Guide to Calculating Ownership and Operating Costs of Department of Transportation Vehicles and Equipment: An Accounting Perspective (2020)

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24 Once all indirect costs are allocated in a similar fashion according to their cost drivers, they can be summed with the direct costs to estimate the total cost of each fleet activity. This is shown in Table 8. Note that the $800,000 in indirect cost for the equipment provision includes the $28,550 cost of the four accountants illustrated in Table 6 and Table 7. Other indirect cost values shown were not calculated explicitly but include a mix of indirect costs shown in Table 3. Table 8. Summary of direct and indirect costs by activity Fleet Activity Direct Costs Indirect Costs Total Equipment Provision $21,550,000 $800,000 $22,350,000 Maintenance and Repair Provision $5,000,000 $300,000 $5,300,000 Parts Provision $1,500,000 $100,000 $1,600,000 Fuel Provision $2,000,000 $200,000 $2,200,000 Total $30,050,000 $1,400,000 $31,450,000 4.5. Calculate Detailed Costs of Activities In the last step, Step 5d, costs are summed together for each of the four fleet activities to enable fleet management decision making. 4.5.1. Equipment Provision The equipment provision activity entails providing equipment to users. All capital and operational direct costs associated with providing equipment should be charged to the specific unit where they belong. Examples of capital costs, which are typically amortized over time, include purchasing and upfitting equipment that has a multi-year life expectancy. The amortization schedule is typically based on the scheduled life of the equipment. For example, if a given unit should be replaced in eight years, the amortization schedule is eight years. Ideally, this amortization schedule reflects the actual loss in residual equipment value as it ages and is used. This allows the remaining book value of the asset (the unamortized amount) to more closely reflect its actual market value. However, many fleets use a linear depreciation schedule for simplicity and ease of administration. For indirect costs associated with equipment provision, there are three common approaches to cost allocation: 1. Unit-Based Approach. Some indirect costs—such as for accounting, systems support, and even any applicable fleet management charges—are relatively linear in nature and do not vary by equipment type. These costs can be evenly distributed between each equipment type, in a unit-based cost driver approach (i.e., each piece of equipment is

25 allocated the same cost). This approach is easy to administer and understand, but can proportionally overburden low cost equipment, such as a hand mower, especially if the range of equipment costs are large. To demonstrate this method, consider the $28,550 indirect costs from the four accounting staff (shown in Table 6). To allocate this cost to the 5,000 fleet vehicles, simply divide $28,550 by 5,000, which comes to $5.71 per vehicle. 2. Percentage of Direct Cost Approach. To more equitably allocate costs to equipment, use the percentage of direct fleet costs approach, which is allocated based on the direct costs for each respective class of equipment. In turn, the share of indirect costs for a class of equipment can be divided by the number of units in that class. This approach is relatively easy to administer while avoiding the potential over-burdening issue associated with the unit-based approach. The hypothetical fleet example has two equipment classes: passenger sedans and half-ton pickup trucks. If the $21,550,000 in direct costs for the equipment provision is composed of $6,465,000 in direct costs for the passenger sedans and $15,085,000 for the half-ton pickups, or 30% is sedans and 70% is pickup trucks, the $28,550 indirect costs for the accountants should be divided so that 30% ($8,565) goes to the sedans and 70% ($19,985) goes to the pickup trucks. Then those amounts can be distributed evenly within each class using the unit-based cost driver approach (or could be allocated by the percentage of direct fleet costs if the direct costs of each vehicle are known). 3. VEU Approach. A third option for allocating indirect costs is to use the VEUs approach, a ratio-based methodology that compares the maintenance requirements of different equipment classes. This concept is discussed in detail in Section 5.10. Indirect costs are allocated to equipment classes based on total VEU count by class, divided by the total fleet VEUs. In the hypothetical fleet, the 1,000 passenger sedans have a VEU of 1.0 and the 4,000 half-ton pickup trucks have a VEU of 1.5. Therefore, the total number of VEUs in the fleet is 7,000 (1,000 * 1.0 + 4,000 * 1.5). Using the VEUs approach, 14% (1,000/7,000) of the $28,550 of accountant-related indirect costs should by allocated to the sedans and 86% (6,000/7,000) should be allocated to the half-ton pickup trucks. 4.5.2. Maintenance and Repair Provision The maintenance and repair provision is one of the most common calculations for fleet managers. More commonly called the shop rate, this cost is expressed in dollars per hour of shop operation. To estimate the example shop rate, begin with the $5,300,000 total estimated for the maintenance and repair provision. The denominator of the shop rate (hours) can be estimated using the guidance in the call-out box below.

26 4.5.3. Parts Provision As shown in Table 8, the direct costs of the hypothetical fleet are $1,500,000 and the indirect costs are $100,000. Thus, at the highest level, the cost of providing the parts provision to the hypothetical fleet is $1,600,000 for the year. However, that information has limited benchmarking or decision-making value unless it can be expressed in a way that allows for year-over-year or fleet-to-fleet comparisons. Generally accepted fleet practice is to apply a markup percentage to the direct cost of parts to cover the indirect support costs for this activity. In the terminology of this Guide, the parts provision is the ratio of the indirect costs (including personnel, utilities, facilities, etc.) to the direct costs (the pure cost of procuring parts). In the hypothetical example, the markup is 6.67% ($100,000 divided by $1,500,000) as shown in Table 9. Table 9. Parts markup calculation example Amount Parts Cost Category $1,500,000 Actual parts cost $100,000 Indirect parts costs 6.67% Part markup required In applying the parts markup, as parts are consumed (issued to an equipment unit to support maintenance or repair), each specific equipment unit is charged a price for that part that equals the actual price plus the markup. For instance, if a replacement sideview mirror that costs $100 Guidance on Estimating Mechanic Hours to Estimate Shop Rate The available hours are the number of hours an employee is paid. A subset of this number is the productive labor hours, reflecting the hours available for performing customer service work (and can therefore potentially be charged). For full-time positions, 40 hours per week for 52 weeks per year equates to 2,080 hours per year. Reduced by 200 hours of vacation, holiday, and sick time, there are 1,880 available accountable hours per position, per year. Some productive hours will be absorbed for activities like clean up, breaks, and training. The remaining hours are referred to as billable or wrench-turning hours. The ratio of available to billable hours is a key benchmark against which to measure a fleet’s success. The fleets interviewed to inform this Guide have an average productivity ratio of 75% to 80%, meaning that an average of 6.0 to 6.4 hours per day are used for billable activities. The remaining 1.6 to 2.0 hours are called the shop indirect labor hours. This ratio is typically calculated after removing holiday, vacation, and sick time. In this simple example with a 75% productivity, there are 1,410 total productive labor hours per year [(2,080 - 200) * 0.75].

27 to purchase is installed on a truck, the equipment unit price to the fleet for that part would be $106.67 (direct parts cost + 6.67% markup). 4.5.4. Fuel Provision Like the parts provision, the cost of providing fuel is typically expressed as a markup. However, the markup for fuel is per gallon, not a percentage. In the hypothetical example summarized in Table 8, direct fuel costs are $2,000,000 and indirect costs are $200,000. The direct costs include only the cost of the fuel, while the indirect costs include personnel support, amortized fuel infrastructure costs (such as storage tanks and dispensing equipment), and operational costs (such as for fuel quality testing and treatment). Suppose 1,000,000 gallons of fuel is used per year in the fleet. This means that the markup is $0.20 per gallon ($200,000 divided by 1,000,000 gallons), as shown in Table 10. Table 10. Fuel markup calculation Cost Fuel Cost Category $2,000,000 Total direct costs $200,000 Fuel indirect costs 1,000,000 Gallons of fuel $0.20 Fuel markup per gallon In applying this markup, as fuel is pumped into equipment units, the cost of fuel charged to that unit should reflect the actual per-gallon cost of fuel plus the per-gallon fuel support markup. For a fuel purchase averaging $2.00 a gallon, fuel would be dispensed at $2.20 per gallon.

28 5. KEY CONSIDERATIONS IN FLEET COST ACCOUNTING The above fleet costing examples illustrate simple, linear approaches to cost allocation. In reality, decisions needed for fleet cost accounting are often complex and nuanced and should be considered an art, not a science (see the blue call-out box). When fleet managers estimate their fleet costs, they should think of themselves as a detective, not as a bean counter who rigidly follows procedures. Like detective work, fleet cost accounting is about following intuitions, tracking down leads, and putting the picture together. It takes hard work, especially if a total cost of ownership calculation has not been done in recent years. Yet, the hard work is rewarded when the fleet manager can make persuasive arguments about the fleet with full conviction. This chapter provides several key considerations that may be useful for building that intuition. Because there is no way to cover every situation, the fleet manager’s expert judgement is often the most important tool in credible accounting. 5.1. Weighing Precision versus Effort A fleet manager must closely weigh the benefits of a more precise indirect cost allocation with the increased cost of collecting high-quality data. In designing a robust set of costing processes for an organization, there is a tradeoff between the cost of collecting the data and the detail, accuracy, and flexibility of the costing system. The quest for precision is expensive and a common reframe is “It is better to be approximately correct than precisely wrong!” A few guiding principles always apply: • The level of detail and accuracy depend on what decisions will be made with the information. • Reasonable accuracy, produced economically, is usually “good enough” to make most cost-related decisions. • Costing processes that support strategic decision-making use more aggregated data and require less detail than those used for operational decision making. Art of Cost Accounting “The fact is, accounting and finance… really are as much art as they are science. We think that if a number shows up on the financial statements or the finance department reports to management, it must accurately represent reality… The art of accounting and finance is the art of using limited data to come as close as possible to an accurate description of how well a company is performing. Accounting and finance are not reality, they are a reflection of reality.” – Berman, Knight, and Case (2006)

29 • In some cases, data collection can be scaled back after the magnitude of expenses and accuracy requirements are understood. • Look for ease when it comes to increasing cost accuracy. Start by capturing information for large costs that requires little or no extra effort. 5.2. Determining which Indirect Costs to Include To determine which indirect costs to include or exclude from a total cost of ownership calculation, consider “traceability”—the extent to which an indirect cost can be linked directly to an activity. For example, suppose a fleet outsources all activities to a private company, including for maintenance, repairs, vehicles, and other. Only the indirect costs that are still needed should be included in the total cost of ownership. This fleet would still need a central fleet office or, at minimum, a fleet manager. Instead of managing DOT employees and equipment, however, this manager would oversee contractors. Similarly, there would not be indirect costs for facilities and utilities, unless the private vendor was contracted to operate from DOT facilities (in which case the DOT would continue to absorb facility and utility costs). Other indirect costs in this example may require deeper consideration. For example, employees above the fleet manager in the organization structure would likely still spend time on fleet- related activities (such as for approving budget decisions). At some level in the DOT organization, an employee’s job may be completely unaffected by the fleet outsource decision, and no indirect costs should be allocated from these employees. Other fleet indirect costs would change significantly in this scenario due to the reduced (but not completely eliminated) costs for accounting, human resources, administrative, IT, and telecommunication. Instead, the costs for providing and supporting vendor personnel would be reflected in the vendor’s indirect costs, shown in the invoice given to the DOT. The above scenario helps explains why it is important to express the costs of internally produced goods and services on a full-costed basis. Otherwise, a fleet manager simply cannot fairly compare fleet costs between the public and private sector. 5.3. Accounting for Inflation When evaluating the per-mile or per-hour cost of fleet equipment, depreciation expenses are typically calculated based on the original cost of the asset. This means that the cost per mile or per hour may not account for the increasing replacement cost of that equipment due to inflation. To avoid this, a self-balancing fund typically requires an inflation factor. Inflation has been 3.2% per year over the past century, but equipment inflation prices tend to exceed general inflation due to the increasing costs of complying with regulatory requirements regarding safety, emissions, and fuel mileage.