Government contractors continually face unique challenges navigating the effects of CARES Act funding such as the Paycheck Protection Program (PPP). These funds can impact financial statements, indirect cost rates, or contracts with various governmental entities.
Gain insight into questions government contractors commonly face around the following areas:
- Recording transactions in financial statements
- Required record keeping
- Qualifying areas and their impact on direct costs and indirect rates
- Requirements to pay the government back
Accounting for PPP Loan Forgiveness
How Did You Record the PPP Loan in Your Financial Statements?
Business entities have generally accounted for a PPP loan as either debt or an in-substance government grant, although other options have also been considered acceptable as well.
The loan proceeds are recorded as debt on the balance sheet.
Any amount forgiven would be recognized in the income statement as a gain from the extinguishment of the loan only when the borrower is legally released as the primary obligor on the loan. Generally, this would be when the lender—not the Small Business Administration (SBA)—provides legal release from the debt obligation.
In-substance Government Grant
By analogizing to International Accounting Standards (IAS) 20, if there is reasonable assurance all requirements on the loan application, including proof of the necessity of the loan, are met and the loan will be forgiven, the loan proceeds may be recorded as a deferred income liability on the balance sheet. The deferred income liability would then be reduced with an offset to the income statement as other income, or through a reduction of the related eligible expenses.
See an overview of PPP forgiveness for more details on the financial statement accounting and other impacts.
Employee Retention Credit (ERC)
The CARES Act established the ERC to help businesses retain their workforces and avoid layoffs during the COVID-19 pandemic.
It provides a per-employee credit to eligible businesses based on a percentage of qualified wages and health insurance benefits paid to employees.
If I Received PPP Loan Money, Do I Qualify for ERC Credit?
The Consolidated Appropriations Act of 2021 retroactively waived the exception for PPP loan recipients to also claim the ERC credit. A business or affiliates of a business who received a PPP loan may go back and claim the ERC credit to the extent the business experienced a partial suspension of operations—or if they met the 50% reduction in gross receipts test—for the eligible calendar quarters in 2020.
PPP recipients may also qualify during the eligible 2021 quarters if they experienced a partial suspension of operations or met the 20% reduction in gross receipts test.
While claiming both PPP and ERC credits in the same year is permitted, any wages forgiven from PPP loans won’t be eligible for ERC.
How and When Do I Account for the ERC Credit on my Financial Statements?
The Financial Accounting Standards Board (FASB) released accounting standards update (ASU) 2021-10 Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance, which is effective for fiscal years beginning after December 15, 2021, with early adoption permitted. However, GAAP doesn’t provide a business entity with specific accounting treatment for government grants.
Business entities have generally accounted for ERCs by analogizing to one of two options:
- ASC 958-605, Not-For-Profit Entities—Revenue Recognition
- IAS 20, Accounting for Government Grants and Disclosure of Government Assistance
Under ASC 958-605, ERCs are accounted for as a conditional contribution, whereby an entity shall recognize the ERC credit income in the period that they determine the conditions have been substantially met.
Analogizing to IAS 20 for ERC credits carries with it similar requirements as described above for PPP loans. That is, the entity must have reasonable assurance that all requirements of the ERC program are met and the credit is or will be received.
IAS 20 states, “government grants shall be recognized in profit or loss on a systematic basis over the periods in which the entity recognizes as expenses the related costs for which the grants are intended to compensate.”
Under IAS 20, there’s an option to show the income as other income or net against the related payroll expense.
What Is the Next Step If You Already Received PPP Loan Forgiveness or an ERC Refund?
Government contractors must now consider whether PPP loan forgiveness or the ERC refund impacts their government contracts or their indirect rates.
It’s important to understand and take inventory of your contracts and what type of contract you have.
There are three common types of contracts:
- Cost type
- Time and material (T&M)
- Fixed price
If you have cost-type contracts and received reimbursement from the government for costs that were covered by either PPP loan forgiveness or an ERC refund, you likely have a liability to the government. If you had already billed the government for costs that were also reimbursed by either a forgiven PPP loan or ERC, then you may need to either refund the government or the government may request that you credit the amount against future billings.
If you have received reimbursement from the government for PPP loan forgiveness or an ERC credit and you have T&M contracts that have other direct cost components, you’ll need to determine whether you had received reimbursement from the government for a direct cost also covered by PPP loan forgiveness or an ERC credit.
If you had already billed the government for such costs, you likely have a liability to the government and you may need to either refund the government or the government may request that you credit the amount against future billings.
If you have fixed-price contracts, you aren’t required to consider whether there are funds owed back to the government as these contracts are negotiated at a fixed rate and aren’t based on specific costs incurred that may have been covered by PPP loan forgiveness or ERC credits.
How Do You Pay Back the Government and What’s the Impact to Financial Statements?
Federal Acquisition Regulation (FAR) 31.201.5 requires the government contractor to either record the credit as a cost reduction or provide a cash refund.
There are several options for paying back the government if you received reimbursement twice for the same direct costs.
The simplest step is to include a credit—offset—of the entire amount on your current invoice. However, there could be a significant impact to your business depending on the credit amount.
You could enter into an agreement with the contracting officer to include a portion of the credit on future invoices to alleviate the cash flow burden of providing the credit immediately. If the contract work isn’t ongoing, discuss a plan and approach for repayment with the contracting officer.
If you determine you owe funds to the government, you’ll have a liability on your financial statements until the funds are repaid. It’s important to understand that impact early because your income statement could be overstated for double counting of revenue or cost reductions covered by the PPP loan forgiveness or ERC credit.
Indirect Cost Rate Considerations
The PPP loan forgiveness and ERC refunds could also impact your indirect rates. Generally, the cost reduction would be recorded in the year that the lender approved the PPP loan forgiveness or you received the ERC refund, which might not align with the period in which such forgiveness or refunds were recorded in accordance with GAAP.
Government contractors should work with their cognizant agency to determine the best presentation and disclosure as there has been some confusion in practice.
If you already submitted your indirect cost calculations to your cognizant agency without considering the impact of the PPP loan forgiveness or ERC credit, discuss it with your contracting officer as soon as possible and provide a revised version if determined necessary.
Commercial Contract Considerations
Over the years, many government contractors diversified their contracts and now have commercial contracts in addition to their government contracts.
Generally, the PPP loan forgiveness amount or ERC credit refund used to pay employees working on commercial contracts wouldn’t require a refund back to the government under their contracts.
Will the Government Ask Questions?
The short answer is yes. Various cognizant agencies are requesting government contractors supply the impact from the PPP loan forgiveness and ERC credit refund on both the direct and indirect costs.
Government agencies expect their fair share of these amounts and expect the contractor to provide and maintain proper records.
It’s critical to keep accurate records to support the necessity of your PPP loan because the SBA has a five-year statute of limitations to audit any applicant, even after forgiveness is granted. This is also important under FAR 31.201-2(d) as far as responsibility for recordkeeping and maintaining adequate support.
This guidance comes well after the enactment of the PPP loan and ERC credit and is based on a continuously evolving understanding of the credit, the nuances of the government contracts, and understanding of the IRS ERC credit claim substantiation and documentation requirements.
We’re Here to Help
For guidance in understanding how PPP loans and ERC credits could impact your government contracts or indirect rates, please contact your Moss Adams professional.
You can also check out our COVID-19 resources for more information.