Background
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which provides relief to taxpayers affected by the novel coronavirus (COVID-19). The CARES Act provides opportunities for certain businesses to receive emergency grants and loans to pay qualifying expenses. Grants do not need to be repaid and certain loans can be forgiven if specified conditions are met. In addition, President Trump signed into law the Paycheck Protection Program and Health Care Enhancement Act on April 24, 2020, which increased funding provided by the CARES Act.
The Paycheck Protection Program (“PPP”) authorized two rounds of up to $660 billion in federally guaranteed forgivable loans to qualifying small businesses to pay their employees during the COVID-19 crisis. This program is open until June 30, 2020.
Accounting Treatment for PPP Loans
There are no specific US GAAP standards on accounting by business entities for government assistance. Therefore, in order to determine the relevant accounting treatment, entities should analyze the nature and form of the assistance as well as the related conditions required to be met.
ASC 105, Generally Accepted Accounting Principles, states that if the guidance for a transaction or event is not specified within a source of authoritative GAAP for that entity, an entity shall first consider accounting principles for similar transactions or events within a source of authoritative GAAP for that entity and then consider non-authoritative guidance from other sources.
The following guidance is included in US GAAP:
- ASC 470 – guidance on accounting for debt
- ASC 740 – guidance about tax credits that are based on taxable income
- ASC 958-605 – contribution accounting by not-for-profit entities. This guidance excludes from its scope transfers of assets from a government entity to business entities.
PPP loans are not in the scope of ASC 740, Income Taxes or ASC 958-605, Not-for-Profit Entities—Revenue Recognition for business entities. In contrast to business entities, ASC 958-605 applies to government grants received by not-for-profit entities. Therefore, no analogy to IAS 20 would be made by NFPs.
As PPP loans are considered legal-form debt, it is appropriate to account for them as such under ASC 470, Debt. Under this model, the liability would only be derecognized upon repayment to the creditor or upon legal release under ASC 405-20, Extinguishment of Liabilities. In this context, we note some entities may repay the PPP loan at the end of five years upon maturity, or earlier because they have reconsidered their eligibility. In those cases, debt accounting must be applied.
In contrast, other entities intend to apply for debt forgiveness. In that scenario, the entity could still elect to account for the PPP loan as debt pursuant to the guidance in ASC 470. However, legal release would only occur upon confirmation of forgiveness from the SBA under ASC 405-20-40-1(b). Such forgiveness would be presented as a non-cash financing activity on the statement of cash flows. Further, interest imputation does not apply to this government loan program under ASC 835-30-15-3(e), even if the interest rate being charged is deemed to be below market.
Alternatively, it may be acceptable in limited circumstances to analogize to IAS 20, Accounting for Government Grants and Disclosure of Government Assistance. This analogy is only acceptable if:
- The entity met the eligibility requirements to participate in the PPP, which may require legal analysis. As noted above, entities with loans under the $2 million safe harbor may be eligible, absent evidence to the contrary.
- At inception, it is probable* the borrower will qualify for forgiveness. In practice, “probable” is commonly understood to mean 75% – 80% likely to occur.
Under an analogy to IAS 20, a deferred income liability would be recognized upon receipt of the forgivable loan if at the time of receiving the loan the entity has determined that it is probable that it would meet the conditions for forgiveness, i.e., the loan will be used to pay for qualifying salaries, rent, mortgage interest, and utilities. Similarly, no interest would be accrued due to the expectation of forgiveness.
The deferred income liability would be derecognized on a systematic basis over the periods in which the entity incurs the related expenses (e.g., payroll). That is, the deferred income would be recognized in the income statement as qualified expenses are paid and presented as either (1) other income or (2) a reduction of the related expenses**. This approach will result in the recognition of the proceeds as a grant for the amount expected to be forgiven prior to legal release; the remainder (if any) would be recognized as a loan consistent with ASC 470 and derecognized upon repayment or legal release in accordance with ASC 405-20.
On the cash flow statement, grant proceeds expected to be forgiven would generally be classified within the operating section since they relate to operating costs such as payroll, rent and utilities.
Disclosure
All reporting entities should disclose the applicable accounting policy in the footnotes and where the loan amounts are presented in the financial statements.
PPP Interim Final Rule Updates
Caution if Applying for PPP Loan Forgiveness Before the Covered Period Expires
The ever-changing landscape for PPP-loan forgiveness guidelines have many small businesses wanting to apply for PPP loan forgiveness as soon as possible, before their covered period expires. The challenge is, the new guidance released Monday night states that if the borrower applies for loan forgiveness early, during their covered period, and has made reductions to its employees’ salaries above the allowed 25% reduction threshold for full-forgiveness, they must account for the “excess” in salary reduction for either the full eight-week or 24-week covered period, whichever is applicable for their particular loan.
The caveat is that borrowers who apply for loan-forgiveness early will forfeit a safe-harbor provision which allows the restoration of salaries or wages by 12/31/20 and therefore avoiding a reduction in the loan forgiveness they would normally receive. An example of this would be; if the borrower’s 24-week period ends in November and wants to apply in September, wage reductions that exceed the 25% threshold as of September would be calculated for the entirety of the 24-week period, regardless of if the salaries are restored by 12/31.
The SBA provided the below example for the interim final rule to show how the calculations would work:
Example: A borrower is using a 24-week covered period. This borrower reduced a full-time employee’s weekly salary from $1,000 per week during the reference period to $700 per week during the covered period. The employee continued to work on a full-time basis during the covered period, with an FTE of 1.0. In this case, the first $250 (25% of $1,000) is exempted from the loan forgiveness reduction. The borrower seeking forgiveness would list $1,200 as the salary/hourly wage reduction for that employee (the extra $50 weekly reduction multiplied by 24 weeks). If the borrower applies for forgiveness before the end of the covered period, it must account for the salary reduction for the full 24-week covered period (totaling $1,200).
Other provisions of the interim final rule include
- The IFR reinforces previous guidance that the SBA will deduct Economic Injury Disaster Loan (EIDL) Advance Amounts from PPP forgiveness amounts.
- Employer health insurance contributions for S-corporation owners cannot be included when calculating payroll costs; however, employer retirement contributions for S-corporation owners are eligible costs.
For owner-employees and self-employed individuals, including those who file Schedule C, Profit or Loss From Business, or Schedule F, Profit or Loss From Farming, forgiveness for owner compensation is calculated for the eight-week period as 8 ÷ 52 × 2019 compensation, up to a maximum of $15,385, in total for all businesses. For the 24-week period, the forgiveness calculation is limited to 2.5 months’ worth (2.5 ÷ 12) of 2019 compensation, up to $20,833, also in total for all businesses.
We will continue to provide more information on PPP Loan forgiveness as we receive it.