While all are helpful, there are significant business implications that need to be considered before deciding on the most appropriate course of action. Specifically, requesting forgiveness for the PPP loan requires attention to several factors to achieve the most advantageous outcome. The effect on current and future awards, indirect rates, revenue, certified cost and pricing data, and timing all have underlying impacts that should be considered.
Government participation: As a government contractor, employing equitable and consistent accounting practices ensures fair treatment of costs and credits. As a recipient of federal relief (PPP loan), from the government’s perspective, forgiveness of such funds constitutes a credit. Therefore, the government expects its fair share of this credit in return in recognizing the relief provided when submitting billings and/or incurred cost submissions. For example, PPP loan forgiveness (credit) should be applied in the same manner and to the same cost elements in which the loaned funds were spent. The regulations set forth in FAR 31.201-5, Credits applies. However, if a flexibly-priced contract has closed (or is complete) and the credit for loan forgiveness can no longer be applied, the administrative contracting officer (ACO) has the discretion to determine the manner credits due are returned. It is recommended to work with the contracting officer to see if there is a preferred use of funds/credits to avoid potential misuse and miscommunication.
Contract mix and indirect rates: Under the CARES Act, PPP loans can be used for expenses that do not include just those costs incurred during the performance of flexibly priced contracts. Use of said funds for commercial efforts does not create a credit or refund due to the government. Contractors operating in a flexibly priced environment should closely track and monitor PPP loan-related expenditures. Contracting officers expect the forgiveness (credit) to offset contract costs consistent with how PPP loan funds were originally spent. With flexibly priced contracts, use of funds for indirect expenses can potentially affect (reduce) indirect rates if the loan is forgiven. For example, if the PPP loan was spent to cover rent, utilities, COVID-19-related leave and other payroll costs—all costs normally included in the fringe and/or overhead pool—contractors should anticipate a reduction in indirect rates in the period the credit is received. The application of funds and corresponding credit to direct costs may warrant the contracting officer to request a separate line item credit or refund. Applying the loan proceeds to a fixed priced contract or to commercial activities could present the least risk and most reward for the contractor. Ultimately, careful consideration needs to be taken when evaluating the type of contracts (flexibly priced versus fixed or commercial) and costs (direct versus indirect) that will be affected by PPP loan forgiveness. Close monitoring of rates should occur and if significant, consideration should be given to updating forward pricing/billing rates to protect the interest of all parties.
Certified pricing submissions: Timing is essential when considering the impact loan forgiveness will have on incurred cost and forward-pricing proposals. If the loan was forgiven during the fiscal year and not reflected in subsequent billings, contractors need to claim allowable costs, less forgiveness credits, in their incurred cost submission. Likewise, the allocation of the PPP forgiveness credit needs to consistently allocate across contracts as funds were expended. Expending PPP funds in FY2020 can also potentially affect the preparation of forward-pricing rate proposals. When considering the basis of estimates, if the intent is to estimate, including CARES Act activity, be certain not to extend cost estimates after the period of enacted legislation relief provisions. Beyond that would result in cost and pricing estimates based on contingent conditions; which is unallowable per FAR 31.205-7, Contingencies. Instead, disclose these conditions separately to negotiate the appropriate contractual action; including the basis used to quantify the contingency. Certified cost and pricing data should disclose anticipated cost performance based on factual, reasonable, verifiable estimates during the defined period of performance; even considering the impact of COVID-19 on costs and credits materialized.
Timing: Until forgiven, costs paid with PPP loan proceeds are considered normal contract costs. The proper accounting treatment for the loan itself is to reflect the loan as a liability on the contractor’s balance sheet. If funds were loaned and forgiven within the same fiscal year, simply apply the credit across contract costs as the loaned funds were applied. As contractors transition into a new fiscal year, some loans will be forgiven after fiscal year-end and should still be applied consistently with how funds were spent regardless of timing of receiving forgiveness. Additionally, when applying the credit to future billings the practice remains in alignment with FAR 31.201-1, Composition of Total Costs, “direct plus indirect costs, less credits is the sum of total costs.” In doing so, indirect rates can tentatively underrun and positively affect cost-type contracts if nearing budget constraints. On the contrary, it can also potentially harm the contractor when performing future work at lower rates. The impact of PPP loan forgiveness is critical and should even be considered when weighing normal ordinary business, mergers and acquisitions (M&A) and other future operational objectives.
Path to success while easing the burden
The various relief available (including PPP loan and forgiveness) affects current and future business; therefore, considering implications is essential in successfully navigating this uncharted territory. In order to do so, maintaining adequate documentation for accounting of costs and credits is imperative. The burden of proof is always on the contractor, now more than ever. For example, if contractors choose to accept PPP funds and request forgiveness, they should consider employing the following:
- Adequately document that “current economic uncertainty makes the loan request necessary to support the ongoing operations.”
- Thoroughly assess the company’s financial position when applying; the amount of loaned funds that exceed the borrower’s correct maximum loan amount cannot be forgiven and are required to be repaid.
- Maintain sufficient documentation, including required company certifications. Although funds are administered through SBA, records can be subject to DCAA audit.
- Establish policies and procedures surrounding COVID-19 to include, but not limited to employer responsibilities, employee expectations and cost treatment incurred as a result of COVID-19.
- Create accounts to segregate COVID-19-related costs such as employee illness/quarantine, caring for spouse/dependent (sick, school/child care closure), plant/facility closure, etc. and document the reason for recording.
- When charging directly to a contract, DCAA recommends creating an Other Direct Costs (ODC) COVID-19 labor category.
- On a transactional level, note when PPP loan funds were appropriated to pay company expenses; this will be integral for identifying and segregating costs for reporting purposes and applying forgiveness credit.
- Obtain and maintain agreements with the contracting officer in writing; especially for loan forgiveness credit application requests.
In this new and constantly evolving environment, establishing company policies and procedures surrounding the implications of COVID-19 is highly recommended. Communicate early and often with employees and contracting officers (and/or DCAA). Implement robust accounting and recordkeeping controls. It is imperative to maintain adequate documentation to support decisions, costs incurred and future estimates. This is a new hot topic area for DCAA that will certainly be audited to ensure the proper allocation of costs and applicable credits. If you are still undecided about how PPP loans, forgiveness and the implications, please do not hesitate to contact an RSM audit, government contracting or tax professional.