The Defense Contract Audit Agency (DCAA) recently issued guidance on how DCAA auditors should address contractor implementation of the Coronavirus Aid, Relief, and Economic Security (CARES) Act; the Families First Coronavirus Response Act (FFCRA); and other guidance from the Defense Department (DOD). This is the first government-based guidance we have seen since August 2020 that addresses Paycheck Protection Program (PPP) loan forgiveness and how it applies to flexibly-priced government contracts.
Specifically, the guidance discusses the impact on incurred cost audits and forward pricing audits. Read on for considerations related to each audit type.
Incurred cost audit guidance
- The requirements of FAR 31.201-1, Composition of Total Cost, and FAR 31.205-5, Credits, apply to the provisions in the FFCRA and the CARES Act, as suspected.
- Using FAR 31.205-5, auditors will be expected to see forgiven PPP loan amounts applied as a credit or cash refund in the incurred cost proposal the same way the contractor originally spent the PPP loan funds. Presentation of PPP loans and loan forgiveness could appear over different accounting periods depending on when the loan is forgiven. If the flexibly-priced contract can no longer be credited for direct and indirect cost, the credit will be returned to the government in a manner agreed to by the administrative contracting officer (ACO). Any reimbursements or tax credits the contractor receives for any COVID-19 paid leave costs should be treated in a similar manner. The memo gives examples of costs such as facility rent or Other Direct Costs (ODCs) that are paid using the PPP monies and explains that the credits should be accounted for as a credit to the rent account in the indirect expense pool or to the contract for the ODC.
- PPP loans used for commercial effort expenses do not create a credit or refund for the government; therefore, strong consideration should be given to the types of contracts a contractor is using to calculate its forgiveness.
- Until legally forgiven, the contractor should present PPP loans as a liability on the balance sheet.
- The contractor should account for Section 3610 COVID-19 leave costs in a newly created cost category – ODC COVID-19 – or through indirect cost pools, whichever applies to the situation. The incurrence of these costs does not represent a cost accounting practice change for contractors who are CAS-covered. The contractor and contracting officer should work together to determine the best method for charging these costs, DCAA advises.
- If the contractor requested Section 3610 reimbursements for contracts with DOD, the auditor shall review the agreement with the ACO and follow the governance in Defense Pricing and Contracting (DPC) Class Deviation 2020-O00021 Revision 1- Section 3610 Reimbursement Requests, dated Oct. 14, 2020. Auditors should rely on the agreement between the contractor and government when testing Section 3610 costs.
Forward pricing audit guidance
- Provisions of the CARES Act could have a potential impact on forward pricing, and many CARES Act provisions were extended into 2021 with the Consolidated Appropriations Act signed into law on Dec. 27, 2020. A key provision that was extended until March 31, 2021, was Section 3610 funding for paid leave. If a contractor’s FY 2021 starts prior to that date, there could be an impact to their forward pricing. Also, the CARES Act could impact FY 2020 costs used as a basis of estimate for out-years costs.
- The CARES Act and DPC guidance on temporarily allowing the costs of donated leave have not been extended into calendar year 2021. Contractors’ estimates that include the assumption that they will be extended represent contingencies that should be excluded from the cost estimates under FAR 31.205-7.
- COVID-19 paid leave costs from Section 3610 funding may be an allowable future cost, and therefore the contractor’s policies and methodology and applicable cost principles should be reflected as such.
- Forward pricing estimates should consider the impact of COVID-19 on future operations. The impact will vary by contractor. If required, the contractor should include cost or pricing data reflecting the prospective cost changes that the pandemic created on future business operations. COVID-19 does not alleviate the responsibility of the contractor to provide sufficient support for its estimates.
- An existing Forward Pricing Rate Agreement (FPRA), Forward Pricing Rate Recommendation (FPRR), or audit report on forward pricing rates that was finalized prior to the COVID-19 pandemic should be updated if it does not consider the potential impact of COVID-19 and “the impact is determined to be significant.”
- Consider these areas of risk for internal controls:
- Impact on current operations and the historical data used as a basis of estimate
- Revisions to policies and procedures
- Changes to production processes, and their impact on historical information and learning curves
This guidance helps to clarify many accounting and compliance challenges resulting from contractor implementation of the CARES Act, FFCRA, and other DOD guidance. The underlying theme in the guidance is that the contractor should maintain proper documentation for costs incurred or future cost estimates related to COVID-19. With the extension of some of the CARES Act provisions and the continuing national emergency, these issues will continue into 2021; therefore, changes to operations and production processes may continue to impact out-years estimates. Make sure you consider impacts to rent, personal protective equipment (PPE), and various types of leave when you apply for forgiveness and complete your incurred cost proposal for 2020 and 2021.
For accounting purposes, we recommend that contractors spend time calculating the “what and if” while applying for forgiveness with this information that the credits will be applied in the same manner the contractor originally spent the PPP loan funds. You cannot also request forgiveness on contract for a cost for which you asked for 3610 funds. If the PPP loan was used for commercial effort expenses or a non-flexibly priced contract, the contractor does not need to create a credit or refund for the government.
It is important for contractors to consult with accounting and compliance professionals to confirm that they are properly accounting for and documenting expenses resulting from legislation enacted in response to the coronavirus national emergency.
Our Top 5 takeaways from DCAA’s guidance are:
- Any forgiven PPP loans, reimbursements, or tax credits the contractor receives will apply as a credit or cash refund in the same way the contractor originally spent the PPP loan funds. Forgiven PPP funds on flexibly-priced direct labor costs should be credited to the applicable contract. Forgiven PPP funds on indirect costs should credited within the applicable indirect pools.
- Section 3610 COVID-19 leave costs should be accounted for through a new ODC COVID-19 cost category or through indirect cost pools.
- Do not include contingencies for CARES Act and DPC guidance extensions in forward pricing proposals. Propose them separately in a way similar to any other contingency proposed in proposal efforts.
- Consider the impact of COVID-19 when using historical data as a basis of estimate for future costs.
- Maintain sufficient documentation for (1) accounting for costs and credits, (2) agreements with the contracting officer, (3) future estimates, and (4) revisions to policies and procedures.
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