Fleet - Battle of the balance sheet
Plans to change the treatment of contract hire cars have caused some misgivings, says Steve Banner.
Plans to change the treatment of contract hire cars have caused some misgivings, says Steve Banner.
The car fleet industry has greeted the Accounting Standards Board’s suggestion that all vehicle leasing arrangements should be shown on company balance sheets with a mixture of fury and bewilderment. As things stand, an operating lease – sometimes also referred to as contract hire – is treated as an off-balance-sheet finance for accounting purposes, and the British Vehicle Rental and Leasing Association is adamant it should remain that way.
‘The point about contract hire is that fleet operators aren’t using it as a financial instrument to obtain the use of a vehicle,’ argues BVRLA external affairs manager Robin Mackonochie. ‘What they’re really doing is buying in a service from an outside provider which can be terminated at any time.
‘There is, in fact, no fundamental difference between renting a car for a day and renting one over a longer period under a contract hire agreement. Other services do not appear on the balance sheet, and there is no reason why this one should.’
Stewart Whyte, director and membership secretary of the Association of Car Fleet Operators, points out that return-on-capital-employed ratios could be dramatically affected by a change in contract hire’s balance-sheet treatment. That’s something likely to be of great concern to UK subsidiaries of American corporations, which monitor these figures particularly closely, and to companies about to become involved in a takeover battle or a rights issue.
‘I would estimate that 30% to 50% of the contract hire market in the UK is made up of people who are actively concerned about balance sheet treatment,’ says Whyte. In theory, that means 30% to 50% of the market could disappear, but Whyte doubts that the impact of any change would be quite that massive.
‘The ASB’s proposal would have a fundamental effect on contract hire, and on the companies that make use of it,’ says Nick Gafney, group marketing manager at Velo, a subsidiary of Kleinwort Benson, a vehicle management company.
‘At the moment, you can offset your contract hire rentals against corporation tax. Put your vehicles on the balance sheet, however, and what you will be claiming instead is depreciation.
‘The depreciation will be less than the rentals you pay, so you won’t be able to reduce your company’s tax liability to the extent you did previously.’
‘What the ASB is proposing will pose a significant risk to the contract hire market,’ says Liz Sarchett, finance director at vehicle leasing and fleet management specialist Axus UK. ‘The ability to obtain off-balance-sheet finance isn’t the number one reason why fleet operators opt for contract hire, but it’s definitely in the top four or five.’
She warns that the suggested change could dilute the appeal of sale and leaseback agreements. Other than the chance to obtain an injection of capital, she says, one reason why some firms opt for these deals is to remove assets from their balance sheets and improve their return-on-capital-employed ratios. A change in the way operating leases are treated means they will no longer be able to use sale and leaseback as a means to this end.
‘What’s more, there’s a danger that the Inland Revenue will start treating operating leases in the same way that they treat finance leases from the capital allowances viewpoint, which will make contract hire more expensive,’ Sarchett contends.
That’s because an operating lease set up, say, one month before the end of the financial year, still benefits from an entire year’s worth of capital allowances. A finance lease set up at the same time doesn’t.
Finance leases are already treated as on-balance-sheet finance for accounting purposes. Sarchett goes on to wonder how essential to a full understanding of a firm’s financial position putting operating leases on the balance sheet is anyway. After all, a note showing them as liabilities is usually attached to the accounts.
Paul Bailey, Vauxhall Master Hire’s financial controller, points out that if the proposed change goes ahead, the same vehicles will end up being shown on both the lessor and the lessee’s balance sheet.
‘It’s a ‘sledgehammer to crack a nut’, and I’m not sure what the ASB is trying to achieve,’ says Bailey. ‘I suppose the argument is that vehicles should appear on the lessee’s balance sheet because he has the enjoyment of an asset; but he only has it for a limited period.’
Stuart Clarke, executive director and group company secretary at Dial Contracts, also has misgivings. ‘I think we are a couple of months away from any meaningful understanding of what the ASB has to say,’ he points out. ‘But it’s right that it could be the case that the lessor will record the asset because he is the owner, and the lessee will record it too because he has the benefit of it.’
Clarke wonders what impact the presence of the same asset on two separate balance sheets will have when it comes to claiming capital allowances.
Keith Milton, commercial manager at PHH Vehicle Management, is a little more sanguine about the ASB’s idea than some of his industry colleagues.
‘It’s not a bolt from the blue – it’s already been advanced at an international level, and we’re not convinced that it will have that dramatic an impact,’ he observes. ‘Clients expect contract hire to be off the balance sheet, but if that were to change, they would adapt to the new situation very quickly.’
Some companies may conclude they might just as well buy their cars outright, enjoy the capital allowances, and outsource the administration of the fleet to a specialist fleet management company. That’s despite the argument that they’re investing their money in depreciating assets, and might be better off using it to acquire productive equipment.
Milton points out that some companies find it more cost-effective to contract purchase expensive executive vehicles because of the substantial capital allowances that can be claimed.
Others might decide to keep their cars off the balance sheet by going the PCP – Personal Contract Plan – route.
Such programmes are usually set up by companies in conjunction with finance houses and have sometimes been favoured by staff members who are entitled to a car because of their status in the company, not because they are high-mileage drivers.
The finance house acquires the car, wielding its purchasing clout to obtain a volume-related discount. It is sold to the employee under a credit-sale agreement, and either the employer – who makes the credit arrangements for the purchase – or the finance house arranges for it to be insured and maintained.
The employee makes monthly repayments calculated according to the vehicle’s guaranteed residual value at the end of the contract and is paid a cash allowance by his employer. The car is not treated as a taxable benefit by the Revenue, is not counted as one of the firm’s assets, and the supplier will buy back the vehicle if the employee leaves the company.
Keith Milton doubts that changes in balance sheet treatment will prompt firms to march down the PCP road in droves, however. Employees with company vehicles are not noticeably enthusiastic about surrendering them, no matter what the claimed advantages might be, and firms implementing such a scheme might face difficulties retaining and recruiting staff, he suggests.
‘They could find they’re placing the accounting cart in front of the operational horse,’ Milton observes. ‘Company cars aren’t simply a means of getting from A to B. They’re part of the individual’s remuneration package, and there’s status plus a lot of emotion surrounding them.’
‘What the ASB is suggesting won’t mean contract hire will die,’ insists Velo’s Nick Gafney. ‘It will still have the advantage that the fleet operator isn’t taking a risk on residuals or unexpected maintenance bills – with contract hire, you know what most of your operating costs are going to be – and will have much less capital tied up in his cars than he would do if he purchased them outright.’
Fleet operators should perhaps be less worried by what the ASB is up to than the long-term impact issues such as European price harmonisation, taxation, and environmental pressures may have on the company car, says Keith Milton.
From April 2002, the current system of taxing employees on a percentage of the list price of their vehicles, with the percentage reducing the more miles they cover, will be scrapped.
It will be replaced by an arrangement which will tax people according to the amount of harmful pollutants their car exhausts produce. A percentage of the list price will also be taken into account when calculating liability.
And price harmonisation? The ‘CAP Black Book’ – a guide to used-car values – does not believe that British new car prices are coming into line with the supposedly lower prices in continental Europe, despite all the suggestions to the contrary.
‘The widescale price realignment theory would hold more water if large discounts and cheap special editions were a new phenomenon, but they are not,’ says Andrew Wilkinson, CAP publishing director and general manager.
‘There has been much talk of large discounts on Mondeo being a sign that Ford is pulling all prices down, but those cars are non-current-specification models that need to be cleared out. When Vauxhall took old bodyshells and created the value-for-money Corsa Breeze, nobody talked then of European price harmonisation.’
Steve Banner is a freelance journalist
HOW THE ASB ARGUES THE CASE FOR CHANGE
A vehicle obtained under an operating lease – sometimes known as contract hire – is a company liability for the duration of that agreement, and the right to use it constitutes an asset, says the Accounting Standards Board.
That is why it should be shown on the lessee company’s balance sheet, it argues. Finance leases are already shown. The ASB is now working towards turning a G4+1 paper issued two years ago, which addresses this area in an ASB discussion paper. It points out that the policy of placing all leased items on the balance sheet will apply to capital equipment and property just as much as vehicles.
The ASB argues this will make it easier to make meaningful comparisons between sets of accounts for different companies.
It plans to issue the discussion paper by the end of this year. If showing contract hire agreements on balance sheets is adopted as a standard, it will not be implemented until at least the end of 2002.