Buy or Lease

Table of contents

1. Exexutive Summary

2. Car policy in Germany

3. Description of 3M Deutschland GmbH
3.1 3M Deutschland GmbH
3.2 Its products

4. Comments on 3M’s financial policy
4.1 Accounting policy
4.2 Profit and loss account
4.3 Sales
4.4 Costs

5. Buy or lease: Questionnaire from an accounting point of view
5.1 The product’s inventory number
5.2 Inital costs of the product
5.3 Book value now or at a specific point in time
5.4 Book value total or single
5.5 Which kind of leasing is used?
5.6 Depreciation method used and depreciation rate
5.7 Depreciation period
5.8 Depreciation base and depreciation costs
5.9 Investment tax credits
5.10 Investment premium
5.11 Tax rate
5.12 Deductibility of added value tax for depreciation base
5.13 3M’s interest rates for short-term and long-term debts Page 11 and capital investments
5.14 Actual lease payments
5.15 Administrative costs
5.16 Deductibility of costs

6. Case and decision

7. References

Executive summary

Companies and experts in special literature often discuss the question whether it is cheaper for a company to buy certain goods on credit or with its own capital. When buying a certain good we moreover have to differentiate between goods that are purchased on lease or bought on credit. This paper does not deal with the fundamental question whether to buy on credit or to lease as it has been proved thoroughly in the respective literature that most of the time leasing is more expensive than buying on loan (compare Prof. K. D. Däumler, in BKK Nr. 13).

The question now is why do companies nevertheless discuss about buying or leasing? Why do companies decide on leasing a wide range of goods from typewriters to cars, trucks and even complete industrial plants? About 11 % of all goods are leased in Germany at the moment. 53 % of which are leasing transactions involving cars. First of all there are considerable differences with regard to the drawing up of a balance sheet. Goods that are bought have to be capitalized with their initial costs while goods that are leased do not have to be shown in the balance sheet of the leaseholder (compare Prof. K. D. Däumler, in BKK Nr. 13).

Companies do follow completely different strategies regarding this subject. HENKEL (chemical industry) and RTL (broadcasting company) on the one hand have leased all of their cars explaining that this is the cheapest alternative for them (Auto Zeitung Nr 24). Bayer and 3M Deutschland on the other hand use the same explanation but they buy their cars. Car policies are even different between various subsidiaries of one company. For example the subsidiaries of 3M in Belgium, the Netherlands and Luxembourg regularly lease all their car.

This paper aims at describing the fundamental considerations of 3M’s finance department when developing a calculation program to support the decision „buy or lease“. 3M Deutschland was asked to develop this program as a pioneer for 3M Europe. I have obtained a prototype of the calculation program in order to test it. My comments regarding the program and the variables that should be considered are laid down in chapter 5 of this paper.

2. Car policy in Germany

In Germany most companies provide their employees with a car but only in accordance with a very hierarchical system that depends on status and income. CEOs and managing directors are entitled to a BMW 7 series, a Mercedes S-class or an Audi A8. The value of the cars ranging from DM 100.000,-- to 120.000,--. General manager and heads of departments are provided with BMW 5 series, Mercedes E-class of Audi A6 which are in a price range between DM 65.000,-- and 75.000,--. Manager will probably get a BMW 3 series, VW Passat or Audi A4 that cost around DM 45.000,--.

Field staff that is normally not entitled to a car will nevertheless get one: It is a lot cheaper for the company than having to pay the mileage allowance for the use of the private car.

HENKEL i.e. runs about 1250 company cars. 270 of which are driven by only one person. According to management all of these cars have been leased. The costs for those cars that are only driven by one person are split between the company and the user. RTL has also leased all of its cars. Contrary to HENKEL the users do not have to participate in the payments. Other enterprises i.e. BAYER, 3M, and Siemens have bought their cars and they are very often made available for the employees without additional costs (compare Auto Zeitung, Nr. 24, 07.11.1997).

3. Description of 3M Deutschland GmbH

3.1 3M Deutschland GmbH

The company was founded in 1951 and it has been called 3M Deutschland GmbH since 1972. The company is completely owned by Minnesota Mining and Manufacturing Company, St. Paul, Minnesota, USA.

In 1902 the parent company was founded in Two Harbours, Minnesota. Today it has subsidiaries in more than 60 countries, R&D facilities in 22 and production plants in 42 countries. 3M employs more than 74.000 people all over the world. The number of shareholders comes up to 132.414 persons. Its 1996 sales were $14.236 million with an income from continuing operations before income taxes and minority interest of $ 2.479 million. The return of invested capital amounted to 17.1% and stockholders’ equity per share came up to 15.08%.

In 1995 3M underwent a thorough re-structuring. As a result the complete data storages and imaging businesses were set up in a new and independent company called Imation Corp..

In Germany the shares of 3M USA have officially been quoted at the stock exchanges in Düsseldorf and Frankfort/Main between November 1972 and July 1997.

3M Deutschland GmbH has its head-quarters and place of business in Neuss. It has own production sites in Hamburg, Kamen, Hilden, Düsseldorf and Borken that produce not only for the German market but also for other 3M subsidiaries world-wide.

The production site in Hamburg manufactures electrical, electronic as well as shielding and protective products. The European processing-plant for abrasives is located in Kamen. In addition car air filter systems are produced here. Hilden produces tapes of any kind as well as reflective and decorative sheetings.

It custom-made adhesives for the automotive industry and advertising. Borken is not only a manufacturing - but also a distribution site. It supplies the market with medical, pharmaceutical and dental products. It produces i.e. monitoring electrodes, hot- and cold-packs and tapes and dressings. In 1995 the customers’ service has been centralized in Neuss.

The building of the new finished goods inventory in Jüchen has been finished in due time in the final quarter of 1994.

In 1990 the monta Klebebandwerk GmbH in Immenstadt was bought. It produces and distributes packaging tapes and is a specialist in this very competitive market segment. As from January 1, 1994, the 3M Medica GmbH, Borken, merged with 3M Deutschland GmbH.

The only task of the 3M Unterstützungskasse GmbH is the management of the pension trust. It supplies recurrent or non-recurring payments as well as contributions from the company pension scheme to employers or their relatives.

The 3M Laboratories (Europe) GmbH has its residence in Neuss and further operational facilities in Borken, Hamburg, Hilden and Kamen. Its main tasks are research and product development as well as technical customer service for the European 3M subsidiaries. In Puchheim close to Munich the inter- Unitek GmbH manufactures and sells materials used by dentists and orthodontics.

3M Deutschland is a limited liability company¹. The legal form „limited liability company“ is typical for foreign subsidiaries. The risk is minimized for the parent corporation. When founding the subsidiary only a lower deposit has to be made. In the case of liability 3M Deutschland is only liable with its basic assets. Moreover this legal form has tax advantages. In addition the fact of being a „limited liability company“ offers a protection against unwelcomed takeovers. The salability is restricted because the associates have a pre-emptive right among themselves. As the limited liability company is subject to less legal provisions compared to stock corporations it can react a lot quicker and more flexible to changing market situations.

3.2 Its products

3M has about 60.000 products and 40 product divisions. These divisions are related to the following markets:

- Traffic and personal safety market
- Consumer and office market
- Industrial market
- Medical market
- Automotive and chemical market
- Electro and communications market
- Pharmaceuticals, dentals and personal care market
- Imaging and information systems

Some of 3M’s best-known brand-names include Scotchgard, Scotch brand, Thinsulate, Post it, Scotch brite, etc. About 500 new and innovative products are developed every year.

4. Comments on 3M’s financial policy

4.1 Accounting policy

The annual report states that the accounting - and valuation principles have not been changed over the last years. Transaction values and computer programs are valued at the original costs minus the permitted depreciations and write-downs. The useful life is three years. The minimum value principle is applied. Low-value assets have to be fully depreciated in the year of acquisition. The accounting valuation of property, plant and equipment is computed with the scheduled depreciations. As far as possible it is depreciated on a reducing balance basis, but if the depreciation is higher on a straight-line basis (compare 3M/Ge 1996, page 27). On the other hand the US annual reports states that property, plant and equipment is generally computed on a straight-line base (compare 3M/US 1996, page 35).

Assets and liabilities in foreign currencies are adjusted monthly. As far as foreign currencies are concerned receivables are calculated at lower market prices on reporting date, liabilities - on the other hand - at higher market prices on reporting date (compare 3M 1996, page 27).

It can clearly be seen that 3M has voted for a conservative accounting. It can be assumed that the company aims at accruing hidden reserves (compare: Küting, Capital 10/96, page 38). At the same time expenditures on banks and affiliated companies went down; this is an unusual development and it raises questions. Financial assets seems to be high. We can assume that a high degree of self-financing is involved .

4.2 Profit and Loss Account

The profit and loss account follows the cost of sales method. In the rating period the profit and loss account of 3M showed a lower result of normal business activity (DM 30.7 million compared to DM 56.7 million in 1995) (compare 3M Ge 1996, page 26). The „other operating expenses“ have fallen by 26%. The net income for the year after tax came up to DM 14.250 million (previous year DM 41.273 million).

4.3 Sales

The sales of 3M Deutschland GmbH are shown in segmented reporting. In the reporting period they came up to DM 1.539.297.665 million Thus the sales revenues have decreased by 7.7%.

Only the sectors Office- and Household Products (+ 4,7%) and Medical, Pharmaceutical and Dental Products (+ 6,9%) are positive. 3M lost strongly in the areas Consumer Goods and Video-/Film Products (- 60%) as well as Data Storage and Imaging etc. (- 46,7%). This development is partly due to the fact that some product lines were sold or launched into the new Imation Corp.

4.4 Costs

According to the management the production costs were reduced by 7,4%. The gross result of the sales was decreased by 8.5%. Because of the Imation-spin off the distribution costs were reduced by DM 33.5 million. Compared to 1995 the labor costs have risen by 1.4% although the number of employees fell by 6.3%.

5. Buy or lease: A questionnaire from an accounting point of view

The decision of 3M’s management whether to buy or lease a certain good is not restricted to cars alone, it affects all other goods too. Therefore the finance department has to provide reliable and binding data in order to support this management decision.

A tool to provide the necessary information could be a calculation program that is valid for the whole company. Because it frankly does not matter whether somebody buys cars in Germany, fork-lift trucks in Spain or leases plants in the US, the considerations regarding the cheapest calculation that take place in the company are always the same.

By using a certain company, 3M Deutschland, and a certain car, BMW 520 i as an example this paper describes the drawing up of such a calculation program, that does not yet exist in any European subsidiary, and the problems the finance department faces when developing it.

5.1 The product’s inventory number

First of all it has to be decided which product or products are going to be purchased. The manager who will receive the car is provided with certain framework conditions regarding type of car and price range and he can then choose individually. In this case the manager has decided on a BMW 520i.

5.2 Initial costs of the product

When including some special feature i.e. air condition system, radio and tape deck, special appliances for car phone the car costs about DM 63.500,--. When comparing this to a leasing offer, it has to be found out whether those special feature exist in the car in question or whether the still have to be installed. Moreover it has to be found out whether the company will get a rebate on the car and how much this is.

5.3 Book value now ore at a specific point in time

The purchase costs are set as book value. When selling we assume the residual value.

5.4 Book value total or single

When looking at this example the book value of the individual car is set at DM 63.500,--. If several cars or products are bought that are comparable, the calculation can be made for several of them at the same time (BStBL EL Nr. 81).

5.5 Which kind of leasing is used?

Financial authorities in Germany are dealing with different types of leasing. They i.e. distinguish between a full amortization contract and partial amortization contract, basic terms, terminability or irredeemability, option rights to buy or not to buy as well as a renewal option, expected useful life, real estate leasing and various other special case. The individual types of leasing are assessed differently with regard to tax questions and accounting (compare NWB, NR22 page 1813 ff) and (BStBL EL, Nr. 81).

5.6 Depreciation method used and depreciation rate

It could be seen in the annual report the 3M either depreciates on a straight- line basis or - if allowed - on a reducing balance basis. According to Mr. Nöcker, financial manager at 3M Deutschland, cars are depreciated on a straight-line basis. Moreover it is important to know that 3M does not keep cars longer than three years or 100.000 kilometers. Whatever comes first is a reason to sell the car.

5.7 Depreciation period

Normally the depreciation period for 3M is three years. According to German law that became effective in 1996 cars have to be depreciated over a five year period (BStBL EL Nr. 81, Seite 1). Before 1996 three years were the normal depreciation period. We are only talking about leasing if the lease is at least 40% or at the most 90% of the useful life (BStBL EL Nr. 81, page 3). The leasing rates reduce the tax base of the leaseholder because they are considered as operating expenditures.

5.8 Depreciation base and depreciation costs

In Germany cars can be depreciated over a five year period at the most. In addition to the leasing costs, further costs that arise from the leasing process can be deducted (BStBL EL Nr. 81, Seite 4). Furthermore the leasing rates have to be divided into an interest part, a cost part and a redemption part. Interests and costs are operating expenditures that can be deducted, but the redemption of the purchase money obligation has to be treated as not affecting the operating result (BStBL EL Nr. 81, page 5).

5.9 Investment tax credits

In many European states or regions enterprises get tax reliefs or subsidies for a certain period of time. Between 1989 and 1994 German companies benefited from tax reliefs or subsidies when purchasing cars. When buying low-pollutant cars the government paid single premiums of up to DM 2000,--. Since 1994 a different car tax rate has to be paid on low-pollutant cars thus making the upkeep a lot cheaper.

5.10 Investment premiums

In Germany there are no investment premiums granted when buying cars. Investment premiums are only granted for long-term investments that directly help to create jobs.

5.11 Tax rate

At the moment the tax rate upon buying goods in Germany is 15%. Companies as well as individuals have to pay a 30%- capital yield tax on interest arising form assets. On top of the capital yield tax an additional 7.5% solidarity contribution for the new Federal States has to be paid. Thus the tax rate for capital and assets is about 33%. This tax rate has to be paid off annually. The tax-free amount is DM 6000,--.

Depending on the annual profit the sales tax is between 35 and 45%. Furthermore when talking about buying or leasing income tax, church tax, corporate income tax, business tax and trading capital tax have to be taken into account. They are calculated from the pre-tax profit (Prof. K. D. Däumler, in BKK Nr. 13).

5.12 Deductibility of added value tax for depreciation base

In some European countries i.e. Belgium, Netherlands and Luxembourg cars cannot be depreciated at all.

5.13 3M’s interest rates for short-term and long-term credits and capital investments

3M has to pay an interest rate between 5.5% and 6% for short-term credits. Long-term credits range between 6.6% and 9%.

At present 3M gets between 3% and 3.3% for time money depending on the typ of investment and its availability. The interest rate is between 3.25% and

3.5% with regard to capital funds which can be paid out at all times.

At the moment the interest rates for long-term securities vary between 5.2% and 7.5% depending on the period of investment, date of investment, etc. At present 3M’s capital investments average between 5% and 5.5%.

5.14 Actual lease payments

The company receives the current leasing rates by leasing agencies. 3M always leases its cars from the dealer where it has bought the cars. There is the possibility of comparing the prices of different leasing agencies, but according to a decision of 3M’s Management Committee this does not take place.

BMW provided the information that the current leasing rate for the model in question (BMW 520i) is DM 1186,-- per month. In case of a „service- leasing“ that includes the costs of service and repairs it comes up to DM 1404,--.

According to the guideline lives of the ADAC (German automobile club) and various car magazines the monthly costs for insurance, service and repair costs, gas, parts subject to wear and tear, car tax including capital reserves for new acquisition with a useful life of 3 years come up to about DM 1130,-- to 1260,-- per month. The monthly car costs without capital reserves come up to DM 540,--.

5.15 Administrative costs

How much does the staff cost that is used for the maintenance and administration of the cars?

5.16 Deductibility of costs

According to German law the car costs can be deducted with 20% of the original value.

6. Case and Decision

When including these different aspects into a calculation model leasing and buying has to be assessed differently in the individual countries due to the various possibilities of depreciation.

When looking at our example we can state that after three years 3M has to pay DM 27.494,-- when leasing a BMW 520i, on the contrary to purchase the car would amount to DM 34.644,--.

But the numbers are completely different if the operating costs are paid by the company and are included as expenditures in the leasing-operation. In this case the leasing of a BMW 520i would cost DM 40.243,--.

In the second example the decision of the finance department to buy the car can therefore be explained very easily. The purchase of the car does neither harm 3M’s own capital nor the capital of the investors. It cannot be explained with this calculation model why HENKEL follows a different path - because HENKEL clearly chose the more expensive alternative. We can only speculate that the HENKEL calculation is more favorable because of the contributions the employees have to make when using one of the company’s cars. Otherwise HENKEL would destroy capital. This car policy can only be explained as a consequence of considerable differences when evaluating the actual lease payments. According to Prof. K. D. Däumler, in BKK Nr. 13 the arguments that support leasing i.e. more favorable cost allocation, easier permission to buy, tax advantages are only dummy arguments. Tax advantages only exist in the areas of business tax and trading capital tax (Prof. K. D. Däumler, in BKK Nr. 13).

In my opinion the prototype calculation program „Buy or Lease“ has to be modified considerably. I tried to show in chapter 5 of this paper which other variables have to be included. What is now needed is a European meeting of 3M’s financial experts in order to decide the variables to be finally included in the program.

7. References:

The following interlocutors have supported me with information and datas:

Adolf Körschges, General Manager Customer Satisfaction, 3M Deutschland, Neuss Klaus Nöcker, General Manager Finance Department, 3M Deutschland, Neuss

Gabi Bathke, customer adviser Commerzbank Viersen, Viersen

Detlef Kunde, BMW-Leasing-Consultant, BMW-Center Bonn

Jörg Ufer, Tax Department, KPMG Deutsche Treuhand-Gesellschaft, Köln

3M Annual Report 1996, 3M USA, 1997

3M Geschäftsbericht 1996, 3M Deutschland GmbH, Neuss, 1997

3M Geschäftsbericht 1995, 3M Deutschland GmbH, Neuss, 1996

Wie deutsche Konzerne mit ihren Bilanzen jonglieren, Prof. Dr. Karlheinz Küting, Capital 10/1996, Hamburg, 1996

Empirische Befunde über die Qualität der Geschäftsberichte von börsennotierten deutschen Kapitalgesellschaften , Prof. Dr. Dr. h.c. Jörg Baetge u.A., Deutsches Steuerrecht 6/97, Verlag C.H. Beck, München, 1997

German Accounting Legislation, Synoptic Translation with Introduction, Books and Mertin, IDW-Verlag, Düsseldorf, 1996

Großwörterbuch Wirtschaftsenglisch, Hamlock/Wessels, Cornelsen, Düsseldorf, 1989

Langenscheid Handwörterbuch Englisch auf CD-ROM, Langenscheid Verlag, München/Berlin, 1997

Die BMW 5er Limousine und Preisliste, BMW, München, September 1997

ADAC Autotest BMW 5er Serie, ADAC, München, Februar 1996

ADAC Motorwelt 4/97, Soviel kostet Ihr Auto im Monat, ADAC, 1997

Auto Motor und Sport 9/96 , Kaufberatung 5er BMW, Motorpresse, Stuttgart, 1996

Auto Motor und Sport 5/96, Testbericht 520i, Motorpresse, Stuttgart 1996

Auto Zeitung Nr 24, Dienstwagen, Heinrich Bauer Verlag, Köln, 1997

NWB Nr 22, Dr. Arno Bodewin, Leasingverträge in Handels und Steuerbilanz, NWB-Verlag, Düsseldorf, 1996

BStBL EL Nr. 81, Bundes Steuer Blatt, Ergänzungslieferung Nr. 81 v. Juni 1995 für BStBL 1 S. 264, vom 19. April 1971, Schreiben betr. ertragsteuerliche Behandlung von Leasingverträgen bei beweglichen Wirtschaftsgütern, Frankfurt, 1995

Prof. K. D. Däumler, in BKK Nr 13 vom 03.07.1993, Leasing Finanzierung, Verlag: keine Angabe, Erscheinungsort: keine Angabe, Erscheinungsjahr: keine Angabe

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¹ Gesellschaft mit beschränkter Haftung, Abk. GmbH, diejenige rechtsfähige Kapitalgesellschaft, für deren Verbindlichkeiten nur das Gesellschaftsvermögen haftet. Sie ist Handelsgesellschaft, auch wenn sie kein Handelsgewerbe betreibt. Ihr Stammkapital (mindestens 50000 DM) wird durch die Stammeinlagen der Gesellschafter (Mindestbetrag 500 DM) aufgebracht.- Eine GmbH wird durch eine oder mehrere Personen gegründet, die in notarieller Urkunde einen Gesellschaftsvertrag (= Satzung) errichten, darin die Stammeinlagen übernehmen und sogleich oder später einen Geschäftsführer mit unbeschränkter Vertretungsmacht bestellen. Durch die Eintragung ins Handelsregister erlangt die Gesellschaft Rechtsfähigkeit. Die Gesamtheit der Gesellschafter faßt ihre (grundsätzlich formlosen) Beschlüsse (Gesellschafterbeschluß) meist in einer Gesellschafterversammlung; ein Aufsichtsrat muß nur ausnahmsweise (z.)B. aufgrund des Betriebsverfassungsgesetzes in Betrieben mit mehr als 500 Arbeitnehmern) bestellt werden.- Auflösungsgründe sind v.)a. Gesellschafterbeschluß und Konkurs. - Die Mitgliedschaft (Geschäftsanteil) gewährt ein Mitverwaltungs-(Stimm-, Auskunfts-)Recht und einen Anspruch auf einen Gewinnanteil, verpflichtet aber auch zur Erbringung der Stammeinlage, ferner (falls im Gesellschaftsvertrag vorgesehen) zur Leistung von (beschränkten oder unbeschränkten) Nachschüssen.