Companies using either flexible expense accounts or expense quotas and whose sales personnel operate their own vehicles (rather than company owned or leased vehicles) need some system for determining the amounts of travel expense reimbursements. Calculating ‘‘exact’’ travel expenses is complicated. Three categories of expense are involved: variable, semivariable, and fixed. Variable expenses include costs of gasoline, lubricating oil and grease, and tires—all varying with the miles traveled. Fixed expenses include the costs of insurance coverage, license fees, and inspection fees. Semi-variable expenses, which vary with the vehicle’s age and rate of usage, include charges for depreciation and obsolescence. Adding further to computation difficulties, expenses differ with the automobile make and model and expenses of ownership and operation, even for the same makes and models, differ from one territory to another, while differences in road and traffic conditions cause operating expenses to vary from territory to territory.
Complications in calculating exact automobile expenses cause most companies to settle for less exact procedures. Among companies using vehicles owned by sales personnel, more than 70 percent use the flat mileage rate system for reimbursing travel expenses. The rest use graduated mileage rates, fixed periodic allowances, combinations of fixed periodic allowances and mileage rates, and other systems.
Flat mileage rates. Most companies use a flat mileage rate system and reimburse travel expenses at a fixed rate per mile traveled. Users of this system must set the mileage rate high enough to cover all expenses of vehicle ownership and operation, yet low enough to permit the company to buy transportation economically.
Administering this system is simple. Sales personnel report mileages traveled, the flat mileage rate is applied, and reimbursement checks are issued. The system works satisfactorily when a company’s sales force covers small territories (requiring limited automobile travel) all in the same geographical area (incurring very similar expense amounts) and the mileage rate applied is on the generous side (eliminating arguments over actual and reimbursed expenses). Probably for these reasons, many companies favor flat mileage rates.
The flat mileage rate system has some fundamental shortcomings. It assumes that automobile expenses per mile vary at a constant rate at all operating levels. It ignores cost differentials arising from the use of various makes and models. It ignores territorial differences in expenses, for example, in prices of gasoline, oil, tires, insurance coverage, license and inspection fees, and even the automobiles themselves. Furthermore, in administering a flat mileage rate system, management often hesitates to adjust the rate, upward as well as downward, in line with changing actual expenses.
Graduated mileage rates. Under this system, different rates apply to mileages in different ranges, for example, 25 cents per mile up to 5,000 miles annually, 22.5 cents per mile from 5,000 to 10,000 miles, and 20 cents per mile over 10,000 miles. Companies using this system recognize that the per mile costs of automobile operation are lower for long than for short distances; however, setting the cents-per-mile rates is difficult, since it is necessary to consider different operating levels in determining the mileages at which rates change. This system takes into account, almost mechanically, differences in sales territories, such as the length of route and frequency of calls. But, like the flat mileage rate system, it does not provide for cost variations resulting from operation of different makes and models and territorial expense differentials. Graduated mileage rate systems are appropriate when sales personnel travel long distances annually and serve concentrated geographic areas without significant regional expense differences.
Fixed periodic allowance. Some companies pay sales personnel a fixed allowance for each day, week, month, or other period during which they use their personal automobiles on company business. The fixed periodic allowance assumes that total automobile expenses vary with duration of use rather than mileage. Companies using this system tend to penalize sales personnel with large territories requiring extensive traveling for adequate coverage; unless the fixed periodic allowances is varied for individual sales personnel, it fails to reimburse for these differences. If allowances are uniform for all sales personnel, morale suffers because of the inequities. When the entire sales force faces similar driving conditions, owns comparable makes and models of cars, and has nearly equal-sized territories, each requiring approximately the same coverage, the standard allowance is defensible. It is unusual to have all these conditions present in the same situation.
Combination fixed periodic allowance and mileage rate. In this system a fixed periodic allowance (to cover fixed and semi-variable expenses such as insurance premiums, license fees, and depreciation) is combined with a mileage payment (for operating expenses, including costs of gasoline, oil, and tires).
This plan recognizes that some expenses vary with automobile usage and some do not. In contrast to mileage rate systems, it provides for the expenses that do not vary directly with the operating level. In contrast to the fixed periodic allowance, it takes account of cost differentials arising from different operating levels. If sales personnel are granted identical fixed periodic allowances, this system, like the others, fails to consider territorial expense differentials and cost variations resulting from operation and ownership of different makes and models.
Some companies using combination systems accumulate reserves to cover depreciation on automobiles and reimburse sales personnel when they buy new cars. This assures that the salesperson can buy a new car without outside financing. Furthermore, this makes it unnecessary for the sales force to request company financial help in buying new cars. These reserves represent the withholding of some portion of expense allowances that otherwise would be paid periodically. When the reserve feature is not used, sales personnel often delay replacing old cars because of financial problems. The withholding feature assures that the sales staff will not drive dilapidated automobiles and risk embarrassing the company.
Source: Richard R. Still, Edward W. Cundliff, Normal A. P Govoni, Sandeep Puri (2017), Sales and Distribution Management: Decisions, Strategies, and Cases, Pearson; Sixth edition.