While many are still wondering how to obtain forgiveness of the loans, there are also accounting considerations to be addressed.
Many businesses have applied for and already received funds under the Paycheck Protection Program (PPP) of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The purpose of these forgivable loans is to help businesses keep their workforce employed during the Coronavirus (COVID -19) crisis. While many are still wondering how to obtain forgiveness of the loans, there are also accounting considerations to be addressed:
Because the legal form of a PPP loan is debt, it will always be appropriate for a business receiving this loan to account for it as debt under Accounting Standards Codification (ASC) 470, regardless of whether the entity expects the loan to be forgiven. However, an entity that expects to meet the PPP’s eligibility and loan forgiveness criteria may elect to account for the proceeds similar as it would for a government grant. Both of these approaches are discussed here in more detail. Whichever accounting model is followed, borrowers should include clear and robust disclosures of the PPP loan in their financial statements.
Under ASC 470, an entity would recognize a liability for the full amount of the proceeds received and would accrue interest at the 1% rate. There would not be a requirement to impute additional interest at a market rate because the guidance on imputing interest in ASC 835-30 excludes transactions where interest rates are prescribed by a government agency.
Costs paid to third parties in conjunction with securing the debt should be deferred and amortized over the term of the debt. Such costs can include external incremental costs such as document preparation costs, advisor, accounting and legal fees.
Under the debt model, a debt instrument is considered extinguished only if the borrower is legally released from being the primary obligor. As it relates to the PPP, borrowers must formally apply for loan forgiveness, including providing documentation to verify the existence and accuracy of the qualified expenses. Therefore, the PPP obligation would be derecognized only when the debt is formally forgiven.
The gain that results from forgiveness will be measured based on the net carrying value of the PPP loan, which should include accrued interest (if forgiven) and unamortized deferred financing costs relating to the forgivable portion of the loan. Within the income statement, this gain is presented as a separate line item.
For cash flow statement purposes, the receipt of the PPP loan proceeds accounted for as debt would be presented as a cash inflow from financing activities. Any amounts repaid would be presented as cash outflows from financing activities, and any amounts forgiven would be disclosed as a noncash financing activity.
If an entity expects to comply with the eligibility and loan forgiveness criteria, it may elect to account for the forgivable PPP loan as, in substance, a government grant that is earned through the compliance with the loan forgiveness criteria. If the entity does not expect to comply with the PPP eligibility and loan forgiveness criteria, the proceeds should be accounted for as debt, as discussed above.
U.S. GAAP does not address how for-profit business entities should account for government grants that are not in the form of a tax credit or revenue from a contract with a customer. As such, business entities will need to determine the appropriate accounting treatment by analogy to other guidance. However, an entity that accounts for PPP proceeds as a government grant will need to continually reassess its ability to meet the forgiveness conditions, and it may have to reverse income if it can no longer support a conclusion that it expects to meet the conditions. A not-for-profit entity that receives a government grant should apply ASC 958-605 and recognize loan forgiveness as qualifying expenses are incurred.
Business entities that account for PPP loan proceeds as government grants may choose to analogize to International Accounting Standards (IAS) 20, the IFRS accounting standard on accounting for government grants, because it includes an accounting framework for forgivable loans. However, we believe they could also analogize to ASC 958-605 for contributions received by not-for-profits or ASC 450-30 for gain contingencies.
If material, the method of accounting for the grant should be disclosed in the entity’s significant accounting policies. Disclosure may also include (1) the amount received, (2) the amount included in income or deferred, (3) the basis for recognizing any deferred amounts, (4) the terms and conditions of receipt, and (5) unfulfilled conditions and any contingent liability for repayment.
In each of these approaches, the related qualified expenses should continue to be accounted for in earnings. Payroll, rent, utilities and mortgage interest are costs that should be shown in the income statement as usual, not as reductions of the PPP, during the forgivable measurement period.
While the Financial Accounting Standards Board has not specifically commented on this issue, there may be additional guidance coming.
For information specific to non-profit organizations, please visit our article Accounting for PPP Loans and Forgiveness by Not-for-Profit Organizations.
Disclaimer: The contents of this resource are for general informational purposes only. While every effort has been made to ensure its accuracy, the information is provided “as is” and no representations are made that the content is error-free. We have no obligation to update any content, comments or other information for retroactive or prospective interpretations or guidance provided by regulators, financial institutions or others. The information is not intended to constitute legal advice or replace the advice of a qualified professional. There are areas of the CARES Act where additional clarification from the Treasury Department and the SBA is needed. Your judgment and interpretation of the act may be needed. Users should consult with their legal counsel and representatives of the lending institution regarding the proper completion of their application and supporting documentation.