As the dust settles on Paycheck Protection Program (PPP), organizations that received the forgivable loans face accounting questions. The program instituted by the Coronavirus Aid, Relief, and Economic Security (CARES) Act provides full or partial forgiveness on loans in an effort to help organizations struggling to cover payroll expenses due to the disruption of the COVID-19 virus. While financial institutions facilitate the loans, the Small Business Administration (SBA) reimburses them.
Forgivable loans from state, local, federal, and international governments are not a new concept, but accounting guidance under U.S. generally accepted accounting principles (U.S. GAAP) for such loans is fairly limited and requires an evaluation of which area of guidance is most appropriate to analogize to. U.S. GAAP contains guidance for accounting for debt as well as contribution guidance for not-for-profit organizations that may be useful to consider. Alternatively, analogy to International Financial Reporting Standards (IFRS), which provides direct guidance on the accounting for government grants, may be appropriate.
Accounting Guidance Options
There are several considerations when it comes to the accounting for the PPP loans and the various components to the program for organizations other than not-for-profits (which will apply ASC Topic 958 Not-for-Profit Entities guidance). The following table provides a summary, and detailed discussion is below.
Summary of Accounting Guidance That Could be Used for PPP Loans
Threshold for Recognition
Timing of Recognition
Income Statement Presentation
Debt – ASC 405-20/470-50
When the debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor (Legal defeasance)
Immediately once the debtor is legally released
Presented on a gross basis as gain on extinguishment of debt
Not-for-Profit – ASC 958-605
When the conditions have been substantially met (when the conditional promise becomes unconditional)
Immediately, once the condition is substantially met
Presented on a gross basis (i.e., grant revenue or other income)
IFRS – IAS 20
When there is reasonable assurance that the conditions have been met
On a systematic basis over the periods in which the entity recognizes as expenses the related costs for which the grants are intended to compensate
May be reported separately as “other income” (gross) or deducted from the related expense (net)
Selecting the Appropriate Accounting Method
If an entity receives money through a potentially forgivable loan, the first factor that should be evaluated is how much, if any, of the debt is expected to be forgiven. If no forgiveness is expected, the loan should be accounted for in accordance with the existing guidance for loans payable over the life of the loan. However, if the entity believes that all or some of the loan will be forgiven, the evaluation of the accounting treatment will depend on if the entity believes it is more appropriate to follow the form or the substance of the transaction.
If the form of the transaction is considered most appropriate, the loan would be accounted for as a lending transaction between the financial institution and the loan recipient. The government’s role would be viewed consistent with their legal form as guarantor of the loan. Alternatively, the intention of the transaction from the standpoint of both the borrower and the lender could be interpreted as being intended for the funds to be used for payroll and other allowable costs with no intention of repayment by the borrower to the lender. In this view, the substance of the transaction for the amount of the loan to be forgiven is that the financial institution is acting as an agent of the government to transfer funds to the entity. An entity taking this view may determine that it is most appropriate to account for the substance of the transaction, resulting in the amount of the loan expected to be forgiven being accounted for as a government grant. Determining the substance of the transaction requires judgment; others may view the substance of the transaction differently.
In the April 17, 2020 Private Company Council meeting, the FASB staff noted that they have had ongoing dialogue with the AICPA and practitioner groups that are preparing to publish papers discussing these issues.
Accounting as Debt
If an entity determines that it is most appropriate to account for the transaction following existing debt accounting guidance, it should recognize a liability when the funds are received and accrue for interest at the stated rate in accordance with existing guidance (level yield method). U.S. GAAP includes considerations for imputing interest on loans using a market rate when the stated interest rate may be considered below market. However, transactions where interest rates are affected by legal restrictions prescribed by a government agency are excluded from this guidance, thus the entity should account for interest at the stated rate of the loan.
An entity that applies debt accounting will need to consider the appropriate time in which to recognize debt forgiveness, if any. Guidance included in ASC Topic 405, Liabilities specifies that a debtor shall derecognize a liability when the debtor is legally released from being the primary obligor under the liability. An entity will need to determine when it is legally released from the liability, however we would expect that this legal release will be evidenced by a lender decision within 60 days of the entity’s request for forgiveness, as required by the PPP provisions of the CARES Act.
Under this approach, debt forgiveness would be recognized as a gain on extinguishment, similar to other financing gains or losses.
Accounting as a Government Grant
Entities may determine that accounting for the amount expected to be forgiven as a government grant is the most appropriate method. U.S. GAAP does not provide guidance for how a for-profit entity should account for a government grant. An entity might choose to analogize to the not-for profit guidance on the accounting for government grants. Under ASC Topic 958, the amount received, including the forgiven part of the loan (i.e., the grant), would initially be presented as the as a liability (e.g., “forgivable loan”). Once the conditions are met for forgiveness, the amount to be forgiven should be recorded as income. Any remaining liability should remain as a liability accounted for as debt.
Alternatively, an entity could determine it is more appropriate to consider the guidance utilized in IFRS by analogy. IFRS requires an entity to determine the amount of the loan that is reasonably assured of being forgiven. The amount to be forgiven is initially deferred and then systematically recognized in a manner consistent with the costs for which the forgiveness is intended to compensate.
If the entity has elected to view the forgivable amount as a grant, consideration needs to be given to whether the entity has already established policies for the accounting for government grants. A decision to change the accounting method for government grants should be assessed as a change in accounting principle, and the new method should assessed to determine if it is preferable.
Analogy to ASC 958 Not-for-Profit Entities
ASC Topic 958 requires an entity to evaluate whether consideration received represents an exchange transaction or a contribution. If a transaction is determined to be a contribution, the entity must further consider if the contribution is conditional or unconditional. A conditional contribution contains a donor stipulation that specifies a future and uncertain event whose occurrence or failure to occur gives the promisor a right of return of the assets it has transferred. The contribution is recognized as income as the conditions are met.
Under this guidance, the consideration received that is expected to be forgiven under the PPP loans is a nonreciprocal transfer by the financial institution to an entity and is a conditional contribution. The entity should record a liability for the cash received until such time as the conditions of the loan forgiveness are met, at which point the debt forgiveness should be recorded as income.
Currently there is not a clear consensus on the timing of recognition under ASC Topic 958, therefore, entities applying ASC Topic 958 should carefully consider their specific facts and circumstances. Because entities must evaluate whether they have met the conditions for forgiveness when applying to receive forgiveness from the lender, it would be reasonable to conclude that since the conditions of the loan forgiveness are met and there is no barrier to entitlement, revenue recognition would be appropriate. Therefore, the occurrence of obtaining lender forgiveness would not have had to occur for the condition of the contribution to be met.
Similar to debt considerations, the entity will need to consider where to include the income recognized in the income statement. Under the guidance in ASC Topic 958, a not-for-profit entity should include contributions received as revenue. By analogizing to ASC Topic 958, a for-profit entity should recognize the grant amount on a gross basis and could reasonably recognize the contribution as a separate line item of revenue in compliance with the separate presentation and disclosure requirements in ASC Topic 606, Revenue from Contracts with Customers or within other income.
Analogy to International Accounting Standards
The guidance included in International Accounting Standards (IAS) 20, Accounting for Government Grants and Disclosure of Government Assistance, requires an entity to estimate the amount of a grant that will ultimately be repaid and what amount will be forgiven. In making this determination, IAS 20 uses a recognition threshold of reasonable assurance. Reasonable assurance is most comparable to the U.S. GAAP threshold of probable. Therefore, an entity does not have to know the exact amount of a loan that will be forgiven to apply this standard.
However, entities must carefully consider the uncertainty about the varying interpretations made by financial institutions about the documentation, types of expenditures, and the methods of applying the thresholds for forgiveness. Uncertainty regarding the amount that will be forgiven may necessitate reducing the amount of estimated forgiveness to arrive at the amount that is reasonably assured until clarification is received from the financial institution or the end of the eight-week time period. Changes in the expected forgiveness amounts should be accounted for prospectively as a change in estimate.
For a PPP loan, the criteria for the loan to be forgiven is based upon payroll and other operating costs of the business, and therefore should be accounted for as a grant related to income. As such, the grant would be earned over the period the related costs are incurred to earn the forgiveness. Recognition should occur using a systematic basis over the periods in which the entity recognizes as expenses the related costs for which the grant is intended to compensate. For period end reporting, the portion of the expected forgiveness that is not yet recognized into income would be presented as a liability on the balance sheet, for example as “deferred grant income.”
A key question that many companies will face is how to present the gain in the income statement. The guidance in IAS 20 states that presentation either as a separate line item, such as other income, or net in the same line as the cost incurred may be appropriate. This type of accounting policy election is common in IFRS and also requires clear disclosures be made about the amount of the grant and how it was recorded in the financial statements.
U.S. GAAP does not directly address a for-profit entities accounting for the PPP loan, so it is of utmost importance that entities provide clear and transparent disclosures providing financial statement users not only information about the PPP loan received, but also the accounting policies applied and presentation of the loans and forgiveness within the financial statements. Consider disclosures that include the amount of PPP loans received, the actual or expected amounts to be repaid and forgiven, the due date if the loan is not forgiven, the applicable interest rate, and amount of interest expense recognized. In addition, clear disclosure should be made of the accounting policy adopted and the amount and line item within the balance sheet or income statement that the loan and forgiven amounts has been recognized.
For More Information
Other programs included in the CARES Act may appropriately be accounting as government grants depending on specific circumstances. For more information about accounting for PPP loans or other programs, contact us. Visit our COVID-19 Resource Center for more up-to-date information on the pandemic.
Published on June 02, 2020