You, CPA, return to your office and begin organizing your notes from a meeting with Blake Merritt, the owner of Hamilton City Transport (HCT) and William Stephenson, a partner in Fretz and Stephenson LLP (F&S), the public accounting firm where you work. HCT has been an F&S advisory client for 20 years, and the partner has asked you to research Blake’s concerns.

HCT has 20 trucks that deliver dry-bulk and liquid-bulk goods, as well as a flat-deck delivery service for large equipment and goods. HCT charges customers per kilometre (km) and has contracts signed with many large companies that ship goods all over North America. However, the past year has been pretty tough on HCT.

Blake has asked for advice on whether he should make a significant change in how he operates HCT. The partner asked you to focus on whether the proposal makes sense from a cost basis. F&S can perform a formal net present value analysis at a later date. As well, Blake wants you to consider the potential opportunities and risks associated with the operational change for HCT.

In addition, Blake is considering implementing an automated fleet management system and would like to understand the payback period for this investment and how this system could benefit HCT's operations. Also, Blake thinks that HCT's liquid-bulk business should be shut down as it is operating at a loss. He would like you to analyze the company’s three divisions to conclude on their profitability.

Finally, Blake is considering re-mortgaging HCT's garage facility to provide HCT with the financial flexibility to pursue another business opportunity. Blake’s father-in-law will be providing the mortgage and would like assurance over HCT's income statement annually. Blake would like to understand what report would be appropriate.

Your notes from your meeting with Blake are found in Appendix I and HCT's divisional income statement is included in Appendix III.

APPENDIX I
NOTES FROM MEETING WITH BLAKE MERRITT

Proposed Operational Change

Currently, HCT owns all of its trucks, pays for all the costs (diesel, insurance, repairs and maintenance, and travel incidentals such as meals), and pays the drivers an employee salary. Blake likes it this way because he has complete control from start to finish. He values his employees and likes to provide them with stable employment and wages. However, it can be very expensive when HCT cannot find a return load and the truck has to come back to HCT empty.

Blake is considering selling the 20 HCT-branded trucks to the company’s drivers so that they would be independent contractors, not employees. The purchase price per truck would equal to the particular truck’s fair market value. If a driver cannot obtain outside financing, HCT will finance the purchase internally at the current prescribed interest rate.

Instead of a salary, HCT would pay the drivers $2.00 per km for a full load and nothing for the return trip if they come back with an empty load. This amount is set by the Truck Drivers Union of North America and must be used by HCT for all its independent contractors. The proposal has not yet been discussed with any of the drivers or other employees at HCT.

A driver would be allowed to haul goods for any transport company if HCT does not have a load for the driver. The driver must call into HCT prior to accepting a load from another company and has to give HCT one hour to find a pick up within 20 km of the driver’s location. Drivers do not have to accept a particular HCT load but will not be able to refuse more than three HCT loads in a row without triggering a penalty clause.

An average return trip is 5,000 km and each truck averages 40 return trips per year. Trucks come back empty close to 20% of the time. There are no costs for lodging as all of HCT's trucks come equipped with a sleeper bed, toilette, fridge, and microwave.

HCT plans to keep its garage and requiring, as part of the truck sale agreement, that the drivers have their vehicles maintained and repaired at the HCT garage at their own expense. Blake expects that the costs of the garage and mechanics will be more than offset by the maintenance revenue received.

While Blake does not need an assessment of whether the truck drivers will be employees or contractors for tax purposes, he would like to understand the deductibility of home office expenses (excluding automobile expenses) for the truck drivers as contractors.

Industry Information

The trucking industry has many medium-sized players, but lately the big players have been taking more and more market share. The industry also has hundreds of individual drivers who only own one truck. It is a perception in the industry that the big players see this as an opportunity to squeeze out the small and medium-sized competition, like HCT, and consolidate capacity within the industry.

With increased competition, and skyrocketing insurance rates, it is becoming more and more difficult to make money in the trucking business. Shipping rates have increased slightly but cannot go any further as the big players in the industry have only initiated slight price increases. Diesel prices are fluctuating causing further uncertainty about profitability.

Fleet Management Processes

HCT's scheduling is accomplished with a series of white boards and pencil logs in the main dispatch room. Maintenance and mileage logs are kept in each truck’s glove compartment and are completed by the company’s mechanics. The data from the logs is input into the master maintenance spreadsheet at the end of each month. The maintenance manager feels he knows which trucks need preventative maintenance through experience. Industry literature notes that regular preventative maintenance based on kilometers driven is very effective in minimizing overall repair and maintenance costs.

The safety manager maintains a manual log book of all recurring safety related maintenance that is required by law. HCT's newer trucks are still under manufacturer’s warranty, but the older trucks are not. Warranty documents are filed with the capital expenditure receipts in a cabinet in the office.

The proposed fleet management system would only save two days of downtime per truck per year. The system will cost $46,000 and will last at least three years before needing an update.

The new automated system would eliminate the manual inputting of data and dispatch information would be communicated electronically to drivers. It would have tracking of location and usage for all trucks. The truck logs would automatically download mileage to the system and notifications would be sent to the drivers and dispatch when maintenance is required.