This is the fifth and final part of our series brought to you by Bob Teska, CPA, and Mike Tresidder, Director of Surety for Insurance Office of America.
Not Another COVID-19 Article: PPP - Savior or Mirage?
The COVID-19 crisis has changed every aspect of our lives, from how we work, interact in public, socialize and stay connected – nothing has been untouched. In a continuation of our conversation this article delves into immortality and the renewed focus on continuity planning.
If you missed our previous articles, you can access below:
Part 1: Where’s my bond, Where’s my financial statement?
Part 2: Contractor or Day Trader?
Part 3: Think You’re Immortal?
Bob's Comments from a CPA's Perspective
The overall economic effects of COVID-19 have been well documented. As of the writing of this article, about 25 million Americans were receiving unemployment benefits. At one point after the onset of COVID-19, the stock market was down over 35%, wiping out years of growth in about a months’ time. According to the CDC there have been approximately 1,700,000 total cases of COVID-19 in the US with more than 113,000 deaths. With businesses forced to close down to adhere to Government mandates the total economic impact of the Pandemic may not be measurable.
In response, the Federal Government took decisive action:
- Travel bans and restrictions were put in place
- The President declared a national emergency under the Stafford Act
- The first and second Coronavirus relief Bills were passed
- Tax deadlines were pushed back to July 15, 2020
- The Federal Reserve took aggressive action including making $2.3 trillion in lending available, supported market operations and slashed interest rates (among other initiatives)
- The CARES Act was passed
- The Paycheck Protection Flexibility Act was passed
The CARES Act has many features beneficial to small and large US companies as well as for individuals. The most talked about business feature of the CARES Act was the Paycheck Protection Program (PPP).
From 10,000 feet, PPP provided businesses loans equal to 2.5 times average monthly payroll costs, based on 2019 annual payroll. The exact calculation of the loan is beyond the scope of this article so we will not be delving into that.
The loan proceeds are to be used on qualified expenditures over the eight week period after receiving the funds. In addition, the businesses had to maintain a head count equal to that of a pre-pandemic period. If all of these hurdles were met, the business could apply for forgiveness of the loan. If a certain part of the loan was not forgiven it would have a 2-year amortization at 1% interest.
Those terms were modified by the Paycheck Protection Flexibility Act signed into law by the President on June 5, 2020 (described below) and are subject to further guidance from the SBA.
I have had clients tell me that the PPP did not make any “business sense.” They are 100% correct. It does not make traditional business sense. At its heart, this is a stimulus Bill, meant to pump dollars into the economy.
The Government wanted business owners to get the funds quickly, so they made the application process relatively easy – the whole thing was only 2 pages. They wanted businesses to use the funds to pay their employees; this would accomplish two things:
- First, it would put money in people’s pockets that they could use to purchase necessities. This would in turn stimulate the economy.
- Second, it would keep the employees on your payroll and off unemployment. This means that when the economy “turned back on”, you would have them on your bench and be able to get back to work immediately. In this way, it allowed you to play defense, so another contractor did not come along and offer your employees a job.
The question is: Did this work? Did PPP have a positive effect for contractors and the economy as a whole?
Based on discussions and consulting with my clients and other professionals in the industry, I believe the answer is a resounding YES!
- Contractors were able to keep their employees on their payroll, off unemployment, and on the jobsites that were considered essential during the stay at home order.
- For contractors that did not have any jobs that were considered “essential”, many paid their employees to stay at home and off unemployment. This ensured they would be ready to go as soon as jobsites opened up.
- Many contractors paid their employees an amount over and above normal pay rates, typically labeled as hazard pay, to entice them to come to the job site and not collect the higher levels of unemployment available under the CARES Act.
- Contractors were able to pay their employees and certain overhead costs without regard to the collection of receivables or depleting savings.
- Many contractors considered the PPP a lifeline, without which they would not have survived the sudden and crushing economic effects of the Pandemic.
Is the program perfect … NO! There are flaws. However, if you step back and look at what the Federal Government did in only a matter of DAYS, it elicits some shock and awe. They passed a $2 Trillion Stimulus Bill, the largest such Bill in US history – equal to 10% of our GDP – with bipartisan support, that was broad reaching and was largely effective. That said, there are some details that will still need to be worked out.
Effects on the Balance Sheet
When a contractor receives the PPP proceeds, cash will increase and the offset should be recorded as a liability. From a Surety prospective, the question is should it be a long-term liability or should all or part of it be a current liability, which would reduce working capital and possibly bonding capacity.
For internal reporting I am telling clients to record it as a long-term liability. My reasoning is that the intent of the CARES Act was to have the proceeds of the PPP to be forgiven. As long as the contractor uses the funds on appropriate expenditures most, if not all of the loan should be forgiven.
The Paycheck Protection Flexibility Act increased the length of time to use the funds to 24 weeks from 8 weeks; reduced the amount of the funds that need to be spent on wages to 60% from 75%; and extended the repayment period to 5 years from 2 years. The relaxed guidelines would allow for a contractor to obtain forgiveness of the loan proceeds much easier.
Effects on the Income Statement
When the PPP proceeds are received, there is no effect on the Income Statement. When the loan forgiveness is determined, an adjustment will be made to reduce the liability that was recorded when the funds were received with the offset going to miscellaneous income. This will be non-operating income that is reported “below the line” with other non-operating income and expense items such as interest expense, gain/loss on sale of equipment or scrap material sales.
This could create abnormal gross profit and operating expense ratios because the expenses paid by the PPP proceeds will be either direct labor as part of direct contract costs or overhead wages in general and administrative costs. Sureties and contractors will need to be aware of this and make appropriate adjustments in their analysis.
PPP is not perfect and there are a lot of hoops to jump through. The legislation that governs it is still changing and will probably continue to be tweaked for quite some time. In spite of all of that, I believe the PPP accomplished its purpose and was the lifeline that many contractors needed to survive the unprecedented economic effects of the COVID-19 Pandemic.
Mike's Response from a Surety Perspective
I know this topic is near and dear to your heart as I’ve seen more PPP coverage from Bowers & Company than OBJ sees double coverage (pre-Cleveland Browns of course). This is a great summary of the Federal response related to the Pandemic, specifically the Paycheck Protection Program PPP.
The PPP guidance and direction has obviously been a moving target, one in which there has been no shortage of an ongoing flow of information. I read an article early on that stated the construction ranked first among industries in the dollar volume of loans approved (at $44.9 billion).
A colleague, who is a banker in our territory, provided his firsthand experience in the sheer monumental volume and ramp up his bank went through in working with clients and supporting their application process for the PPP proceeds. He was talking about unheard of employee shifts, overtime hours, weekend coverage etc. to deal with the program.
I think it would be undeniable that this did not have a positive effect for contractors and the economy at large.
I am very interested in actually seeing financial statements (both internally-prepared interims and CPA-prepared fiscal year ends) come in that show the effects on the balance sheet and more importantly how surety companies analyze and treat the resulting liability. I’m intrigued by the potential impact to the income statement once determinations have been made on whether proceeds are forgiven or not and how expense ratios (sureties often look at) may be impacted as compared to revenue and margin that now will have a potentially large miscellaneous income component (non-related to operations).
I tend to be more of a visual person and would love to see an actual example of what you’ve described.
Bob's Final Response
Mike, this project has been a lot of fun and it is hard to believe that this is our last article. However, I couldn’t in good conscience have you asking for examples and not provide them for you. So below are some very basic examples of what the effect of a PPP Loan would have on the financials of a contractor.
Michael Tresidder is the Director of Surety at Insurance Office of America. Contact Mike at (315) 728-3926 or Michael.Tresidder@ioausa.com.