist in the operation and control of the business. Like cost accounting the information provided is based on functions and activities - e.g.
crew, technical supplies, etc. just as a manager's plans form part ofthe larger unit or corporate plan, so the budget he prepares and the costs he incurs form part of the overall corporate accounts and management information data of the business. These are recorded and presented in a number of different ways in the following accounts, statements and plans:
Balance sheet: Is a statement of the assets, share holders equity and liabilities ofa company at a given moment in time. They are defined as long and short term as appropriate. For the purpose ofthese extracts it is sufficient to say that the effects of costs eventually find their way through to the balance sheet, shown under the heading of the 'profit and loss account'.
Profit and loss account or revenue account: Is a financial acc ounting statement which shows the earnings and expenses (costs) of the company for a given period. Running costs are seen more clearly in this account although the amounts need not relate directly to money spent during the period due to the accounting 'treatment' of certain expenses - i.e. when the money is considered to have been spent.
Management accounts or reports: Show the manager the detail he requires to control the department for which he is responsib le. They show the total costs of each cost centre for the period and the year to date although, as in other accounts, the amounts accounted for will not necessarily relate to money actually spent. For comparison purposes the management accounts or rep orts will also show the budget for the period and year to date and any variances between the two sets of figures. The costs themselves can also be broken down into various components showing sums actually paid, assumed to have been paid or apportioned as will be described later.
Cash fiow statement: Is a month by month statement of anticipated actual earnings and expenditure over a given period, summarised each month to show the high and low points of the actual cash situation. It highlights irregularities in the flow of cash and gives warnings of when there may be a shortage of cash, despite the fact that over the total period earnings may exceed expenditure. Managers may be required to supply data for these statements and in such cases the budget notes will be of considerable value.
Budgets: These have been described in some detail earlier. However, it is important to draw a distinction between the estimated expenditure shown on a budget setting form and the cash flow statement, with which it is sometimes mistaken. The budget shows costs
expected to be incurred but which may not in fact be paid in the period, while the cash flow statementshows the actual movement of cash. For example, the cash flow statement would show the cost of an insurance premium when it is paid, whereas the budget would show the cost to the ship per month or quarter - i.e.
spread over the period of the insurance cover. Because budgets form part of the total accounting system it is important that their format aligns itselfwith the format of other accounts.
Treatment of costs: It is most important that the accounting treatment of costs referred to earlier is consistent. Ship managers must have an understanding of the way the costs are 'treated' or dealt with, if they are to relate the facts presented in management accounts to what they know has actually happened The treatment with which ship managers are most likely to be associated are as follows:
The prudence concept: This is an accepted accountancy practice which indicates how a prudent businessman would 'treat' earnings and expenditure.
In essence the philosophy is that exceptional or uncertain earnings should not be accounted for - i.e.
considered as being earned - until they have actually been received, but once defined costs are incurred they should be accounted for even though not actually paid. It is important to note that although the emphasis is on 'prudence', much depends upon the type of transaction or business and the policy of the company.
Accrued and prepaid expenses: While the prudence concept endeavours to ensure that once costs are incurred they are included in the accounts, even if not paid, another concept ensures that only those costs which refer to the accounting period are included in the accounts. The resultant allocations and apportionments are known as accrued and prepaid expenses.
Accrued expenses: These are costs which have been incurred in the period but for which payment has not been made. Although there may be some flexibility, in the main any such sums 'accrued' would be known fairly accurately, such as a bill agreed with a repair yard but only part paid, the balance being due after the end of the accounting period. As the outstanding amount is known accurately it would be accrued accordingly.
Example: Ship repaired during the 4th quarter of the year.
On completion of repair costs agreed as Agreed sum paid on leaving repair yard Balance due in 3 months i.e, in next financial year
But4th quarter accounts show total repair costs
$ 520,000
120.000 400.000 520,000
Prepayments: These are items such as rentals, property taxes and insurance premiums which are paid in advance for a period which does not align itself with the current accounting period. The total sum has been paid but only part applies to the accounting
period; therefore only the appropriate proportion is shown in the accounts and the balance is carried forward to other accounting periods.
Example: Insurance premiums paid on 1st April for one year
$
Actual Cost 10.000
2nd Qtr accounts show 2,500 cost 3rd Qtr accounts show 2,500 cost 4th Qtr accounts show ~ cost
Total for year 7,500
Balam:e ofthe premiwn of$2,500 is carried fOlward and shown in 1st Qtr of next year's aCcoWlts.
Provisions: are sums of money accounted for as costs in two principal categories.
Depreciation: this is a charge to the accounts to reflect the use of an asset and its reduction in value over its useful life. As the depreciation period is usually longer than the accounting period a charge is made in each accounting period equal to the proportionate reduction in value ofan asset. The treatment of this is very much a bookkeeping exercise as the depreciation will, in time, reduce the value to nil although the asset will still have a real value which in the case of a ship is its scrap value. Depreciation is a som ewhat c om plex su bj ect entering into th e areaofIin anc ial accounting and is often associated with tax allowances. From the point ofview of the ship manager it is sufficient to have ageneral ideaofwhatitmeanswhen seen on amanagement accounting report. The maj or asset treated in this way is the ship.
Amortisation: is similar to depreciation and is applied in the same way. It only applies to a loss of value of an asset through time, as distinct from use, as in depreciation. It is used in accounting forleasehold improvement charges in administration costs. Allowance for a liability, the cost of which cannot be determined with any accuracy is thus a
sum which cannot be treated as an accrual.
Reserve: Is a charge which cannot be classed as a provision. It is a sum of money put aside for an anticipated purpose in the future. The action of putting the sum aside in the financial accounts prevents its
allocation for other purposes (such as tax, profits, etc.) and ensures its availability in the future. However, it should be noted that shipping accountancy practice today does not make so much use of re serves as in the past.
To give an example: ships used to be taken out of service for a special hull and engine survey every four to five years. The cost of the work was high compared with the other years and the time out of service long.
Because of the high cost ofthe survey a sum of money was placed in 'reserve' each year in readiness for the next special survey. Two things have changed this:
The time out of service necessary to carry out special surveys hasbeenreduced considerably by the introduction of staged or continuous running surveysto spread the survey of individual items of hull and machinery over the period between the special surveys. Today, when aspecial survey takes place, it is only necessary to complete outstanding items which, for various reasons, have not been surveyed earlier. This has resulted in spreading the costs over the period and reducing the time out ofservice.
126 THE NAUTICAL INSTITUTE
Theuncertainty of shippinghasresulted in apractice of letting costs lie where they fall- i.e. to face each year as it comes andbudget andpay for costs for th at P art icu lar year.
It is argued that it is pointless toputmoney into reserve for a survey ~ or other pUfllose~ in four years' time when the ship may have been sold by then.
Stock concept: Is similar to that used for accrued and prepaid expenses in that unused stock in hand is like a prepaid expense. Whereas once the costs of crew and repairs are incurred, money is spent in the sense that it has or must be paid out and cannot be retrieved, stocks ofunused consumable stores can be considered as a credit - i.e. they are in place and unused at the end of the accounting period and, therefore, ready for use at the beginning of the next. To include them in the current accounting period may give the appearance of very high consumption and cost, particularly if the ship has only just taken on supplies before the accounting period ends.
In theory the detail of all the unused stocks in ships should be reported regularly and the value carried forward to the next period. In practice this may create work which is disproportionate to the sums involved and thus there should be a policy decision on stock to be treated in this way. This should reflect the magnitude ofthe costs.
In businesses which have large stocks of materials , stock accounting can be very complex due to the change in value of the stock which can occur while the materials lie in storage. Applied to a ship this means that a large quantity oflubricating oil bought near the end of one year and carried forward to the next could increase in value due to a worldwide increase in oil prices.
Shipping companies with a number of sister ships often keep stocks ofcommon items, particularly spare gear, in storage ashore and such stock should also be treated in this way. Victualling stocks should always be reported regularly as, apart from their value, the information is required in order to calculate the daily costs offeeding the crew.
Capitalisation and capital costs: The ship and items bought for its future operations are generally 'capitalised' i.e. they are considered to be a long-term acquisition and therefore not something consumable.
The initial outfit of a new ship may include some items which are normally considered to be consumables but are, by convention, included initially as capital costs.
These are such items as the chart outfit, the original lubricating oil 'charge' and items of spare gear not included in the price of the ship. Modifications to the ship and its equipment at a later date are also capitalised.
Capital items are shown as assets in the balance sheet; they are reduced by the 'cost' of depreciation at each accounting period until 'paid for' and considered fully used, but will still be shown as an