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The Coronavirus Aid, Relief, and Economic Security (CARES) Act created the Payroll Protection Program (PPP) that is being administered by the Small Business Administration (SBA). As discussed in our recent blogs and webinars that are part of our COVID-19 Actionable Insights for Businesses Series, eligible businesses can apply for a PPP loan to cover payroll and certain other qualifying costs. These loans and accrued interest are eligible for forgiveness by the SBA if a company uses them to pay for these qualifying costs and meets the other requirements of the program. As many companies spend the last of the proceeds of their loans and prepare to apply for loan forgiveness, our team is starting to receive questions about how to account for these loans and their forgiveness.
Like many situations we have encountered this year, uncertainty exists with the PPP because there is no direct guidance about how to account for these loans under the Generally Accepted Accounting Principles (GAAP). However, the American Institute of Certified Public Accountants (AICPA) has recently issued guidance to assist companies in accounting for their PPP loans and their subsequent forgiveness, when applicable. That guidance has provided several options for companies to consider. Because no direct guidance exists, the AICPA guidance suggests that companies should analogize the loan to other similar situations for which accounting guidance currently exists. Below are the four analogies or methods which a company may evaluate when determining how it should account for the loan:
- 1. Debt;
- 2. Government grant;
- 3. Contribution;
- 4. Gain contingency.
Based upon currently available guidance, we believe if a company determines that it was not eligible for the loan or may not be eligible for loan forgiveness, then the loan should be accounted for using the debt method. Further, if a company determines that a portion of its loan is not forgivable, then that portion of the loan should be accounted for under the debt method. For companies that expect their loans to be fully or partially forgiven, they may choose to follow the debt method but can also consider following one of the other three methods.
Under the debt method, a company would recognize the receipt of the loan proceeds similar to other debt instruments by recording a note payable and accruing interest at one-percent, the stated rate of the loan, as long as the loan remains outstanding. The loan would remain outstanding until either (a) it is wholly or partially forgiven and the company has been legally released or (b) the loan is repaid. For the portion of the loan which is forgiven, the company would recognize a gain on extinguishment of debt when the company is legally released from its obligation under the loan agreement. On the statement of cash flows, the receipt of the loan proceeds and any repayments of the non-forgivable portion of the loan would be recognized as financing activities while any gain on extinguishment would be accounted for as a non-cash financing activity.
Government Grant Method
If a company expects to meet the eligibility criteria for its PPP loan to be fully or partially forgiven, it may consider accounting for the loan similar to a government grant. Under this method, a company would recognize receipt of the loan proceeds as a deferred income liability. The deferred income liability would be recognized as a grant once reasonable assurance that (a) any condition attached to the assistance will be met and (b) the assistance will be received. Since the assistance is received in advance, the second criteria would already be met. The conditions to the assistance would be spending the funds for one of the specified expenditures outlined in the PPP and complying with the other requirements of the program.
When the reasonable assurance criteria are satisfied, the company would recognize the grant 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.” The company can choose to either recognize the grant on a gross basis, in other income, or on a net basis, as a reduction of the expenses for which the grant was received (e.g., eligible compensation expense, etc.). On the statement of cash flows, the receipt of the loan proceeds will likely be recognized as cash flows from operating activities because the expenditures that the proceeds may be used for will likely be operating activities (although exceptions to this will exist).
The third method would allow a for-profit business to account for its PPP loan similar to how a not-for-profit company would account for a contribution. Because the contribution would be deemed conditional, a company would not recognize the contribution as income until it has substantially met the conditions for which the contribution was made. A company would record the initial receipt of the PPP loan proceeds as a refundable advance. They would then reduce the refundable advance and recognize the contribution once the conditions of the release have been substantially met or explicitly waived.
Gain Contingency Method
The final method that a company can consider is to account for the loan similar to a gain contingency. When accounting for a gain contingency, a company would recognize a gain when (a) all the contingencies related to receipt of the assistance have been met and (b) the gain is realized or realizable. If a company utilizes this method, it would record the initial receipt of the PPP loan proceeds as a liability and recognize the gain as income when all of the contingencies related to the gain are satisfied. Under the PPP, this contingency would not be satisfied until the lender approves the loan forgiveness, at the earliest.
Determining the Best Approach for Your Company
If you are questioning which approach is best for your company, it is important to understand that the debt method can always be used as a default to account for a PPP loan. However, the additional three methods may also be used if specific criteria are met. It is important to consider your company’s specific situation before determining your approach.
There is one method we would suggest avoiding at this time. Because the SBA is continuing to issue guidance related to the PPP, we do not believe it is appropriate to recognize forgiveness of the loan through income until the loan is legally forgiven. However, we will continue to review guidance as it is issued and will update our recommendations as needed.
Regardless of the method a company determines is appropriate to account for its loan, the significant terms of the loan, the effect on the company’s financial statements and the method used to account for the loan should be disclosed in the company’s financial statements. If you need assistance accounting for your PPP loan in your financial statements, managing and tracking your PPP loan funds, calculating your loan forgiveness amount or completing your PPP loan forgiveness application, the Moore Colson team is available to help. To learn more, visit the COVID-19 Business Services section of our website or contact us. Also, be sure to subscribe here to get our news and alerts as they are released as we are committed to keeping you updated on how to navigate financial challenges associated with the COVID-19 pandemic.
David Walker, CPA, is a Director in Moore Colson’s Business Assurance Practice. David’s successful business and consulting experience spans over 18 years and includes serving private-equity-owned, owner-managed and internationally-owned privately-held businesses.