Many private company owners who borrowed Paycheck Protection Program (PPP) funds have questions on how to account for the initial loan and subsequent forgiveness. Primarily, does the accounting follow existing debt guidance, or is the loan, in substance, a government grant? Two methods are available to you as a result of two different accounting standards.
The nature of the PPP loan is unique. There is no guidance in US GAAP that addresses the accounting for forgivable loans received by a governmental entity. On June 10, 2020, the AICPA updated a technical accounting guide that answers how private companies should account for these loans.
To catch you up, as a part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act many nongovernmental entities (private companies) benefited from the Small Business Administration’s (SBA) Paycheck Protection Program (PPP). The program allowed private companies to apply for loans to incentivize these businesses to keep their employees on payroll. Borrowers that meet certain employee retention criteria and that use loan proceeds on eligible expenses can apply for PPP loan forgiveness through the SBA.
Debt Method to Account for PPP Loans
PPP loans should be accounted for as a financial liability until the loan is partly or wholly forgiven or the borrower pays back the loan. Loans received may be accounted for as a financial liability under Accounting Standards Codification (ASC) 470 regardless of whether or not the borrower expects to pay back the loan or seek PPP loan forgiveness.
As a financial liability, interest should be accrued according to the interest method in ASC 835-30 Interest – Imputation of interest. It is important to note that the borrower should not impute additional interest at a market rate. When the interest rate is prescribed by governmental agencies it is excluded from the scope of ASC 835-30. Upon forgiveness, the borrower would reduce the liability by the amount forgiven and record a gain on extinguishment.
In-Substance Government Grants Method to Account for PPP Loans
Loans received may also be accounted for as an in-substance grant based on the conditions and circumstances of each entity. If the borrower expects to meet the PPP’s eligibility criteria and concludes that the loan is forgivable, it may analogize to International Accounting Standards (IAS) 20 Accounting for Government Grants and Disclosure of Government Assistance to account for the PPP loan.
Under IAS 20, government assistance is not recognized until there is reasonable assurance (or it is “probable”) that the conditions of the assistance will be met and the assistance will be received. If the criteria are met the company would record the cash received from the PPP loan as a deferred income liability. As the company uses the funds to pay for eligible expenses the company would reduce the liability and recognize income on a systematic basis over the period in which the entity recognizes the related expense. The PPP loan income under this model would be presented as either Other Income or as a reduction of related expenses on the income statement.
How to choose a method
“Uncertainty” continues to be a theme of this year. Discuss the two method options with your tax consultant to choose the one with the least amount of uncertainty for your situation. Use their advice to take the appropriate factors under consideration. We suggest that if there is doubt surrounding whether you will be eligible for forgiveness you should account for the loan as a financial liability.
We hope you, your family and business are staying safe and healthy during this time.
By: Adrian Wirstiuk, CPA
Manager
