The new revenue recognition rules: Contractors, are you ready for tax Implications?

In an industry where challenges abound when it comes to serving employees with robust physical and mental well-being support, we wanted to share this article from Construction Executive about construction companies that are taking the lead in creating a “culture of caring.”

As you’ll see in the article, companies who are doing well-being right are taking a variety of actions every day to help ensure that their employees feel supported, including:

• Getting leaders and managers out in the field to talk to employees (don’t just send emails)
• Giving everyone a voice
• Prioritizing mental health
• Finding and addressing root causes of employee burnout and stress
• Looking at well-being from a systemic perspective, the same way you look at workplace safety

As we’ve seen in our work with clients in the construction industry, running a successful company depends to a large extent on a loyal, satisfied, and (physically and mentally) healthy workforce. Companies that take care of their people are the companies well positioned for financial success.

That’s why BerryDunn has a well-being, culture, and engagement consulting team. If you’re looking for a simple way to assess your current employee well-being program, and actionable steps to improve, start by downloading our Well-being Maturity Model or scheduling a call with a member of our team.

Read this if you are a financial manager of an ESOP.

Employee Stock Ownership Plans (ESOPs) must generally buy back, or repurchase, participants’ shares when they leave the plan or want to diversify holdings. If the ESOP does not purchase the stock, the company is required to purchase the shares from the participant under the “put option” described in Internal Revenue Code (IRS) Section 409(h). These rules require the company to either provide enough cash to the ESOP to fund stock repurchases, if adequate other assets are not available within the ESOP, or to fund the repurchase of shares outside of the ESOP. Anticipating the amount and timing of these repurchases requires a lot of number crunching and assumptions to arrive at an estimated “Repurchase Obligation” at a point in time. In most cases, ESOPs enlist the help of valuation specialists, actuaries, or outsider vendors to prepare a study.

All this is done as a component of ESOP cash flow planning but also begs the question, "What do you need to record or disclose in your company’s financial statements related to this obligation?"

The Financial Accounting Standards Board’s guidance on the subject is contained in Accounting Standards Codification (ASC) Topic 718, Compensation - Stock Compensation. More specifically, ASC Section 718-40-50 clearly outlines the terms, allocated share and fair value information, compensation, and other related disclosure requirements for ESOPs in paragraphs 1a through g. One of these requirements—paragraph f—requires disclosure of “the existence and nature of any repurchase obligation...” While the existence of a potential repurchase obligation is undeniable due to the requirements of IRC Section 409(h), disclosure of the nature of the obligation may require judgment and a careful reread of the plan documents.

Reporting on the existence of obligation for ESOPs

What private companies record for redemptions is straightforward. They are required to accrue obligations related to redemption events initiated on or before the balance sheet date and disclose share and obligation balance information related to those transactions that are material to the financial statements.

Disclosures must include the number of allocated shares and the fair value of those shares as of the balance sheet date. This sounds like a general disclosure of terms, but the intention is to communicate maximum repurchase obligation exposure. If redemptions subsequent to the balance sheet date require material and imminent use of cash, the company should consider whether it is required to disclose them as a subsequent event (including amounts) under ASC Topic 855, Subsequent Events.

Disclosing the nature of the repurchase obligation for ESOPs

So, what do you need to disclose specific to the nature of your company’s ESOP shares repurchase obligation?

Put options against the ESOP trust (i.e., rights afforded under the ESOP requiring the trust to purchase outstanding stock at given prices within specific time horizons). Plan terms allowing redemption payments in excess of a certain threshold to be made over a defined period of time (e.g., retiring employees with vested balances greater than $5,000 may receive their payments in equal installments over a five-year period, while those with lower balances may receive their benefit in a lump sum).

If your company’s ownership has an ESOP component or you are considering an ESOP as part of your exit strategy, please reach out to Linda Roberts. Our team can help you better understand the myriad considerations to be taken into account, and the required and potential financial statement impact and disclosures.

BerryDunn’s Construction team partners with clients to provide meaningful insights on best practices in building capacity, stabilizing cash flow in growth, reducing tax liabilities, capturing reimbursable local taxes in estimates, and navigating state nexus. We thrive on helping each client gain control over opportunities and challenges unique to their business, ownership structure, and project mix. We offer a range of services that strengthen confidence in reported results, financial position, and value, including tax and financial planning, acquisition, due diligence, quality of earnings assessments, ESOP feasibility and formation consulting, business valuation, and more.

Read this if you are an engineering or architecture firm working with government agencies reimbursing overhead established in an overhead rate schedule based on direct labor.

We are approaching the end of 2020 and we still don’t have final and authoritative guidance from the U.S. Department of Treasury and the Office of Management and Budget about how to treat the PPP loan forgiveness. Will the Federal Acquisition Regulation, Part 31.201-5, Credits, apply and drastically diminish overhead rates for 2020? Will any credit follow the timing of legal forgiveness? Will you be required to offset subsequent forgiveness against 2020 expenses? 

The lobbyists are hard at work fighting any offset. Will they gain legislative support or will a compromise be negotiated? In the face of so many unknowns, we encourage companies to plan for potential outcomes of this unique situation in order to avoid unwanted surprises in the years to come. What can be done now? Let’s first explore trends we’ve observed for A/E firms for this year:

• Certain costs, such as travel, meals, seminars and overall office expenses, are lower in 2020 with many employees working from home. 
• Employees are traveling less and are not participating in networking events; they are focusing more of their time on chargeable work. As a result, utilization rates are higher in 2020 compared to recent years. A 1% change in utilization generally results in an approximate 4% directional change in overhead rate. 

These lower spending, higher chargeability trends are pushing overhead rates down considerably for 2020 and, likely too, for 2021. Depending on the type and the length of projects contracted to include those overhead rates, resulting profitability will also be lower for a few more years when indirect costs increase to normal levels. Proper planning is extremely important in this situation. Here are some questions to ask when considering your options:

• Are there opportunities to negotiate the project price or terms so project profitability is maintained? Can you negotiate higher labor rates or a fixed overhead rate? 
• If there isn’t any room for negotiations on projects using actual audited overhead rates, should your company focus business development efforts on bidding on or seeking and forming strategic partnerships to pursue more non-governmental projects? 
• If the company remains profitable and realizes savings in certain costs this year, can you find ways to spend and increase allowable indirect costs while simultaneously strengthening your company? Can you award higher employee bonuses to boost employee morale and help retain great talent? Or maybe now is the time to ramp up cybersecurity training to strengthen IT controls and employee awareness of how to prevent, detect, and respond to cyber threats or invest in cyber penetration testing. 

Targeted spending on allowable costs will help elevate your overhead rate and help position your company to emerge stronger post-pandemic. If you need any help modeling expected overhead rates or have questions about allowable overhead costs, please contact Estera or Linda. We're here to help. 

Read this if you are an engineering or architecture firm working with government agencies reimbursing overhead established in an overhead rate schedule based on direct labor.

It seems everyone is both anxious to gain forgiveness of their PPP loans and worried about the ramifications of requesting and being granted forgiveness. There is so much you need to consider to understand the potential impact forgiveness may have on your future cash flow and revenues. Let’s focus, though, on your overhead rate.

Some things to consider:

• PPP loan forgiveness may significantly reduce your overhead rate. As a result, future contracts and related revenues from federal, state, or local government agencies will be impacted. 
  
  Federal Acquisition Regulation (FAR) 31.201-5 dictates that the applicable portion of any income, rebate, allowance, or other credit relating to any allowable cost and received by the contractor shall be credited to the government. If the credit will be used to reduce the indirect labor costs and rent, some of the largest costs of A/E firms, the overhead rate might be reduced by as much as 25% to 30%. 

• Guidance on the timing of credit offset is still unclear.
  
  Do you offset 2020 expenses for forgiveness not settled until 2021 to better match cash flows and credit expenses relevant to forgiveness? Or reflect the forgiveness in the Schedule during the period forgiveness was formally received?

• The IRS is currently communicating that the costs incurred to gain PPP loan forgiveness will not be deductible expenses, thus increasing 2020 taxable income.
  
  If your company is in a taxable position, federal income taxes will increase as a result and impact cash flows. And remember, federal income taxes are unallowable costs in overhead rate schedules under FAR Part 31.201-41.

Depending on the concentration of your contracts with federal agencies, the significance of overhead rate reimbursement on contract revenues and expectations for growth, it may actually be more beneficial to pay the loan back instead of asking for forgiveness.

The Department of Defense (DOD) weighs in:

Often the first agency to establish policy or make changes, the DOD has issued guidance in the form of answers to FAQs about CARES Act impacts on DOD pricing and contracting. Q23 specifically addresses the issue of PPP loan forgiveness. It states, “to the extent that PPP credits are allocable to costs allowable under contract, the Government should receive a credit or a reduction in billing for any PPP loans or loan payments that are forgiven.” You can read that and other CARES Act credit guidance here. Even if you don’t directly work with DoD, other federal agencies and state DOT’s generally adopt DoD’s guidance. 

What if we apply forgiveness credit against direct labor? 

You might wonder, why not just apply the credit against direct and indirect labor in proportion to the actual payroll paid during the PPP loan covered period? If this was possible, the overhead rate might actually increase. Unfortunately, billing the government for direct labor costs offset on the overhead rate schedule with the credit of PPP loan forgiveness would violate FAR Part 31 cost principles. Since you can’t bill for credited costs, revenues for contracts with government agencies would be further reduced. 

We advise a wait and see approach.

The best action plan to do right now is to wait for better and clearer guidance. Industry associations such as ACEC are advocating for more favorable PPP loan forgiveness treatment. Furthermore, there are still quite a few unanswered questions by the SBA. 

If you have any questions related to your overhead rate and the impact of PPP loan forgiveness on your revenue from contracts with government agencies, please contact us. We’re here to help. 

We have talked about the two recent GAAP updates for years now: 1) changes to the lease accounting and 2) changes to revenue recognition standards. We have speculated what the outcomes are going to be and how they will affect the financial statements, requirements for certain ratio calculations and the like, and finally we have some answers! Both standards were finalized and published, and will be in effect in 2019 and 2020. The new rules for both require more than a couple of hours of reading and can be very confusing.

Two questions we have heard recently: Are the changes intertwined? And do we now need to consider the new revenue recognition standard when we implement the new lease accounting? The answer is a resounding NO!

The new GAAP for revenue recognition is very clear about this: it specifically carves out lease contracts. As a matter of fact, accounting applied by lessors will not change significantly when the new lease rules come into effect. If you are a lessor, you will continue to classify the majority of operating leases as operating leases, and will recognize lease income for those leases on a straight-line basis over the term of the lease. However, if you find the new rules confusing, your BerryDunn team is standing by to help you get the answers you need.