The Impact of Sarbanes-Oxley on Fleet Operations
Compliance with the Sarbanes-Oxley Act of 2002 is mandatory for all publicly traded corporations, which must establish processes to ensure honest corporate disclosure and greater accountability. Sarbanes-Oxley (SOX) was the legislative reaction to the spate of corporate scandals involving companies such as Enron, WorldCom, and Adelphia. The law is named after Sen. Paul Sarbanes and Rep. Michael Oxley, the bill’s key sponsors.
In essence, Sarbanes-Oxley is about corporate responsibility and accountability that is focused on financial reporting. The law makes it corporate management’s responsibility to document all internal controls in a way that auditors can inspect them and render an opinion. The focus of Sarbanes-Oxley is documentation, validation, and testing of those controls.
One aspect of Sarbanes-Oxley is the testing of the key controls to support senior management’s assertion that the financial statements are materially correct. With Sarbanes-Oxley, the key is to facilitate the quality and transparency of financial reporting, as well as to support the CEO and CFO certification of the financial reporting that is now required.
How SOX Affects Fleet
The accountants of a business may view the fleet department’s expenditures as big enough to be considered a key process. If so, they will want to make sure the fleet department has proper expenditure controls. Usually, the SOX team has decided a process the fleet manager is involved with (and sometimes it is travel, not fleet) is important to the company and feeds into financial reporting. The internal Sarbanes-Oxley team will want the fleet manager to docu-ment the fleet process, look for controls that should be in place to support the financial statement assertions, and test those controls. A fleet manager should pay attention to specific areas within fleet when documenting and validating processes. The fleet department should have expenditure process controls because it can enter into contracts. Likewise, it should also have contract controls. The fleet manager may or may not have some approval authority to pay fleet department invoices.
Depending on the size of the fleet expense relative to the business, there may be periodic audits and testing and recalculation of the lease bill. This may include recalculating an amortization amount or randomly validating charges, either directly with their employees or with the lessor. It depends on the scope of the fleet operation relative to the size of the business and the financial controls of the company.
The important point for fleet managers is to work within the expectation of the internal Sarbanes team. It may involve documentation and validation of the lease contract on an annual basis or validation of the FAS 13 operating lease test, which is documented periodically through the course of a year. It may also include expenditure approval. The SOX team may want basic, rudimentary controls of who has proper authorization to pay bills. Sometimes it may be as simple as dual signatures to approve the payment of invoices. Or, it could be as complex as monthly recalculation of all new leases and validation of any charges over $1,000. The scope of the Sarbanes team requirements depends on how fleet expenditures fit in the business.In addition, the Sarbanes team may require periodic testing of charges back through drivers, verifying whether specific work was done on their vehicles.
When the SOX team looks at fleet, they first document the process, study it, and look for ways to reduce complexity. They look for repeatable and reliable performance. They want to know that every time someone writes a check, they are doing it the same way and it is consistently sound.
Not all fleet managers of publicly traded companies will be affected by Sarbanes-Oxley because fleet may be a relatively small part of the overall business, even though it may manage a sizeable number of vehicles. In other instances, a smaller publicly traded company may have a very large portion of its expenditures in fleet relative to the size of its business, which would place fleet under Sarbanes-Oxley scrutiny.
Used-Vehicle Sales to Employees
There are two ways to sell a used fleet vehicle to employees — at a fixed price or through a negotiated sale. Because a vehicle is a valuable corporate asset, a fleet manager must be sure that the company approves the resale process and, once approved, follows it very strictly.
Since most fleets are funding vehicles using an operating lease, these should be fair market value sales transactions. A fleet manager should ensure the fair market value is documented and that the transaction is completed at that fair market value. There should be no special allowances made because those situations become problematic under review by a skeptical auditor. It is always easy, after the fact, for auditors to second-guess earlier transactions. This reality is best summarized by the adage that “the faintest ink is better than the best memory.” If a bidding procedure is used, a fleet manager must develop a process in which employees and others can submit bids on vehicles within specified parameters. The bids are accumulated and should be reviewed by two people to confirm that the best offer is accepted. Keep a record of all offers. Have two people in the department sign off and confirm that it is indeed the best offer. Keep a copy of the sales notice with your documentation. It is good to remember that auditors, by their nature, are skeptical.
A fleet manager has a lot going on in a busy fleet department, so a year later, and maybe several hundred cars later, he or she may be hard pressed to justify a transaction of a particular vehicle. It is good to be able to pull out the file and say “here are the signatures of two people in the department. Both looked at the offers. Here are all the offers, here is whom we sold the vehicle to and as you can see, it was sold at the highest offer.”
When only one bid is received, it is important that the price should be within a range of a fair market value. A floor should be set based on the vehicle’s fair market value at the time it is offered for sale.
Issues with Decentralized Fleets
A decentralized fleet can be more at risk for Sarbanes-Oxley scrutiny than a centralized fleet. A fleet manager at decentralized fleet operations is the focal point for fleet responsibility within the company, but much of the day-to-day operations are handled outside of his or her purview.
Some corporate fleet managers may have regional offices or even different business units operating the fleet. These drivers report to a regional manager, and the regional manager approves expenditures and maintains policy compliance. As a corporate fleet manager, you have ultimate responsibility for the fleet to ensure that your decentralized management stays in compliance. To do so, you need proactive communication. How do you know in a huge multi-million company that all the numbers are right? You have to have processes. How do you know the processes are right? One way is to reduce complexity, to standardize, and make policies more uniform.
The fleet manager should ensure that regional or branch employees understand the company’s policies and procedures specifically related to fleet. Typically, with those types of decentralized situations, the regional manager who has approval authority operates within certain parameters. There should be other mitigating process controls to confirm transactions are compliant with corporate fleet policy. There can be differences in internal controls between a centralized fleet and a branch fleet. But it is not just restricted to fleet. The branch manager is authorizing expenditures, paying people, and managing a variety of non-fleet functions. Fleet is only one dimension of their responsibilities.
Upfront Incentive Monies
One fleet activity that has Sarbanes-Oxley implications is the acceptance of manufacturer incentive monies as a lump sum at the end of a model year, rather than capitalizing the incentives in the cost of a vehicle. It is important for a company’s accounting department to understand the fleet manager’s responsibilities for incentives. Typically, a fleet manager works with the motor company, validates the number of units, the correct dollar amount, and hands the check to accounting to be coded and deposited. However, there could be different accounting treatments required for a motor company incentive, or it may be recorded incorrectly when the check is processed.
Frequently, a fleet manager is not aware of the accounting treatments that could arise or may have changed relative to rebates from the motor companies. The fleet manager should be proactive and meet with the accounting department to discuss incentive accounting.
“If a fleet manager is getting a multi-million-dollar check in December, they’re probably setting themselves up for a red flag. The concern is from a revenue recognition standpoint,” said one CFO, who wished to remain anonymous.
Should incentives be capitalized in the cost of a vehicle? Many fleet management companies encourage their clients to capitalize incentives and amortize them over the life of the vehicle. The most important reason is proper matching of revenue and expense. The reduction in expense should be realized through the life of the vehicle, the same way the reserve rate is set to match and record expense during the period that the sales or service employee is generating revenue.
Fleet is a Transparent Business
Corporations are like human bebeings. They are all different shapes and sizes, and they have different systems and different structures. Their control issues, their risks, and their strengths are going to be very different.
Fleet is inherently a very transparent business. When you think about an open-end lease, the lease calculation is disclosed, if you look at an invoice you can see its components, you see the same calculations vehicle after vehicle. There is a large volume of standardized, uniform transactions so that you can easily recalculate, and it is a fairly straightforward expense recognition. Fleet incentives present a complication, but by taking incentives off the capitalized cost, there is no question as to where you record this expense and to what period.
In addition, fleet transactions are very current events. They are not like project accounting, which goes on for years. If you have a maintenance incident, chances are you are going to see a bill within a relatively short period of time. It is relatively easy to say your maintenance is 30 days in arrears because it is typically billed the following month, and you can estimate your accrual based on history, and next month you get the actual bill.
Most companies have an accounting procedures manual that resides in the accounting department. Whether it is an expenditure policy or contractual authorization policy, not all fleet managers are aware of their companies’ accounting policies. Because Sarbanes-Oxley is ultimately about the financial statement and adequate controls to support the financial statement, the accounting policies and procedures are reference points. A fleet manager needs to periodically meet with accounting and ask which policies affect fleet and read those policies.
In the final analysis, fleet is a straightforward and well-documented business from an accounting standpoint. There are invoices for third-party transactions, the calculation of the lease is very transparent, and the transactions are current.
How Sarbanes-Oxley Apples to FAVR Programs
Three types of payment plans are utilized to reimburse employees who drive their personal vehicles for business use. They are fixed pay-ments (a monthly allowance), variable payment (cents per mile), and fixed and variable reimbursement (FAVR).
First established in 1992, a FAVR plan reimburses employees on a non-taxable basis through a combination of a monthly allowance and a per-mile reimbursement. In IRS Revenue Procedure 2004-64, the FAVR fixed payment includes projected fixed costs, such as depreciation (or lease payments), insurance, registration, license fees, and personal property taxes. A FAVR plan also covers projected operating (or variable) costs, such as gasoline, fuel taxes, oil, tires, and routine maintenance and repair.
To be eligible to participate in a FAVR plan, an employee must meet a number of requirements specified by the IRS 2004-64 standards. However, not all employees can meet the non-taxable standards, so companies often administer two reimbursement plans – one taxable and one non-taxable.
As a result, a FAVR plan is more complicated to implement than other reimbursement plans and requires a great deal of administrative recordkeeping to satisfy IRS regulations to maintain a non-taxable payment status. Companies are required to document annual business mileage, the number of years the vehicle will be retained, model-year of the employee vehicle, vehicle’s acquisition cost, and proof of employee insurance. In addition, the depreciation method used on employee tax returns must be documented by the company, and the business mile documentation must include the time, place, and purpose for which the vehicle was used.
How do SOX rules affect FAVR reimbursement? Sarbanes-Oxley requires corporations to confirm that their processes are in compliance. “There are numerous requirements to set up and maintain a FAVR program, all of which must be met or a company can find itself out of compliance with IRS rules, and thus out of compliance with Sarbanes-Oxley,” said Jim Fredlund, president of FasTrac Solutions, a tax and fleet leasing consulting service headquartered in Chanhassen, Minn. “Most companies rely on an outside vendor to set up and maintain a FAVR program and assume the vendor will be in compliance, but ultimately, it is the company’s responsibility, from the standpoint of the law, to be in compliance.”
A SOX audit typically examines the processes in place to validate the accuracy of corporate payments and ensure that calculations are done consistently and correctly. Both the setup and ongoing administrative requirements of a FAVR program may cause a company to become non-compliant with Sarbanes-Oxley requirements. “There are so many FAVR rules that it is difficult to be compliant with all of them. Companies are always chasing after data from employees to make sure they remain in compliance,” said Fredlund. “I’d bet that if a corporation did an audit of its FAVR plan, it would discover that the plan is not in compliance.”
How accurate is your FAVR reimbursement program from a Sarbanes-Oxley perspective?Annual Business Mileage. To participate in a FAVR program an employee must have a minimum 5,000 annual business miles. “Can you verify that each year the employee is over the minimum of 5,000 miles of business use by the end of the year?” asks Fredlund. “If you can’t, this may be a Sarbanes-Oxley issue.” Insurance. FAVR rules require employees to maintain insurance on the vehicle. “Although you may verify insurance coverage at the start of the program, can you verify that an employee didn’t cancel the insurance at a later time?” said Fredlund. Number of Management Employees in a FAVR Program. At no time during the calendar year may a majority of the employees covered by a FAVR allowance be management employees. Do you have processes in place to monitor this requirement?