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Allowability of Lease Pre-Payments


jcb2k

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Hi All,

Although I've been using WIFCON as a resource for almost 15 years, this is the first time I've actually asked a question, so thanks in advance for sharing you knowledge with me, and for all of the guidance in the past 15 yrs!

I've recently taken a new job at a small R&D contractor, and I'm dealing with an issue that is utterly confounding me, as I've never dealt with leased equipment under a gov't contract. Here's the facts relevant to the situation (all of which took place prior to my employment):

1. Our company is leasing some scientific equipment to be used on an R&D contract for our DOD customer.

2. The company from who we leased the item wanted pre-payment prior to delivery of the equipment.

3. The Government contracts attorney we were using prior to my arrival advised that pre-payments are not allowable, and we would have to get permission from our KO to bill the full amount of the lease to the contract.

4. We requested permission from the ACO, who's response was "I don't have a problem with it".

5. To complicate matters, we now need to use this leased equipment on two other contracts, but it has already been charged and billed to one contract.

Here's my questions:

1. I can't find any reference to pre-payment of leased equipment being unallowable. Does anyone have a reference for this?

2. In order to use the leased equipment (already billed to one contract) on another contract, what do I need to do from an accounting standpoint? Also, leases are not GP subject to part 45, but do I need to also request KO permission to use the leased equipment on another contract?

Thanks again for your help!

--j

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jcb, you did not say how the original contract was priced or what the length of the lease is/was. Also, you did not say whether it was a capital lease or an operating lease or the value of the lease. Did you charge the lease pre-payment as a direct cost of the original contract or as an indirect cost? If you bought this item, would you expense it or depreciate it?

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Sorry about that... This is a CPFF completion contract; I believe this is an operating lease with a total value of ~$90k. The full amount of the lease was charged direct to one contract (but now needs to be used on two others). If we bought the item I would think it would be depreciated. However, it will be returned at the end of the lease.

Thanks for the questions! Let me know if you need any other info.

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This first a question of direct versus indirect. If the only benefiting effort was the government CPFF contract, then it's a direct cost of that contract. But if there is more than one contract that will use the equipment it should be apportioned or (better yet) charged to overhead. Now, with 20/20 hindsight, you see that there is more than one benefiting contract--but too late--because you already charged it to the one contract. You can fix this by crediting the CPFF contract and doing what you should have done in the first place.

What you should have done was follow GAAP and charge the pre-paid lease expense to the balance sheet, and recognize the expense over time as the leased equipment was used. If you had done this, you would have charged the CPFF contract for the initial use, and then charged the other two contracts as they started to use it, likely via pro-ration (apportionment).

So go credit the initial contract for any lease cost in excess of its actual usage, charge the other two contracts based on their actual usage, and put the remainder on the balance sheet where it belongs. Relieve the pre-paid balance sheet item over time and charge the using contracts based on how much they use.

At least, that's what I would do.

Also, when you charged the entire pre-paid amount to the contract, I would have classified it as an Advance Payment to a subcontractor. We can quibble about whether or not it was such, but doing so would have avoided the inevitable DCAA argument that you created an out-of-period expense (which I think is the concept your attorney was trying to articulate, poorly).

Hope this helps.

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What you should have done was follow GAAP and charge the pre-paid lease expense to the balance sheet, and recognize the expense over time as the leased equipment was used. If you had done this, you would have charged the CPFF contract for the initial use, and then charged the other two contracts as they started to use it, likely via pro-ration (apportionment).

So go credit the initial contract for any lease cost in excess of its actual usage, charge the other two contracts based on their actual usage, and put the remainder on the balance sheet where it belongs. Relieve the pre-paid balance sheet item over time and charge the using contracts based on how much they use.

Two questions about the above guidance:

1. You seem to imply that we charge the actual usage as a direct cost to the individual contracts. Is this the case? I'm a bit confused because I thought something that benefited more than one final cost objective could not be a direct cost. But my understanding is based solely on a week of reading, not any actual experience.

2. If the answer to #1 is yes, and we can charge direct, then what about usage that benefits the company and not a gov't contract? Would we then have to charge all of the cost to OH, and tie the gov't portions of usage to cost pools tied to the individual contracts and the company portions of usage to IR&D?

Thanks again for your help!

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jcb2k,

I'm answering your original post, which said that there was ONE contract that benefiting from the leased equipment, and then it was determined that 2 other contracts also needed to use it. When there was only one, it was a legitimate direct cost of the contract. When there was more than one, you either apportion it between the benefiting contracts -- i.e., split up the invoice based on usage -- or charge to overhead. The problem with overhead is that, if you have more than three contracts, you are allocating the cost to the contracts that don't benefit from usage. Is that a problem for you? I don't know because I don't know the relative dollars involved. If the cost of the leased equipment is less than 1 percent of your total overhead, you're probably just fine charging to overhead. Why 1 percent? I just made up that number. Materiality is a tricky concept.

Now you ask about "usage that benefits the company and not a government contract"? That's an entirely different animal. How can usage benefit the company and not the contracts? Why would you lease equipment if there is no benefit to your ongoing work? If you are talking about IR&D efforts, then perhaps you should apportion to the IR&D efforts. You really need to figure out why you are leasing the equipment and charge accordingly.

Also there's a concern if you pay more through equipment leases than you would have, had you just purchased the equipment. If there's any question about the total lease expense versus outright purchase, be advised you can purchase the equipment and charge to the balance sheet as a capital asset, and then depreciate into the appropriate indirect cost pool.

Hope this helps.

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