Should Payroll Protection Program (PPP) Loan and Forgiveness Have Been Treated as a Credit?

We understand this revelation (so to speak) is likely too late for many contractors that have already established final indirect rates for the year of PPP forgiveness; however, any direct costs adjusted for loan forgiveness still remain open until closeout of the contract. As we stated in our November 2021 Newsletter “we continue to disagree with the government’s interpretation that PPP loan forgiveness should be credited to the government, barring action from Congress or the courts, it does not appear the government will change its position.” Below is an outline of why we believe a reasonable argument can be made to press the Department of Defense (DoD) position.

What Does the FAR Say About “Loans?”

First a review of Federal Acquisition Regulations (FAR) Part 31, Contract Cost Principles and Procedures, disclosed no required cost accounting treatment related to a contractor attaining a loan, whether that loan is from a commercial lender or the Small Business Administration through a commercial lender. A “loan” is not a “cost.” The dictionary definitions of both words clearly show that they are not synonyms for one another.[1] Therefore, it is hard to see how a loan, or its forgiveness, should be treated as an allowable cost and a later reduction of that allowable cost (i.e., credit) under the plain reading of FAR 31.201-1, Composition of total cost and FAR 31.201-5, Credits.

The plain language of FAR 31.201-1, Composition of total cost, clearly states it is applicable to “total cost … incurred or to be incurred … less any allocable credits.”[2] The plain language of FAR 31.201-5, Credits, clearly states it is applicable to “credit[s] relating to any allowable cost.”[3] FAR 31.201-1, Composition of total cost, further states: “In ascertaining what constitutes a cost, any generally accepted method of determining or estimating costs that is equitable and is consistently applied may be used.” Based on this regulatory language, we believe that these definitions clearly eliminate the application of the “total cost” and “credit” provisions to a loan, as a contractor’s accounting treatment does not recognize a cost (or expense) related to the loan, other than unallowable interest expense.

The FAR Requires the Contractor to Use GAAP

We found no FAR or Cost Accounting Standards (CAS) provisions related to the appropriate cost accounting treatment of a contractor’s practice related to raising capital (i.e., obtaining a loan). Generally Accepted Accounting Principles (GAAP) does require the contractor to record the receipt of loan proceeds by debiting “Cash” and crediting the appropriate long-term or short-term liability accounts.[4] During the administration of the loan, GAAP does not require the recognition of a cost related to the repayment or relief of the loan obligation, other than interest. In fact, GAAP would not allow for the recording of a reduction to the cost of goods sold related to the relief of a loan obligation. GAAP does require the recognition of income related to the relief of a loan obligation. Still GAAP does not consider this income a reduction of previously paid expenses and properly presented financial statements would include all the expenses paid for under the covenants of any loan as cost of goods sold. Thus, no commercial business (i.e., businesses not having Federal Government contracts) would or should credit or reduce its cost of goods sold for the PPP loan forgiveness.

For example, a contractor obtains a loan or line of credit from a local bank to perform on a government cost type contract. The contractor makes some payments to the bank which generate no cost allocable to the contract other than unallowable interest expense; however, the contractor does charge all the allowable production cost to the contract through direct and indirect cost which the Government pays. After delivering all the contracted items to the Government, the contractor later defaults on the loan, and the bank has to write-off the loss. A credit would not be due to the Government for the properly allocated allowable production costs that were paid for using the loan proceeds that were then found to be in default. No credit is due to the Government as the properly allocated allowable costs were not refunded or credited back as a reduction to the contract costs incurred. The accounting transactions related to the raising of capital do not create costs that are allocable to contracts based on the FAR part 31 cost accounting requirements, other than unallowable interest expense. As such, no credit is due the contract when the liability related to the raising of capital is somehow relieved (i.e., forgiven, defaulted on, or repaid in full).

A loan may create an expense (i.e., cost) at the point in which a loan repayment is recorded, if interest expense must be recognized. However, FAR 31.205-20[5] makes interest unallowable and while subject to the FAR 31.201-1, Composition of total cost, the unallowable interest cost is not subject to the FAR 31.201-5, Credits, as the credit requirement is limited to allowable cost. The remaining accounts impacted by loan repayment (e.g., Cash and the Liability account to which the loan was recorded) do not result in or represent a cost (or expense) allocable to a Federal Government contract per the requirements set forth in FAR part 31.

ASBCA and Court View of Credits Provision

Our review of ASBCA and Court cases[6] disclosed that the ASBCA and Courts do not view the credits provision at FAR 31.201-5 narrowly; however, the Government’s right to a credit is not limitless or without restrictions. The cost principles are concerned with assuring that if the Government pays a cost and later that cost is reduced, by whatever means, the Government receives the benefit of that reduction. It was clear that the provision was only applicable to cost arising out of the operation of Government contracts that are later reduced by any income, rebate, allowance, or other credit relating to any allowable cost the Government reimbursed under its contracts. As discussed above, the proceeds of a loan which is later forgiven is not an allowable cost for which the Government reimbursed the contractor. Again, a loan is not an accounting transaction creating an allowable cost reimbursed by the Government. The fact that the covenants of the PPP loan are similar to any business loan requiring the contractor to use the proceeds for business-related expenses does not create some direct relationship to the use of the proceeds or reduction in the recorded expenses that are allocable to the Federal Government contracts.

Is It Even “Fair and Reasonable?”

The Government’s stated pricing policy at FAR 15.402 is to “[p]urchase supplies and services from responsible sources at fair and reasonable prices.” We fail to see how it is fair or reasonable for DoD to expect a cost reduction as a result of the appropriated funds from the CARES Act when no commercial customers purchasing similar goods and services received such a cost reduction. For example, let us consider two similarly situated small businesses providing engineering services to its customers. The first business receives a $500,000 PPP loan which is later forgiven. This first business has no Federal Government contracts and, as a result, the economic stimulus funding remains with the business. The second business receives a similar $500,000 PPP loan which is later forgiven. The second business has DoD cost reimbursement contracts representing 100% of its customer base. The application of the DoD’s theory that FAR 31.201-1 total cost and FAR 31.201-5 credits provisions requiring a cost reduction on the DoD contracts results in the economic stimulus funding going to DoD in the form of a contract cost reduction, providing no economic stimulus benefit to the second business.

We also question the appropriateness of funds appropriated by Congress with the intent to stimulate the economy, at a time of a national emergency due to Coronavirus pandemic significantly impacting the economy, ending up as a windfall to DoD. We believe the Congressional intent was for the funds to remain in the economy, not end up accruing to DoD. In fact, the CARES act included Section 3610[7] which allowed DoD to use funds already appropriated to DoD by Congress to maintain contractor workforces in a ready state, if necessary. Additionally, Congress took steps to ensure the Internal Revenue Service (IRS) did not remove a portion of the economic stimulus from the economy by passing the Consolidated Appropriations Act, enacted December 27, 2020,[8] which clarified that the gross income resulting from the PPP loan forgiveness was not taxable and the expenses paid with the loan proceeds remain allowable tax-deductible expenses for Federal income tax purposes.

The Redstone GCI Position

It should be noted that Redstone Government Consulting has issued several blogs and newsletter articles addressing PPP. As with most of the GOVCON Industry, we did not directly challenge the DoD position related to the requirement for a credit to Federal Government cost reimbursable contracts. However, we did make the following comments in our Redstone Government Consulting, Government Contract Insights, November 2021 Newsletter:

• While we continue to disagree with the government’s interpretation that PPP loan forgiveness should be credited to the government, barring action from Congress or the courts, it does not appear the government will change its position. Unfortunately, for DoD, the PPP loan forgiveness credits represent free budget money that doesn’t have to be authorized by Congress and appears to have no real concern about its impact on small businesses.
• While we certainly understand the credit requirements within the FAR, we are not sure Congress intended for money it wanted in the hands of small businesses to be a windfall to the Department of Defense and other federal agencies doing business with small businesses.

After completing our research, we question why we did not stand up sooner to help support the numerous small businesses that play such a vital role in the Industrial base supporting DoD. We find it unconscionable that DoD is looking to strip the economic stimulus from its Small Business partners that represent over 20% of what DoD spends at the prime level and over 30% at the subcontract level.[9] I guess we thought at some point the government would recognize its mistake, but we were gravely disappointed.

[1] Per Merriam-Webster Dictionary

[2] 31.201-1 Composition of total cost.

     (a) The total cost, including standard costs properly adjusted for applicable variances, of a contract is the sum of the direct and indirect costs allocable to the contract, incurred or to be incurred, plus any allocable cost of money pursuant to 31.205-10, less any allocable credits. In ascertaining what constitutes a cost, any generally accepted method of determining or estimating costs that is equitable and is consistently applied may be used.

     (b) While the total cost of a contract includes all costs properly allocable to the contract, the allowable costs to the Government are limited to those allocable costs which are allowable pursuant to part 31 and applicable agency supplements.

[3] 31.201-5 Credits.

The applicable portion of any income, rebate, allowance, or other credit relating to any allowable cost and received by or accruing to the contractor shall be credited to the Government either as a cost reduction or by cash refund. See 31.205-6(j)(3) for rules governing refund or credit to the Government associated with pension adjustments and asset reversions.

[4] Accounting Standards Codification (ASC) 470, Debt

[5] 31.205-20 Interest and other financial costs.

Interest on borrowings (however represented), bond discounts, costs of financing and refinancing capital (net worth plus long-term liabilities), legal and professional fees paid in connection with preparing prospectuses, and costs of preparing and issuing stock rights are unallowable (but see 31.205-28). However, interest assessed by State or local taxing authorities under the conditions specified in 31.205-41(a)(3) is allowable.

[6] 58-1 BCA ¶1653, HYDROCARBON RESEARCH, INC., Armed Services Board of Contract Appeals, (Feb. 28, 1958)

59-2 BCA ¶2344, WYMAN-GORDON COMPANY, Armed Services Board of Contract Appeals, (Sept. 10, 1959)

92-1 BCA ¶24,631, NI Industries, Inc., Armed Services Board of Contract Appeals, (Nov. 29, 1991)

97-357C USCofFC ¶77,523, Johnson Controls World Services, Inc. v. The United States, U.S. Court of Federal Claims, (Aug. 10, 1999)

[7] Public Law No: 116-136 (03/27/2020) Coronavirus Aid, Relief, and Economic Security Act or the CARES Act, Section 3610, This section permits federal agencies to reimburse contractors for certain leave paid to employees or subcontractors due to facility closures or other restrictions as result of the public-health emergency declared on January 31, 2020.

[8] Public Law No: 116-260 (12/27/2020) Consolidated Appropriations Act, 2021, Section 278, Clarification of tax treatment of certain loan forgiveness and other business financial assistance under the CARES Act.

[9] Percentages from DoD Small Business Program Goals & Performance, Goals and Performance (defense.gov)