The recent memorandum from DCAA provides guidance on legislation enacted in response to the Coronavirus national emergency. Our DCAA Compliance Expert, Craig Stetson, Partner, Capital Edge Consulting provided insight into the memorandum and what it could mean for contractors.
We invite you to watch the video below with Craig Stetson regarding the recent MRD containing information on the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the Families First Coronavirus Response Act (FFCRA), and other Department of Defense (DoD) guidance.
Also, read below for insight highlights and Incurred Cost Submission FAQs and Forward Pricing FAQs listed as Enclosures 2 & 3 on the 12.11.2020 DCAA MRD Audit Alert on Coronavirus Legislation and Regulations.
MRD focuses on Incurred Cost Proposals and Forward Pricing
The new DCAA MRD regarding audits of COVID-impacted costs focuses on incurred cost proposals and forward pricing. As previously reported by Capital Edge, there is not a single answer on the treatment of forgiven PPP loans and potential credits due under flexibly-priced contracts. Also, until the loan is actually forgiven, the initial loan amount remains a balance sheet liability item and no accounting treatment is required for incurred cost purposes.
See below for some of the answers to the most frequently asked questions to help shed some light.
What Auditors Need to Do
Each contractor dealt with and many continue to deal with the impact of COVID-19 in ways that make sense for its unique circumstances. During the planning phase of an audit, the auditor should discuss with the contractor which relief opportunities, if any, the contractor chose to employ.
Covid-19 Company Policies
Furthermore, the auditor should ask for any COVID-19 company policies and procedures, as well as any changes or exceptions to policies and procedures in effect before the pandemic. The audit team should be familiar with the key provisions of the legislation and regulations discussed in this memorandum to determine how an audit may be impacted. See Enclosure 1 for details of the legislation.
Planning the Incurred Cost Audit
When planning the incurred cost audit, the audit team should also refer to Enclosure 2 or below FAQs that address what we believe will be the more common scenarios for CARES Act provisions for loans and paid leave.
Forward Pricing Audits
Likewise, when performing forward pricing audits, the audit team should be aware that most of the relief provisions discussed in this memorandum currently expire in the calendar year 2020, and may or may not have an impact on future pricing audits. See Enclosure 3 or below FAQs for more detailed information.
Incurred Cost and Payroll Protection Program (PPP) FAQs
Answer: The amount of a PPP loan that is forgiven will apply as a credit or cash refund under FAR 31.201-5. The credit should apply to contract costs in the same manner in which the PPP loan funds were originally spent by the contractor. For example, if a portion of the forgiven PPP loan was used to pay facility rent, the cost of facility rent should be credited. If that rent is part of an indirect cost pool, then the indirect cost pool would be reduced by the credit in the period in which the loan is forgiven. If a PPP loan was expended for direct contract cost and the contract can no longer be credited (i.e., it is complete), then the credit will be returned to the Government in a manner agreed to by the ACO. Section 1106 has strict documentation requirements and a company certification. This documentation should be available to the auditors.
Answer: Yes. FAR 31.201-5, Credits, states “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.” FAR 31.201-1, Composition of Total Cost, states that total cost is the sum of the direct and indirect costs allocable to the contract less any allocable credits. To the extent that PPP credits are allocable to costs allowed under a contract, the Government should receive a credit or a reduction in billing for any PPP loans or loan payments that are forgiven. Furthermore, any reimbursements, tax credits, etc. from whatever source that contractors receive for any COVID-19 Paid Leave costs should be treated in a similar manner and disclosed to the government. Additional Guidance Defense Pricing and Contracting (DPC) issued guidance, including:
• CARES Act Section 3610 Implementation (2020-O0013, Revision 2) – This class deviation provides guidance to contracting officers for implementing Section 3610 and provides deviation clause DFARS 231.205-79 CARES Act Section 3610 – Implementation.
• Section 3610 Reimbursement Requests (2020-O0021, Revision 1) – This class deviation provides guidance to contracting officers for reviewing and processing contractor requests for reimbursement under Section 3610, and provides three checklists the contracting officer may use to review the contractor’s request.
• Implementation Guidance for Section 3610 of the CARES Act, Frequently Asked Questions. FREQUENTLY ASKED QUESTIONS – INCURRED COST ENCLOSURE 2 Page 2 of 3
• Allowability of Contractor Costs – Donation of Unused Leave in Response to the COVID-19 National Emergency. A complete listing of DPC guidance issued in response to COVID-19 can be found at: https://www.acq.osd.mil/dpap/pacc/cc/COVID-19.htm.
Answer: Maybe. The amount of a PPP loan that is forgiven will apply as a credit or cash refund under FAR 31.201-5. The credit should apply to contract costs in the same manner in which the PPP loan funds were originally spent by the contractor. For example, if a portion of the forgiven PPP loan was used to pay facility rent, the cost of facility rent should be credited. If that rent is part of an indirect cost pool, then the indirect cost pool would be reduced by the credit in the period in which the loan is forgiven.
However, PPP loans may be used for expenses that do not include flexibly-priced contracts. For example, a business may wish to use the PPP to pay its employees for work they would have performed for commercial customers and request support under other CARES Act or FFCRA provisions for time employees would have spent supporting federal customers. In this scenario, forgiven loan amounts used solely to pay employees working on commercial effort would not create a credit or refund for the Government.
Answer: First, be aware that the loan forgiveness may not have been granted in the same accounting period as the loan issuance. The contractor may claim allowable costs in the year incurred, and provide the related credits to the government when the loan is forgiven, even if the contractor is expecting the loan forgiveness.
The presentation of credits and refunds to the Government in the incurred cost proposal depends on each contractor’s cost accounting structure and practices. PPP loan amounts that were expended on flexibly-priced Government contracts and were subsequently forgiven should be credited to those contracts in the same manner in which the original funds were expended. If a credit results due to a specific contract’s ODC costs, then that credit should be accounted for as a credit to ODCs for that contract in the incurred cost proposal for the period in which the loan is forgiven.
Answer: Until forgiven, PPP loans are a liability of the contractor and, therefore, should be on the balance sheet. Costs paid for by these loans are normal contract costs.
Answer: The Department recommends that Section 3610 paid leave costs be charged to a newly created cost category, Other Direct Costs (ODC) COVID-19. Costs from ODC-COVID-19 may be allocated to the applicable contracts based on some reasonable, agreed upon allocation. In some situations, it may be more appropriate to charge these costs through indirect cost pools (overhead, G&A, etc.). In either case, the contracting officer and contractor should work together, as appropriate, to determine how the costs should be charged to the contracts.
Answer: No. 48 CFR 9903.302-2(a) states that “the initial adoption of a cost accounting practice for the first time a cost is incurred…is not a change in cost accounting practice.” By creating a new category of costs in the Class Deviation, the Department has determined that cost accounting practices initiated to account for Section 3610 leave costs are not subject to the regulations for cost accounting practice changes set forth in FAR Part 30.603 and 30.604.
Answer: The process for requesting Section 3610 reimbursements for contracts with the Department of Defense is determined by agreement with the ACO and is governed by DPC Class Deviation 2020-O0021 Revision 1—Section 3610 Reimbursement Requests, dated October 14, 2020. When auditing assertions that involve Section 3610 costs, auditors should become familiar with the agreement entered into between the contractor and Government and, if selected for testing, verify that the costs as presented in the incurred cost proposal are consistent with the methods of cost accumulation and the determinations of allowability in the agreement.
Auditors should note that CARES Act Sections 2101 through 2116 provide unemployment insurance articles. Auditors should ensure that 3610 requests for reimbursement do not include costs for which the employee received unemployment benefits. Under the CARES Act, employees do not have be laid off or furloughed to collect unemployment benefits.
Forward Pricing FAQs
Answer: Yes. Most of the provisions of the CARES Act have a potential impact on forward pricing. • The CARES Act extends to December 31, 2020. If a contractor’s FY 2021 starts prior to December 31, 2020, its FY 2021 indirect rates could possibly be impacted by CARES Act. If costs incurred during the calendar year 2020 are used as part of the basis of estimate for the proposal, the auditor needs to understand how the costs incurred are impacted by the CARES Act and what impact they have on the future estimates.
Answer: Currently, there is no enacted legislation that would extend the CARES Act into calendar year 2021. If the contractor’s estimating assumptions include extending CARES Act relief provisions beyond the dates provided in the legislation then these would represent contingencies under FAR 31.205-7. Contingencies may arise from presently known or unknown conditions that the effect of which cannot be measured so precisely as to provide equitable results to the contractor and to the Government. Contingencies should be excluded from cost estimates under the elements of cost, but should be disclosed separately (including the basis upon which the contingency is computed) to facilitate the negotiation of appropriate contractual coverage.
Answer: Possibly. The paid leave reimbursed for COVID-19 under Section 3610 is limited to the period of March 27, 2020, to December 11, 2020. Section 3610 does not prohibit the reimbursement of paid leave prior to or after that period. Therefore, the reimbursement of the paid leave costs (other than Section 3610 paid leave) would be allowable charges to a contract if they were allowable, allocable, and reasonable per the existing regulations, contract terms, and consistent with the contractor’s accounting practices. If a contractor is proposing future paid leave for COVID-19, the auditor should obtain and review the contractor’s policy and methodology used for paid leave related to COVID-19 and evaluate it against the applicable cost principles.
Answer: Yes. The circumstances and manner in which each contractor’s estimates have been impacted by COVID-19 will vary. However, the contractor should consider how COVID-19 and changes in response to COVID-19 have impacted its future operations.
Answer: The proposal data should include cost or pricing data reflecting the prospective cost required to provide the product or service during the defined period of performance. When certified cost or pricing data is submitted, the contractor is certifying that, to the best of its knowledge and belief, the cost or pricing data (as defined in FAR 2.101 and as required under FAR 15.403-4) the submissions are accurate, complete, and current as of a specific date. The auditor must assess the disclosure requirements against the cost or pricing data definition. The key considerations include:
• Factual not judgmental;
• Reasonably expect to affect price negotiations (significantly);
• Verifiable – this would include the data forming the basis for judgment; and
• Contributes significantly to the soundness of estimates – does not have to form the basis of the estimate.
In assessing the proposal and expectation for disclosure, the auditor needs to be aware of the items in which a clear decision is made by someone in authority within the contractor organization to act, and the outcome is readily apparent. Generally, circumstances that may appear unclear or uncertain, but a decision has already been made by the contractor management, which have a significant potential impact on future costs, should be disclosed.
Answer: The auditor should be aware of changes or decisions that have a potential impact on the contractor’s indirect rates and assess the materiality of the impact on existing audit opinions expressed on the rates, FPRAs or FPRRs. Rates require updates to remain accurate, complete, and current as changes at the contractor occur. If the prior audit, FPRA, or FPRR does not consider the potential impact of COVID-19 and the impact is determined to be significant, action may be required to protect the Government’s interest. The auditor should determine if the contractor plans to submit an updated proposal and notify the contracting officer of the contractor response.
The auditor should work with the contracting officer and cost monitor to develop a plan to evaluate and update the forward pricing rates.
Answer: Currently, there is no enacted legislation that would extend the allowability of donated leave to beyond December 2020. If a contractor’s estimating assumptions include extending this rule beyond the date provided in the DPC guidance they would represent contingencies under FAR 31.205-7. Contingencies may arise from presently known or unknown conditions, the effect of which cannot be measured so precisely as to provide equitable results to the contractor and to the Government. Contingencies should be excluded from cost estimates under the elements of cost, but should be disclosed separately (including the basis upon which the contingency is computed) to facilitate the negotiation of appropriate contractual coverage.
Answer: Yes. The Department of Defense’s response to the COVID-19 pandemic includes using the provisions in the CARES Act, as well as using class deviations and existing FAR and DFARS flexibilities. One key flexibility impacting forward pricing is the ability to grant no cost extensions. COVID-19 caused closures or delays can result in the Government granting no cost extensions. This shift in contract performance can result in significant impacts in a contractor’s indirect cost bases.
Answer: No. COVID-19 does not alleviate the responsibility of a contractor to provide sufficient support for its estimates. In accordance with FAR Part 15, a contractor’s proposal should be based on a well-supported basis of estimate (including COVID-19 costs set out as contingencies). To demonstrate reasonableness, the contractor must show how it computed the proposed COVID-19 costs while also providing the supporting data and appropriate explanations.
Answer: Yes. The pandemic has resulted in changes to the way companies are doing business and is influencing management decisions related to short/long term operations and policies and procedures. Below are a few items to consider when planning forward pricing audits.
• How has the pandemic impacted current operations – How the contractor’s current operations were impacted by the pandemic can provide a lot of information to consider in audits. While some contractors may experience limited disruptions, others may have been significantly impacted. Increased telework, facility closures, layoffs, changes in historical spending trends, and contract delays all provide insight into possible impact to future operations. It is important to understand how historical data used as the basis for estimates was impacted and if those impacts will continue into the future.
• What changes to the contractor’s policies and procedures occurred or are planned – Operating in a pandemic has changed how contractors function. This has resulted in contractors revising existing policies and procedures or adopting new policies and procedures. We are seeing increased use of telework, revisions to leave policies, and expansion of employee benefits or company reimbursed expenditures. The allowability of such costs would be determined using the existing applicable cost principles. The auditor should be aware of the contractor’s new or pending policies and procedures to assess the impact on future estimates.
• Have production processes changed – The need for employee safeguards have resulted in the contractor looking at its production processes and implementing changes to protect employee health and wellbeing. These changes can influence the accuracy of using historical information and learning curves on future estimates.
Capital Edge Consulting is a professional services company comprised of adept problem solvers who deliver tangible results to address today’s most complex U.S. government contracting challenges. Capital Edge helps clients address the challenging regulatory, contractual, and compliance requirements of U.S. federal contracts and we have experience working with a wide variety of industries that provide goods or services to the federal government including industries such as biotech and healthcare, nuclear energy, education, information technology, non-profit, professional services, defense, and software.