Fleet Decisions - The on-off switch

Next year, international accounting standards will be introduced for listed companies in Europe with financial years starting on or after 1 January 2005.

These standards will have some major repercussions for companies operating fleet cars. For example, operating leases, currently an off balance sheet item and shown in the profit and loss account, will have to be recorded on the balance sheet. “Where cars are on an operating lease, although they are an asset they do not currently have to appear on the balance sheet,” says Vincent Ashe, a qualified accountant and chief executive of leasing company Provecta. “But if they are owned outright or financed through hire purchase, they are already on the balance sheet,” he explains.

This will not affect the validity of the lease, nor how it operates, but it affects the numbers. A company with a balance sheet of £100m and profits of £10m makes returns on capital of 10%. If it has to add, say, £50m for fleet cars to the bottom line, the same £10m profit becomes a return of 6.7%. Moreover, the gearing and ability to borrow may be affected.

But Robin Mackonochie of the British Vehicle Rental and Leasing Association does not see this as a problem. “Analysts will have looked at an organisation’s total liabilities, and fleet cars represent an unending stream of expenditure. They should be on the balance sheet,” he says.

“The International Accounting Standards Board felt it was wrong that companies could record operating leases off balance sheet,” says John Boon, financial director of LeasePlan. “It (the IASB) aims to abolish the distinction between operating and finance leases.”

Finance leases are where the client company takes on all the risk and reward. Cars have to be written down in value by some 25% depreciation a year to a maximum of £3,000 per annum. Not surprisingly, therefore, most cars are acquired on operating leases, where fleet management companies such as any of those quoted in this article take the pain.

But for the moment, anyway, the status quo remains. “The work on off balance sheet issues (FRS 15 Treatment of Tangible Assets) started six years ago but has been put on hold because of the implications for listed companies,” says Mike Waters, head of market analysis for Arval PHH.

“The imponderable is when it may restart. We may be looking at 2007 before it is completed because the people dealing with FRS 15 are involved with bringing in the standards next year.”

This is not the first time the vehicle leasing world has had to redesign itself. In 2001, when benefit in kind (BIK) taxation was changed from being based on the value of the car to being calculated on CO2 emissions, many companies looked at whether they would continue to offer a fully expensed company car or whether to go for personal contract plans. As a result, leasing companies are writing different leases than they were four years ago in order to meet their customers’ requirements. “Companies will continue to make more flexible and innovative leases,” says Waters.

Ashe points out that company car tax has been going up since the 1970s, so there has long been good reason to get out of company car schemes.

However, there is no quick response to the forthcoming implementation of FRS 15 because most operating leases run for 3-4 years, with heavy early termination penalties. But companies have to start taking action now. “Of the eight companies we have contracted most recently, six have stated that staying off balance sheet is a reason to move to employee car ownership,” he says. “Where the client owned the car, we have bought the vehicles and sold them to the drivers on employee car ownership schemes, which remain off balance sheet,” says Ashe.

As company cars become less tax efficient, they become less important as part of remuneration. The advantage of structured employee car ownership schemes is that they allow drivers more choice, create company savings, and the fleet management companies that run them ensure that regular servicing, MOT and insurance are maintained.

Not surprisingly, companies are resisting the idea of bringing cars on to the balance sheet. “They are reluctant because a lot of cars are non-performing assets. They are perks and do not contribute to the creation of business wealth, unlike those driven by a sales team,” says Ashe.

Just as the change in benefit in kind laws in 2001 did not turn the industry on its head but made people opt for more fuel-efficient cars, the introduction of international accounting standards is also unlikely to force organisations out of company cars schemes in droves. The number of cars on the road is not going to drop dramatically just yet.