PPP Loan Accounting Guidance for Business Entities
Linda J. Burke, Paraprofessional at Klatzkin, contributed to this post.
Paycheck Protection Program (PPP) loans have been a lifeline for many businesses during the COVID-19 pandemic. Along with these much-needed funds comes the question of how to account for the loan proceeds and subsequent forgiveness of the loan. Although the legal form of the PPP loan is debt, it also has the appearance of a government grant. There has been no definitive answer from the FASB on how to account for the unique nature of these loans for business entities. Instead, the FASB has referred entities to the AICPA’s Technical Question and Answer (TQA) issued in June 2020 to provide some guidance on the appropriate treatment.
The TQA mentions four possible models that can be used by business entities to account for PPP loans. Regardless of whether the loan is expected to be repaid or forgiven, the business entity may account for the loan as debt under FASB ASC 470, Debt. If the business entity expects to meet the eligibility and forgiveness criteria for all or substantially all of the PPP loan, it may alternatively account for it as, in substance, a government grant that is expected to be forgiven by analogizing to International Accounting Standard (IAS) 20, Accounting for Government Grants and Disclosure of Government Assistance. Two additional models are available by analogy, FASB ASC 958-605, Not-for-Profit Entities – Revenue Recognition, and FASB ASC 450-30, Gain Contingencies. However, these models are not as widely used by business entities.
There are distinct differences in the initial accounting for the loan proceeds and the timing of the recognition of income that should be considered when deciding between the options. Let’s walk through the first two more commonly used options to help clarify these differences in accounting.
Reporting PPP Loans as Debt
Under FASB ASC 470, the loan proceeds are recorded as debt on the Balance Sheet and are broken out between the current and long-term portions on a classified statement. Interest is accrued on the loan at the effective interest rate over the term of the loan. However, the business entity should not impute additional interest at a market rate because government-guaranteed obligations, such as PPP loans, are excluded from the scope of the FASB ASC 835-30 guidance on imputing interest.
Under the debt model, the loan remains a liability until either (1) the loan is legally forgiven by the Small Business Administration (SBA) or (2) the business entity pays off the loan. Once the loan is legally forgiven, the liability is reduced by the amount forgiven, and income is recorded as a gain on extinguishment of debt on the Statement of Income. If forgiveness is received after the date of the financial statements but before the date, they are issued, it should be disclosed in the notes to the financial statements but not recorded in the financial statements.
The PPP loan proceeds should be shown as a cash inflow from financing activities on the Statement of Cash Flows in accordance with the presentation as debt. Any principal repayments should be shown as cash outflows from financing activities, and interest payments should be shown as cash outflows from operating activities. Any subsequent forgiveness of the loan should be disclosed as a non-cash financing activity.
Reporting PPP Loans as Government Grants
If the business entity expects to meet the PPP’s eligibility and forgiveness criteria, then it may alternatively account for the PPP loan as a government grant, in substance, that is expected to be forgiven using the guidance in IAS 20 by analogy. Under this model, the initial loan proceeds would be recorded as a deferred income liability in the current liabilities section on a classified Balance Sheet. Interest should not be accrued under this model.
Under IAS 20, government assistance income is not recognized until there is reasonable assurance (similar to “probable” in U.S. GAAP) that the PPP loan conditions will be met. Once there is reasonable assurance that the conditions will be met, the income should be recorded on a systematic basis over the periods in which the eligible expenses are recorded. When the liability is reduced, the offset to earnings could be presented as (1) income shown separately or under “other income” or (2) a reduction of the related expenses as they are recognized. If the business entity subsequently discovers that a portion of the PPP loan is repayable (i.e., because a required condition is not met), it should prospectively account for it as a change in estimate.
The PPP loan proceeds should be shown as a cash inflow from operating activities on the Statement of Cash Flows to correspond to where the eligible expenses related to the loan are recorded. If the loan forgiveness is recognized in a different period, then the income should be shown as an adjustment to reconcile net income to net cash provided by operating activities.
The business entity should justify and document the reasons for choosing which option to use. The accounting policy for PPP loan reporting and its related impact on the financial statements should also be disclosed in the notes to the financial statements. As you can see, accounting for PPP loans is not straightforward as the different options may have implications for debt covenants (current vs. long-term liability) and the timing of the recognition of income.
Contact Us
If you would like to discuss these options for recording the PPP loan proceeds and forgiveness and determine the best treatment for your business entity, or if you need assistance with another PPP-related issue, Klatzkin can help. Please click here to contact us. We look forward to speaking with you soon.
©2021 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date and should not be construed as accounting, tax, or financial advice. Please consult your accountant concerning your specific situation.