Managing depreciation expense is one of the most important challenges faced by a fleet manager. It is a function of vehicle cost, anticipated resale value, replacement cycle policy, and, increasingly, timing.
Some fleet managers have begun to buck the conventional wisdom by taking depreciation expense more slowly than perhaps they should, thus accepting a large negative adjustment when the vehicle is sold. The logic behind this says that booking depreciation at a slower rate enables the company first to use the cash flow made available for other purposes and, second, to "pay" for the depreciation with future, cheaper dollars.
Some fleet managers who have begun, or are considering, extending depreciation schedules say that by booking less depreciation during vehicle life, then "paying" the balance as an adjustment two, three, or four years down the road with cheaper dollars, increases cash flow and saves money.
But in interviews with three fleet managers on the subject, although some evidence shows that underdepreciation might be less costly (on a present value basis), basic accounting principles won out.
Rick McDonald says he doesn't necessarily agree with the strategy of underdepreciation.
"On a net present value basis, it might well be cheaper, but only if the present value factor was high enough to make it worthwhile; I haven't seen the numbers," said McDonald, who is the Memphis, TN-based fleet director for ServiceMaster, whose 25,000-vehicle fleet is one of the largest private fleets in the nation.
"Keep in mind that we are in a very low-inflation environment, and the depreciation would have to be slowed dramatically, as the present value factor you would have to use would be low as a result," McDonald said. "I don't think that this is the right question to ask, though. I would ask whether this was the right thing to do; and I would answer no, I do not."
Asked why not, McDonald answered that depreciation' is an expense, and basic accounting principles require that expenses be recognized in the period in which they occur. "Booking artificially low depreciation violates this principle, and can cause other problems as well," he said.
Kim Boteler, who is fleet manager/insurance coordinator at Heidelberg USA in Kennesaw, GA, agreed with McDonald that underdepreciation carries disadvantages that might overshadow the savings.
"Ideally, our goal is no gain, no loss at resale," said Boteler, who manages a fleet of 800 units. "We try to match our depreciation rates to the market, and to our replacement schedule."
Budgeting cash flow is one disadvantage of underdepreciation, said Dave Haviland, fleet manager for Acosta Sales & Marketing in Jacksonville, FL.
"We need to do our part to provide a cash flow forecast that [the company] can use to develop sources of funds," said Haviland, who oversees a fleet of about 4,000 vehicles, primarily cars. "When a forecast is unpredictable, a company is put into a position to develop short-term funds, usually from bank lines. This adds to interest expense, and can wipe out any savings from stretching out depreciation schedules."
McDonald added: "We can budget lease charges, of which the largest portion is depreciation. How can we budget the back end of a lease? We've got some history that shows us how much our vehicles will be worth, and we can try to set up depreciation to match that forecast. If we upset our depreciation, we run the risk of having huge losses when we sell, losses for which we cannot reasonably budget."
What part of Heidelberg's program would such a change affect the most?
"Our replacements are budgeted in two large buys, one in the spring and one in the fall," Boteler said. "Any depreciation adjustments, gains or losses, are booked into these two, relatively short, periods. It's difficult enough now; if we extended our depreciation schedules, forecasting the inevitable losses would be nearly impossible. The used-vehicle market is unpredictable, and such a change would make us far too sensitive to changes."
Boteler said those changes would upset Heidelberg's budget.
"For example, suppose we were selling a large number of units in the Northeast in the fall, and the area was hit with bad weather, depressing the market," Boteler said. "With inflated book values, the losses we would normally experience would increase, perhaps dramatically."
Haviland and McDonald agreed.
"Let's say that we were coming up on selling a lot of a particular make or model, and we had drawn out our depreciation rates," Haviland said. "The model begins to exhibit a serious, continuing problem with the transaxle, let's say, or is being discontinued. This could kill the resale market for that model, and we'd be stuck with losses even greater than those that would normally result."
McDonald said that even under normal circumstances, not every vehicle can be replaced according to ServiceMaster's normal cycle. Accidents, major mechanical failures, or changes in the company's operations, require the sale of units prior to planned replacement, he said.
"A major component of the repair/replace decision is the remaining book value," McDonald said.
"If that amount was skewed by an unrealistic depreciation rate, the decision would be impacted," he said. "What I'm saying is that you'd be making decisions that you wouldn't normally make under such circumstances, decisions which might be costly."
If you ask Boteler whether she can see any advantages to underdepreciation, she will say, not for Heidelberg.
"We tend to be conservative in our financial decisions," she said. "Under-depreciating our fleet, with the hope that we can save money on a present value basis, is just too risky. The downside is too steep."
Haviland said any advantages would still not serve his fleet well.
"I do a lot of selling myself, so I suppose I might have a bit more control under those circumstances," he said. "But our goal is a wash at termination, and this wouldn't permit that.
How 3 Fleets Make Depreciation Decisions
Dave Haviland, Acusta Sales & Marketing: "Our barometer is past performance. The historical gains and losses under the TRAC in our open-end leases tell us what we should do going forward. An important part of my job is to provide a steady, predictable flow of funds for vehicles, and I do what I can to avoid surprises."
Kim Boteler, Heidelberg USA: "We track our sold reports closely. We compare the actual depreciation vs. book, and plan depreciation accordingly. Whenever we see large differences between the two, we make adjustments to bring the rate closer to the market rate."
Rick McDonald, ServiceMaster: "Because of the broad range of vehicles we operate, we've got depreciation rates ranging from four to seven years. Past performance is our guide in establishing these rates. When changes occur, we adjust accordingly."
3 Say Over-Depreciation Is Better
Three fleet managers were asked: Suppose you had to make the choice: over- or under-depreciation. Which way would you go?
Kim Boteler, Heidelberg USA: "Over. As I mentioned, we are conservative, and overdepreciation would at least ensure that we would have money coming back at resale."
Rick McDonald, ServiceMaster: "I wouldn't like either, but if I was forced to decide, I would over-depreciate."
Dave Haviland, Acosta Sales & Marketing: "Over-depreciation. I think that it's easier to handle the decreased cash flow during the vehicle life, with the larger in-flow at resale, than it would be the reverse."