By Mike Bullock& Ray Chipman
As many small businesses have received Paycheck Protection Program (PPP) loans and forgiveness, the question of how to account for this assistance is top of mind. The chances are that you have already finalized your 2020 financial statements. However, many small businesses are working toward PPP loans forgiveness. Understanding the various accounting options available will make for seamless preparation of 2021 year-end financial statement reporting.
General Information about PPP Loans
PPP loans are administered by the Small Business Administration (SBA) and are disbursed by banks for potentially forgivable loans to support eligible small businesses impacted by COVID-19. The loans have a two- or five-year term and bear interest at 1 percent. The PPP’s purpose is to help with payroll and operating costs for entities that have experienced business disruption caused by the COVID-19 pandemic. The principal and interest may be eligible for complete forgiveness if the funds are utilized correctly and certain eligibility and forgiveness criteria are met.
Accounting for PPP Proceeds and Forgiveness
Accounting for PPP loans consists of four main options for public, private and not-for-profit entities:
Option 1: Loan. The legal form of a PPP loan is debt; therefore, it is appropriate for businesses that receive such a loan to account for it as debt under Accounting Standards Codification (ASC 470), regardless of whether it expects the loan to be forgiven.
Under ASC 470, a business would recognize a liability for the full amount of PPP proceeds received and accrue interest over the term of the loan. If any of the loan is ultimately forgiven or paid off, the loan and related accrued interest will be removed when notice of the loan forgiveness has been received from the SBA.
For cash flow purposes, any amounts forgiven according to this option should be disclosed as a noncash financing activity.
Summary: If accounting for the PPP loan and forgiveness following the U.S. Generally Accepted Accounting Principles (GAAP) guidance for debt:
• Recognize the liability and accrue interest according to loan terms.
• Any amount forgiven is recorded as gain from extinguishment/forgiveness of debt once legally released from being the primary obligor.
• Gain from forgiveness is presented on its own line in the income statement as other income or operating income (since location is not specified by GAAP).
• Cash flow treatment: Receipt of the PPP loan proceeds would be recorded as cash from financing activities and any amounts forgiven would be disclosed as a noncash financing activity.
Option 2: Government Grant (IFRS model). Small businesses may account for the forgivable PPP loan as, in substance, a government grant that is earned if the entity is compliant with the PPP eligibility and loan forgiveness criteria. Accordingly, business entities will need to determine the appropriate accounting treatment similar to other guidance since GAAP is not available (i.e., IAS 20). International Accounting Standards (IAS) 20, the IFRS accounting standard on accounting for government grants, includes an accounting framework for forgivable loans. Another similar guidance for contributions received by not-for-profits is ASC 958-605 (see Option 3).
Under this option, PPP proceeds received would be accounted for as an income grant. A deferred income liability would be recognized when forgivable loan proceeds are first received if a business determined that there is “reasonable assurance” that it will meet the conditions for forgiveness of the entire loan amount. The deferred income liability would be recognized in income on a systematic and rational basis over the periods in which the business incurs the eligible expenses to which the grant relates.
If a business elects to account for PPP proceeds as a government grant, it will need to continually reassess its ability to meet the complete forgiveness conditions. If the entity can no longer support a conclusion that it expects to meet the conditions, it may have to reverse income that has previously been recognized.
Summary: If accounting for the PPP loan and forgiveness following government grant IFRS model (IAS 20):
• Recognize the deferred income liability.
• Recognize income and relieve deferred income liability on a systematic and rational basis according to recognition of eligible expenses.
• Continually reassess ability for complete forgiveness; potentially reverse income if forgiveness conditions are not met.
Option 3: Government Grant (FASB model) — Not-for-profit. If a not-for-profit (NFP) organization expects to meet the PPP’s eligibility criteria and chooses not to follow the loan model in Option 1, and if the NFP concludes that the PPP loan represents, in substance, a grant that is expected to be forgiven, it should account for such PPP loan as a conditional contribution (refundable advance) in accordance with FASB ASC 958-605. If contributions are conditional, the contribution is not recognized until the conditions are substantially met or explicitly waived.
The scope of FASB ASC 958-605 excludes contributions made by governmental entities to business (for-profit) entities; however, the FASB staff has acknowledged that entities scoped out of that guidance are not precluded from applying it by analogy when appropriate. Therefore, per ASC 958-605, the timing of recognition for a contribution received will depend on whether the contribution is conditional or not.
Summary: If a not-for-profit organization chooses to account for the PPP loan and forgiveness as a conditional contribution (in substance, government grant) following ASC 958-605:
• Recognize the proceeds as a refundable advance (liability).
• Reduce the refundable advance and recognize contribution revenue once the conditions of release have been substantially met or explicitly waived.
Option 4: Gain Contingency Model. A small business may approach recording the PPP loan analogous with gain contingency guidance. Which, in the GAAP, is not recognized in the operating system until forgiven or paid. As applied to forgivable loans received under the PPP, a business would initially record the cash inflow from the PPP loan as a liability. The proceeds from the loan would remain recorded as a liability until the grant proceeds are realized or realizable, at which time the earnings impact would be recognized.
Summary: If an entity chooses to account for the PPP loan and forgiveness as a gain contingency:
• Proceeds would be recorded as a liability until the gain is realized or realizable.
• A contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization — ASC 450-30-25.
If you have or are anticipating receiving a PPP loan within the year, reflect on these options and consult a CPA before proceeding to finalize your financial statements. Frequently evaluating your options to determine the best solution for your business will result in a simplified financial reporting experience for your 2021 year-end financial statements.
Mike Bullock is an audit manager at Squire, a full-service accounting firm with offices in Orem and Salt Lake City. Ray Chipman is a CPA and certified internal auditor at Squire.