In a previous blog, we stated that firms who use their overhead rate to negotiate long-term contracts could eliminate all profit on future contracts unless states revise their contracting practices. Here we provide some background and associate numbers to the issue.
According to the proposed guidance developed by the Federal Highway Administration (FHWA), the approach to implementing the credits clause from FAR 31.201-5 is to credit the entire amount of the loan forgiveness to the firms’ overhead rate. This application of the credits clause is not compliant with FAR Part 31. As a result, because the reduced overhead rate would be applied to all DOT contracts, the consequences for engineering firms contracting with state DOTs could result in the firm paying back the forgiven loan many times over through lost revenue.
Per 23 USC 112(b)(2)(D), “Once a firm’s indirect cost rates are accepted under this paragraph, the recipient of the funds shall apply such rates for the purposes of contract estimation, negotiation, administration, reporting, and contract payment…”. So, state departments of transportation must use the approved overhead rate for contract pricing using the “FAR formula” – level of effort x direct labor rate x FAR overhead rate + fee + FCCM = contract value. Firms who negotiate multi-year contracts using the artificially low overhead rate will be forced to accept CPFL (cost plus fixed loss) contracts during the period of the approved overhead rate.
To illustrate this, we are using actual and projected data from a 100-person engineering firm that predominantly contracts with state departments of transportation.
The Truth of the Matter
This firm received a PPP loan for $1,439,600 and received forgiveness in the fourth quarter of 2020; thus, this will be an issue for their 2020 FAR overhead rate. We used their actual 2019 allowable overhead for planning purposes and treated the forgiveness as a credit to overhead per the draft guidance provided by FHWA.
The result is a 34.71 point drop in their overhead rate, which will be used to negotiate long-term contracts.
We randomly selected a DOT contract that has a work schedule of five years. This contract was negotiated with their 2019 audited overhead rate. We recomputed this contract value using their rate less the loan forgiveness of 124.50%.
If the reduced overhead rate were used to negotiate all firm contracts during the one-year period of approval and they were one-year contracts, the loss of revenue would be $1,655,540 (reimbursement reduction of $1,439,600 plus 15% lost profit). However, this is not a typical contract term. The illustrated contract size and terms are indicative of their average contract, and they can have as many as 50 of these contracts active during any given year. If these contracts were negotiated using the lower overhead rate, this would equate to a $7 million loss in revenue for the five years. This amount is far more significant than their $1,439,600 PPP loan that was forgiven.
We have been working with AASHTO and ACEC on this issue and need your help. ACEC has an Action Alert Center where you can send an email to members of Congress informing them of your concern for the future of engineering firms. If you have not already done so, please take a few minutes to complete the form. Should you wish to reference the information in this blog, we are providing a pdf version here.
For the latest PPP and Overhead Rate guidance and strategies to minimize impact on your firm, register for our upcoming webinar, The Saga Continues: PPP, FHWA & FAR Overhead Rates.
Over his 35+ year career, T. Wayne has established himself as a respected thought leader in the architecture and engineering industry. As the founder of T. Wayne Owens & Associates, PC, Wayne honed his skills providing consulting, auditing, and financial management services for firms nationally as well as serving as CFO of an architectural firm. You can frequently find him presenting to national audiences on his favorite industry topics including AE auditing and financial management, the AASHTO Uniform Audit & Accounting Guide, FAR overhead rates, government contracting, and project accounting.