Read the Over-land Trucking and Freight Case Study. Consider the proposal from FHP and provide a recommendation to management. Use the questions in the Decision section at the end of the case study to organize your recommendation. Responses to each question should be substantive with supporting information and calculations.

IMA The Association of EDUCATIONAL Case Study ima Accountants and Financial Professionals Case Journal in Business SSN 1940-204X Over-land Trucking and Freight: Relevant Costs for Decision Making * Thomas L. Albright Paul Juras Russ Elrod Naval Postgraduate School Babson College Arab Cartage and Express Co. ABSTRACT replace older equipment (usually in blocks of five trucks). Alan knew the slim profit margins associated with trucking, Over-land Trucking and Freight has a long-established coupled with a downturn in the economy, could spell disaster and mutually beneficial business relationship with a major if saddled with too much debt. See Exhibits 1 and 2 for the international automotive parts company, FHP Technologies. company's most recent statement of income from operations Management at FHP has approached Over-land with a and the balance sheet, respectively. request to provide additional routes that are important to Roger Simmons, Over-land's operations manager for the the efficiency of its supply chain. Over-land's management past 16 years, had been reviewing the FHP proposal and wishes to nurture the business relationship with FHP but pproached Alan. "Alan, we need to discuss this offer from is concerned about the available capacity to service the FHP. I think it is a great opportunity for our company, and new routes, potential risks, and profitability associated with we need to find a way to make it work." Within 10 minutes FHP's request. Alan and Roger were in a closed-door meeting discussing the pros and cons of FHP's offer. Roger began by stating the INTRODUCTION obvious: "Alan, this is a huge opportunity for us to grow the business. Not to mention, as FHP becomes more dependent Alan James founded Over-land Trucking and Freight in on our services, we will be in a stronger position to negotiate 1968 and has grown the business into a sizeable operation future rate increases. I know you are opposed to debt, and with 90 trucks and 180 trailers. His largest customer, FHP I understand the risks of carrying more debt, but there is Technologies, has submitted a proposal to him to add more than one way to grow our fleet. If you would consider delivery routes that would improve the efficiency of FHP's using independent contract drivers, we could grow the fleet supply chain. Alan was not certain that Over-land could enough to accept FHP's offer without incurring more debt." handle the additional routes since the company currently was Alan cringed at the thought of using independent operating at (or near) full capacity. contract drivers. Although independent contractors owned FHP offered a total of $2.15 per mile (including fuel their own trucks, Alan viewed them as difficult to deal service charge and miscellaneous fees) for the new route. with and not worth the headache. "Roger, I hear you, but But Alan knew that to accept the offer he would have to add this new route will not last a week if we cannot give FHP more trucks and perhaps incur additional debt. The question great service. Independent contractors call the shots, not was whether the rates offered by FHP were high enough us. They own the rig and will sit at home if they want to. I to offset the associated risks of growing the fleet. Although would rather deal with our own company's rigs and drivers. the business had been grown organically through the years The rewards just do not justify the risks of damaging our by reinvesting profits, it incurred debt from time to time to relationship with FHP. * The views expressed in this document are those of the author and do not reflect the offical policy or position of the U.S. Department of Defense or the U.S. government. IMA EDUCATIONAL CASE JOURNAL 1 VOL. 7, NO. 2, ART. 2, JUNE 2014"But I am not sure we should take on any more debt at Included in miscellaneous revenue are the following: this point to purchase additional rigs. The economy is in Storage fees are collected when Over-land stores a loaded the tank, and it is a bad time for us to leverage the balance trailer on its lot for a customer. sheet any further. Roger, my success in this business was not built by jumping on every offer that came along. Sometimes Lumper revenue is collected if a driver assists with unloading you have to say no, even to your biggest customer. Unless a trailer. you can find a way to squeeze out more capacity within our Certain flatbed loads, such as drywall, unpainted steel, and current fleet, I just do not think we can accept FHP's offer at some types of wood products, that would be damaged by this time," Alan concluded. rain must be covered. Trucking companies typically charge a As the two men left the room, Roger was convinced that tarping fee for such loads. Alan was wrong. Roger knew that Alan was leaving money on Additional insurance is required when transporting high- the table. He just needed to prepare a financial analysis that value cargo. Practices vary throughout the industry. If a load would prove it. Was it possible to squeeze out more capacity is above a company's standard cargo insurance limits, many from an already fully utilized fleet? Perhaps they could shift companies simply will not haul it. Trucking companies trucks from another account. Was taking on more debt truly that are willing to bind additional cargo coverage normally "risky" given the profit potential of this new route? Roger do so for a fee that covers only the extra cost of insurance. knew he had to make a convincing argument before FHP (Alternatively, this revenue line item could have been took its offer to another truck line. booked as a reduction to the "Insurance" expense account.) INDUSTRY TERMS Loads transported on flatbed trailers must be secured by straps or chains. These types of loads often are associated . A tractor-trailer rig is a truck that consists of a tractor with higher worker's comp claims. Thus an extra strapping attached to a trailer. The tractor typically is powered by a and chaining fee is charged only for a flatbed load. diesel engine. If a truck sits idle at the dock for more than two hours, . A flatbed trailer is long flat platform with no sides. customers can be charged a fee that is classified as detention . A dry van trailer is a boxed cargo compartment designed for revenue. Placing a detention revenue clause in the contract nonrefrigerated freight. encourages customers to load trailers efficiently in order to avoid further constraints on Over-land's tractor capacity. Trucking companies often have a revenue-generating load in one direction but need a revenue-generating contract TYPES OF BUSINESS ARRANGEMENTS WITH for the return trip. The return trip is known as a backhaul. DRIVERS Often trucking companies contract with freight brokers to acquire backhauls. Over-land has potentially two arrangements with drivers. They are classified as employees or as independent operators. INDUSTRY BACKGROUND AND COST STRUCTURE Employees receive traditional employee benefits and a Form W2 for tax purposes. These persons are typically engaged in Trucking firms generate a variety of revenue types from work for the company that is considered "permanent." hauling goods for their clients. Presented next is a brief Alternatively, independent operators are not considered overview of key types of revenues included in the 2013 employees and receive a Form 1099 (rather than a Form income from operations of Over-land Trucking and Freight. W2) for tax purposes. These operators typically provide the Line haul revenue is earned from hauling freight. tractor but generally do not provide the trailer. In addition to driver salaries and depreciation on trucks, expenses incurred Fuel prices in recent years have been volatile. Because by independent contractors include: trucking companies are exposed to fuel price volatility when Tags (known as International Registration Plan (IRP)) - they sign a long-term contract with their customers, they The independent contractor buys the IRP tag for the tractor, may charge an additional fee associated with fuel costs when while the shipping company buys the tags for the trailer. prices exceed predetermined levels. Thus, the primary IRS Form 2290 - Heavy Road Use Tax. purpose of the fuel surcharge (FSC) revenue is to protect the Diesel fuel, engine fluids, and all maintenance-related truck line from fuel price increases during the contract term. parts and items. IMA EDUCATIONAL CASE JOURNAL 2 VOL. 7, NO. 2, ART. 2, JUNE 2014Physical damage insurance. arrives, drops an empty trailer to replace the trailer just Non-trucking "bobtail" Liability Insurance (needed for filled, then immediately hooks onto the loaded trailer and when the truck is not transporting a trailer). departs. Tractor utilization improves because tractors are not Tolls and scale fees. sitting idle while a customer loads a trailer. This approach is For an example of a publicly traded transportation company economically feasible because trailers are far less expensive that primarily uses independent operators, visit Landstar Trucking to purchase and operate than tractors. Company's website at www.nonforceddispatch.com/landstar.php. Most trucking companies keep some tractors "on For a description of a publicly traded transportation company the fence" as spares, in case one breaks down. There is that primarily owns its rigs and employs company drivers, see considerable disagreement, however, over what constitutes J. B. Hunt Transportation Services' Form 10K at www.sec. too many spares. Some owners believe a truck line should god(Archivesledgaridata(728535/00014377491 4002605/ put all available equipment on the road and rent a tractor jbht20131231 10k.htm. Read the discussion in Item I-Business. if a spare is needed. Others disagree and maintain a small number of tractors in reserve. Currently, Over-land Trucking Independent contractors generally control their own and Freight keeps a small number of tractors and trailers out working hours, unlike an employee. Further, independent of service but prepared for duty in case a rig breaks down. contractors' work generally is considered temporary, rather Some managers believe this policy is an expensive luxury than permanent (unlike for an employee). In the trucking and that some of these idle rigs could be used to add the industry, an independent contractor often signs a one-year new routes requested by FHP. When estimating a tractor's contract for a temporary job. But an employee is hired practical capacity, management at Over-land use 85% of total permanently under the assumption that he or she will make potential miles driven in a period. Theoretical (or 100%) deliveries until further notice. This arrangement constitutes capacity utilization is virtually impossible in the industry a permanent job. because of factors such as traffic and loading delays. CAPACITY ISSUES AND INDUSTRY PRACTICES THE PROPOSAL AND RELATED ISSUES Over-land Trucking typically assigns one driver to one Management at FHP has asked Over-land to consider adding tractor. But this practice can constrain the available hours two dry van loads per week; each load would require 1,500 the tractor can operate. For example, laws require a driver round-trip miles. Because FHP is a long-term client with a to take a 10-hour break after 11 hours of driving. Further, strong financial position, the company's management has asked a driver cannot work more than 70 hours in an eight-day for a very favorable rate of $2.15 per mile including FSC and period without taking a 34-hour break. To improve tractor all miscellaneous fees. Roger believes the potential volume of utilization by avoiding constraints based on legal driving freight from FHP can be used to grow Over-land's business and time requirements, some trucking companies use "slip profitability. There is also risk associated with not taking the seating." This is a practice that permits greater tractor new lines. If Over-land does not accept the new routes, another utilization by placing a fresh driver behind the wheel at trucking line will, thus building loyalty with FHP. the end of the former driver's shift. Slip seating is similar in FHP is a stable, solvent company that presents no question practice to an airline company that keeps its planes flying of collection, thus ensuring a reliable cash flow. If FHP decides longer by inserting fresh flight crews as the previous crew to restructure its supply chain in the future, Over-land could goes off duty. It also is efficient to utilize "team drivers" that find itself in the undesirable position of holding dedicated are commonly husband-wife teams. One person drives while assets (trucks and trailers) for routes that no longer exist. The the other sleeps. Relative to a single driver, this arrangement owner's aversion to increased debt levels further exacerbates basically doubles the amount of miles driven in a given concerns about acquiring additional fixed assets. Perhaps Over- week. Typically, teams are paid more, but additional line land could service the initial demand with existing equipment. haul revenues offset the extra labor costs. But, as additional routes are added in the future, Over-land Another strategy to improve tractor utilization is to use must acquire more tractor-trailer rigs or consider outsourcing the trailer pools, commonly referred to as "drop and hook" miles by using independent contractors systems. For example, trucking companies will leave an Exhibit 1 presents Over-land Trucking and Freight's empty trailer with customers, who will load it with products income from operations for the year ending December 31, as units are produced. When the trailer is filled, a tractor 2013. This statement is not prepared in accordance with IMA EDUCATIONAL CASE JOURNAL 3 VOL. 7, NO. 2, ART. 2, JUNE 2014Generally Accepted Accounting Principles (GAAP) but presents costs by behavior. Exhibit 2 presents Over-land Trucking and Freight's balance sheet for the year ending December 31, 2013. Exhibit 1 Income from Operations (All financial information in the case has been scaled and disguised for educational purposes.) Over-land Trucking and Freight Income from Operations For the year ending December 31, 2013 Revenue FYE 12/31/2013 Per Mile Line Haul $20,925,280 $1.86 Fuel Surcharge 4,950,160 0.44 Miscellaneous 450.120 0.04 Total Revenue $26,325,570 $2.34 Variable Expenses Insurance 675 , 120 0.06 Fuel 8,775,190 0.78 Oil Lubricants 112,700 0.01 Tolls 112,550 0.01 Parts and Small Tools 787,630 0.07 Hourly Wages: Drivers 4,950,160 0.44 Trailer Pool Expense 255,120 0.02 Total Variable 15,638,480 1.39 Fixed Expenses Insurance General Liability 112,620 0.01 Physical Damage 225,010 0.02 Workers Compensation 226,000 0.02 Health Insurance 224,500 0.02 Security 111,750 0.01 Depreciation 2,137,500 0.19 Salaries, Benefits ( Garage) 675,000 0.06 Salaries, Benefits [Office) ,012,520 0.09 Bad Debt Expense 113,500 0.01 Permits 111,520 0.01 Rental Equipment 1,013,000 0.09 Payroll Taxes 562,500 0.05 Accounting Fees, Supplies, Computer Maintenance 1 12,350 0.01 Miscellaneous 337.510 0.03 Total Variable 6,975,280 0.62 Income from Operations $3,681,810 $0.33 Note: Per-mile values are based on 11,250,000 miles and have been rounded to two decimal places. IMA EDUCATIONAL CASE JOURNAL 4 VOL. 7, NO. 2, ART. 2, JUNE 2014Exhibit 2 Over-land Balance Sheet Over-land Trucking and Freight Balance Sheet For the year ending December 31, 2013 Assets Current Assets Cash $200,000 Accounts Receivable 300,000 Total $500,000 Property Plant and Equipment and ,000,000 Buildings 3,000,000 Accumulated Depreciation Buildings (1,250,000) Tractors, Trailers, and Equipment 8,650,000 Accumulated Depreciation (4,750,000) Tota $16,650,000 Total Assets $17,150,000 Liabilities and Equity Current Liabilities Accounts Payable 150,000 Taxes Payable 65,000 Current Portion of Long-Term Debt 35,000 Total Current Liabilities $250,000 Long-Term Liabilities Notes Payable 1,865,000 Total Long-Term Liabilities $1,865,000 Total Liabilities $2,115,000 Owner's Equity Contributed Capital 3,550,000 Retained Earnings 11,485,000 Total Owner's Equity $15,035,000 Total Liabilities and Owner's Equity $17,150,000 IMA EDUCATIONAL CASE JOURNAL 5 VOL. 7, NO. 2, ART. 2, JUNE 2014THE DECISION Over-land's management is considering the proposal from FHP. There are many issues involving strategy, cost, risk, and capacity Prepare a recommendation to management Use the following questions to guide your analysis. 1. Assume Over-land could service the contract with existing equipment. Use Exhibit 1 to identify the relevant costs concerning the acceptance of FHP's request to add two additional loads per week. Which costs are not relevant? Why? 2. Calculate the contribution per mile and total annual contribution associated with accepting FHP's proposal. What do you recommend? (Use 52 weeks per year in your calculations) 3. Consider the strategic implications (including risks) associated with expanding (or choosing not to expand) operations to meet the demands of FHP. Analyze this question from a conceptual point of view. Calculations are HOE HCCCSSET']. 4. After a closer examination of capacity, management believes an additional rig is required to service the FHP account. Assume Overland's management chooses to invest in one additional truck and trailer that can serve the needs of FHP (at least initially). Assume the annual incremental xed costs associated with acquiring the additional equipment is $50,000. Further, FHP would agree to pay $2.20 per mile (total including FSC and miscellaneous) if Over-land would sign a ve-year contract. What is the annual number of miles required for Over-land to break even, assuming the company adds one truck and trailer? What is the expected annual increase in prombility from the FHP contract? (Use 52 weeks per year in your calculations.) 5. Over-land has business relationships with independent contractors, though Alan is reluctant to use them. Another possibility for expanding capacity is to outsource the miles requested by FHP. One of Over-land's most reliable independent contractors has quoted a rate of $1.65 per mile. As with question 4, assume FHP would agree to pay $2.20 per mile if Over-land would sign a ve-year contract Further, assume Over-land would incur incremental xed costs of $20,000 annually. These costs would include insurance, rental trailers, certain permits, salaries and benets of garage maintenance, and ofce salaries such as billing. How many annual miles are required for Over- land to break even if the miles are outsourced? What is the expected annual increase in protability from the FHP contract? What are your conclusions? a. Why might Over-land use an independent operator if the variable cost per mile is higher than if the company had purchased a rig and hired a driver? b. At what point would management be indifferent between the scenarios illustrated in questions 4 and 5? Based on your analysis, would you recommend adding capacity by purchasing an additional rig or by utilizing the services of an independent contractor? Why? The case references J. E. Hunt and Landstar as two publicly traded companies that have two very different cost structures. This is true because the companies practice two different philosophies for using (or not using) owner operators (e.g., independent contractors). Speculate about the company that may produce higher prots in periods of high economic demand. Why? Speculate about the company that may have a less risky cost structure in poor economic times. Why? All organizations have the potential to perform work, which is determined by the types of resources and the organization's capacity. Effective use of resources can be critical to a rm in any competitive market. In their efforts to efciently use capacity, managers may ask questions such as: What portion of the available capacity is in use? Of the capacity in use, what portion is used productively? How can we increase the productive use of capacity? Why is a portion of available capacity not in use? Can we eliminate unused capacity? Over-land's management is no different In fact, management is not exactly clear about how to view capacity Discuss the challenges that Over-land's management faces with dening and managing capacity, Consider various denitions of capacity, such as theoretical, practical, normal, and actual capacity. Based on the facts presented in the case, prepare an estimate of capacity for Over-land (assuming one driver per rig without slip seating or team driving). ABOUT IMA With a worldwide network of more than 70,000 professionals, IMA (Institute of Management Accountants) is the world's leading organization dedicated to empowering accounting and nance-professionals to drive business performance. IMA provides a dynamic forum for professionals to advance their careers through CMA (Certied Management Accountant) certication, research, professional education, networking, and advocacy of the highest ethical and professional standards. For more information about IMA, please visit wwwimanetcrg. IMA EDUCATIONAL CASE JOURNAL a VOL. 7, N0. 2, ART. 2, JUNE 2014