Expert answer:Relevant costs, overland trucking and freight, ass

Answer & Explanation: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 five-year contract. Further, assume Over-land would incur incremental fixed costs of $20,000 annually. These costs would include insurance, rental trailers, certain permits, salaries and benefits of garage maintenance, and office 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 profitability from the FHP contract? What are your conclusions?20150503162544case_3_relevant_costs___overland_trucking_and_freight_cs.pdf
20150503162544case_3_relevant_costs___overland_trucking_and_freight_cs.pdf

Unformatted Attachment Preview

ISSN 1940-204X
Over-land Trucking and Freight:
Relevant Costs for Decision Making*
Thomas L. Albright
Naval Postgraduate School
Paul Juras
Babson College
Russ Elrod
Arab Cartage and Express Co.
ABSTRACT
replace older equipment (usually in blocks of five trucks).
Alan knew the slim profit margins associated with trucking,
coupled with a downturn in the economy, could spell disaster
if saddled with too much debt. See Exhibits 1 and 2 for the
company’s most recent statement of income from operations
and the balance sheet, respectively.
Roger Simmons, Over-land’s operations manager for the
past 16 years, had been reviewing the FHP proposal and
approached Alan. “Alan, we need to discuss this offer from
FHP. I think it is a great opportunity for our company, and
we need to find a way to make it work.” Within 10 minutes
Alan and Roger were in a closed-door meeting discussing
the pros and cons of FHP’s offer. Roger began by stating the
obvious: “Alan, this is a huge opportunity for us to grow the
business. Not to mention, as FHP becomes more dependent
on our services, we will be in a stronger position to negotiate
future rate increases. I know you are opposed to debt, and
I understand the risks of carrying more debt, but there is
more than one way to grow our fleet. If you would consider
using independent contract drivers, we could grow the fleet
enough to accept FHP’s offer without incurring more debt.”
Alan cringed at the thought of using independent
contract drivers. Although independent contractors owned
their own trucks, Alan viewed them as difficult to deal
with and not worth the headache. “Roger, I hear you, but
this new route will not last a week if we cannot give FHP
great service. Independent contractors call the shots, not
us. They own the rig and will sit at home if they want to. I
would rather deal with our own company’s rigs and drivers.
The rewards just do not justify the risks of damaging our
relationship with FHP.
Over-land Trucking and Freight has a long-established
and mutually beneficial business relationship with a major
international automotive parts company, FHP Technologies.
Management at FHP has approached Over-land with a
request to provide additional routes that are important to
the efficiency of its supply chain. Over-land’s management
wishes to nurture the business relationship with FHP but
is concerned about the available capacity to service the
new routes, potential risks, and profitability associated with
FHP’s request.
INTRODUCTION
Alan James founded Over-land Trucking and Freight in
1968 and has grown the business into a sizeable operation
with 90 trucks and 180 trailers. His largest customer, FHP
Technologies, has submitted a proposal to him to add
delivery routes that would improve the efficiency of FHP’s
supply chain. Alan was not certain that Over-land could
handle the additional routes since the company currently was
operating at (or near) full capacity.
FHP offered a total of $2.15 per mile (including fuel
service charge and miscellaneous fees) for the new route.
But Alan knew that to accept the offer he would have to add
more trucks and perhaps incur additional debt. The question
was whether the rates offered by FHP were high enough
to offset the associated risks of growing the fleet. Although
the business had been grown organically through the years
by reinvesting profits, it incurred debt from time to time to
*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.
IM A ED U C ATIO NA L C A S E JOURNAL
1
VOL. 7, N O. 2, ART. 2, JUN E 2014
“But I am not sure we should take on any more debt at
this point to purchase additional rigs. The economy is in
the tank, and it is a bad time for us to leverage the balance
sheet any further. Roger, my success in this business was not
built by jumping on every offer that came along. Sometimes
you have to say no, even to your biggest customer. Unless
you can find a way to squeeze out more capacity within our
current fleet, I just do not think we can accept FHP’s offer at
this time,” Alan concluded.
As the two men left the room, Roger was convinced that
Alan was wrong. Roger knew that Alan was leaving money on
the table. He just needed to prepare a financial analysis that
would prove it. Was it possible to squeeze out more capacity
from an already fully utilized fleet? Perhaps they could shift
trucks from another account. Was taking on more debt truly
“risky” given the profit potential of this new route? Roger
knew he had to make a convincing argument before FHP
took its offer to another truck line.
Included in miscellaneous revenue are the following:
INDUSTRY TERMS
Loads transported on flatbed trailers must be secured by
straps or chains. These types of loads often are associated
with higher worker’s comp claims. Thus an extra strapping
and chaining fee is charged only for a flatbed load.
Storage fees are collected when Over-land stores a loaded
trailer on its lot for a customer.
Lumper revenue is collected if a driver assists with unloading
a trailer.
Certain flatbed loads, such as drywall, unpainted steel, and
some types of wood products, that would be damaged by
rain must be covered. Trucking companies typically charge a
tarping fee for such loads.
Additional insurance is required when transporting highvalue cargo. Practices vary throughout the industry. If a load
is above a company’s standard cargo insurance limits, many
companies simply will not haul it. Trucking companies
that are willing to bind additional cargo coverage normally
do so for a fee that covers only the extra cost of insurance.
(Alternatively, this revenue line item could have been
booked as a reduction to the “Insurance” expense account.)
• A tractor-trailer rig is a truck that consists of a tractor
attached to a trailer. The tractor typically is powered by a
diesel engine.
If a truck sits idle at the dock for more than two hours,
customers can be charged a fee that is classified as detention
revenue. Placing a detention revenue clause in the contract
encourages customers to load trailers efficiently in order to
avoid further constraints on Over-land’s tractor capacity.
• A flatbed trailer is long flat platform with no sides.
•A
dry van trailer is a boxed cargo compartment designed for
nonrefrigerated freight.
•T
rucking companies often have a revenue-generating load
in one direction but need a revenue-generating contract
for the return trip. The return trip is known as a backhaul.
Often trucking companies contract with freight brokers to
acquire backhauls.
TYPES OF BUSINESS ARRANGEMENTS WITH
DRIVERS
Over-land has potentially two arrangements with drivers.
They are classified as employees or as independent operators.
Employees receive traditional employee benefits and a Form
W2 for tax purposes. These persons are typically engaged in
work for the company that is considered “permanent.”
Alternatively, independent operators are not considered
employees and receive a Form 1099 (rather than a Form
W2) for tax purposes. These operators typically provide the
tractor but generally do not provide the trailer. In addition to
driver salaries and depreciation on trucks, expenses incurred
by independent contractors include:
• Tags (known as International Registration Plan (IRP)) –
The independent contractor buys the IRP tag for the tractor,
while the shipping company buys the tags for the trailer.
• IRS Form 2290 – Heavy Road Use Tax.
• Diesel fuel, engine fluids, and all maintenance-related
parts and items.
INDUSTRY BACKGROUND AND COST STRUCTURE
Trucking firms generate a variety of revenue types from
hauling goods for their clients. Presented next is a brief
overview of key types of revenues included in the 2013
income from operations of Over-land Trucking and Freight.
Line haul revenue is earned from hauling freight.
Fuel prices in recent years have been volatile. Because
trucking companies are exposed to fuel price volatility when
they sign a long-term contract with their customers, they
may charge an additional fee associated with fuel costs when
prices exceed predetermined levels. Thus, the primary
purpose of the fuel surcharge (FSC) revenue is to protect the
truck line from fuel price increases during the contract term.
IM A ED U C ATIO NA L C A S E JOURNAL
2
VOL. 7, N O. 2, ART. 2, JUN E 2014
• Physical damage insurance.
Independent contractors generally control their own
working hours, unlike an employee. Further, independent
contractors’ work generally is considered temporary, rather
than permanent (unlike for an employee). In the trucking
industry, an independent contractor often signs a one-year
contract for a temporary job. But an employee is hired
permanently under the assumption that he or she will make
deliveries until further notice. This arrangement constitutes
a permanent job.
arrives, drops an empty trailer to replace the trailer just
filled, then immediately hooks onto the loaded trailer and
departs. Tractor utilization improves because tractors are not
sitting idle while a customer loads a trailer. This approach is
economically feasible because trailers are far less expensive
to purchase and operate than tractors.
Most trucking companies keep some tractors “on
the fence” as spares, in case one breaks down. There is
considerable disagreement, however, over what constitutes
too many spares. Some owners believe a truck line should
put all available equipment on the road and rent a tractor
if a spare is needed. Others disagree and maintain a small
number of tractors in reserve. Currently, Over-land Trucking
and Freight keeps a small number of tractors and trailers out
of service but prepared for duty in case a rig breaks down.
Some managers believe this policy is an expensive luxury
and that some of these idle rigs could be used to add the
new routes requested by FHP. When estimating a tractor’s
practical capacity, management at Over-land use 85% of total
potential miles driven in a period. Theoretical (or 100%)
capacity utilization is virtually impossible in the industry
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
tractor. But this practice can constrain the available hours
the tractor can operate. For example, laws require a driver
to take a 10-hour break after 11 hours of driving. Further,
a driver cannot work more than 70 hours in an eight-day
period without taking a 34-hour break. To improve tractor
utilization by avoiding constraints based on legal driving
time requirements, some trucking companies use “slip
seating.” This is a practice that permits greater tractor
utilization by placing a fresh driver behind the wheel at
the end of the former driver’s shift. Slip seating is similar in
practice to an airline company that keeps its planes flying
longer by inserting fresh flight crews as the previous crew
goes off duty. It also is efficient to utilize “team drivers” that
are commonly husband-wife teams. One person drives while
the other sleeps. Relative to a single driver, this arrangement
basically doubles the amount of miles driven in a given
week. Typically, teams are paid more, but additional line
haul revenues offset the extra labor costs.
Another strategy to improve tractor utilization is to use
trailer pools, commonly referred to as “drop and hook”
systems. For example, trucking companies will leave an
empty trailer with customers, who will load it with products
as units are produced. When the trailer is filled, a tractor
Management at FHP has asked Over-land to consider adding
two dry van loads per week; each load would require 1,500
round-trip miles. Because FHP is a long-term client with a
strong financial position, the company’s management has asked
for a very favorable rate of $2.15 per mile including FSC and
all miscellaneous fees. Roger believes the potential volume of
freight from FHP can be used to grow Over-land’s business and
profitability. There is also risk associated with not taking the
new lines. If Over-land does not accept the new routes, another
trucking line will, thus building loyalty with FHP.
FHP is a stable, solvent company that presents no question
of collection, thus ensuring a reliable cash flow. If FHP decides
to restructure its supply chain in the future, Over-land could
find itself in the undesirable position of holding dedicated
assets (trucks and trailers) for routes that no longer exist. The
owner’s aversion to increased debt levels further exacerbates
concerns about acquiring additional fixed assets. Perhaps Overland could service the initial demand with existing equipment.
But, as additional routes are added in the future, Over-land
must acquire more tractor-trailer rigs or consider outsourcing the
miles by using independent contractors.
Exhibit 1 presents Over-land Trucking and Freight’s
income from operations for the year ending December 31,
2013. This statement is not prepared in accordance with
• Non-trucking “bobtail” Liability Insurance (needed for
when the truck is not transporting a trailer).
• Tolls and scale fees.
For an example of a publicly traded transportation company
that primarily uses independent operators, visit Landstar Trucking
Company’s website at www.nonforceddispatch.com/landstar.php.
For a description of a publicly traded transportation company
that primarily owns its rigs and employs company drivers, see
J. B. Hunt Transportation Services’ Form 10K at www.sec.
gov/Archives/edgar/data/728535/000143774914002605/
jbht20131231_10k.htm. Read the discussion in Item 1-Business.
IM A ED U C ATIO NA L C A S E JOURNAL
3
VOL. 7, N O. 2, ART. 2, JUN E 2014
Generally 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
$26,325,570
$2.34
Total Revenue
Variable Expenses
Insurance
675,120
0.06
8,775,190
0.78
Oil Lubricants
112,700
0.01
Tolls
112,550
0.01
Parts and Small Tools
787,630
0.07
4,950,160
0.44
Fuel
Hourly Wages: Drivers
Trailer Pool Expense
255,120
0.02
15,638,480
1.39
General Liability
112,620
0.01
Physical Damage
225,010
0.02
Workers Compensation
226,000
0.02
Health Insurance
224,500
0.02
111,750
0.01
2,137,500
0.19
Total Variable
Fixed Expenses
Insurance
Security
Depreciation
Salaries, Benefits (Garage)
Salaries, Benefits (Office)
Bad Debt Expense
Permits
675,000
0.06
1,012,520
0.09
113,500
0.01
111,520
0.01
1,013,000
0.09
Payroll Taxes
562,500
0.05
Accounting Fees, Supplies, Computer Maintenance
112,350
0.01
Miscellaneous
337,510
0.03
6,975,280
0.62
$3,681,810
$0.33
Rental Equipment
Total Variable
Income from Operations
Note: Per-mile values are based on 11,250,000 miles and have been rounded to two decimal places.
IM A ED U C ATIO NA L C A S E JOURNAL
4
VOL. 7, N O. 2, ART. 2, JUN E 2014
Exhibit 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
Land
1,000,000
Buildings
3,000,000
Accumulated Depreciation Buildings
(1,250,000)
Tractors, Trailers, and Equipment
18,650,000
Accumulated Depreciation
(4,750,000)
Total
$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
IM A ED U C ATIO NA L C A S E JOURNAL
5
VOL. 7, N O. 2, ART. 2, JUN E 2014
THE DECISION
expected annual increase in profitability from the FHP
contract? What are your conclusions?
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.
6
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
1. Assume Over-land could service the contract with
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?
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?
7. The case references J. B. Hunt and Landstar as two
2. Calculate the contribution per mile and total annual
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
profits in periods of high economic demand. Why?
Speculate about the company that may have a less risky
cost structure in poor economic times. Why?
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
not necessary.
8. 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 firm in any competitive market. In their efforts
to efficiently 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 defining and managing capacity. Consider various
definitions 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).
4. After a closer examination of capacity, management believes
an additional rig is required to service the FHP account.
Assume Over-land’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 fixed
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 five-year contract. What is the annual number of
miles required for Over-land to break even, assuming the
company adds one truck and t …
Purchase answer to see full
attachment

How it works

1. Paste your instructions in the instructions box. You can also attach an instructions file
2. Select the writer category, deadline, education level and review the instructions 
3. Make a payment for the order to be assignment to a writer
4.  Download the paper after the writer uploads it 

Will the writer plagiarize my essay?

You will get a plagiarism-free paper and you can get an originality report upon request.

Is this service safe?

All the personal information is confidential and we have 100% safe payment methods. We also guarantee good grades