The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) designated $349 billion in Paycheck Protection Program (“PPP”) loans to help small businesses stay afloat during the COVID-19 crisis. The Small Business Administration (“SBA”) will forgive PPP loans if certain conditions are met.
Some recipients of PPP loans have been unclear as to how to account for these loans, however. Should these arrangements be treated as loans or grants under U.S. Generally Accepted Accounting Principles (“GAAP”)? On June 10, the American Institute of Certified Public Accountants (“AICPA”) updated a technical accounting guide that answers how borrowers may account for forgivable loans received under this program.
PPP loans may be subject to 100% forgiveness if certain criteria are met, and the amounts forgiven are excluded from the borrower’s gross income. Under current rules, PPP loans may be used to cover the following expenses for up to 24 weeks after receipt of funds:
- Certain employee health care benefits,
- Mortgage interest,
- Rent, and
On June 5, 2020 President Trump signed the PPP Flexibility Act, which increases the time for PPP loan recipients to spend the funds and still qualify for forgiveness. Among other changes, the new law also lowers the threshold for funds that must be spent on payroll and employee benefits. Under the modified rules, borrowers must spend at least 60% on payroll costs.
The AICPA recently updated Technical Questions and Answers (TQA) 3200, Long-Term Debt, to explain how a nongovernment entity should account for a PPP loan.
Whether a borrower expects to pay back the PPP loan or believes it is a grant that will be forgiven, the AICPA said the borrower may account for the loan as a financial liability under Accounting Standards Codification (“ASC”) Topic 470, Debt, and accrue interest according to the interest method in Subtopic 835-30, Interest — Imputation of Interest. The Securities and Exchange Commission (“SEC”) has also indicated that its staff would not object to a public company accounting for a PPP loan under ASC 470.
TQA 3200 states, “An entity would not impute additional interest at a market rate (even though the stated interest rate may be below market) because transactions where interest rates are prescribed by governmental agencies (for example, government guaranteed obligations) are excluded from the scope of the [ASC] 835-30 guidance on imputing interest.”
For derecognition of the liability, the proceeds from the loan remain as a liability until the loan is forgiven and the debtor has been “legally released,” or the debtor pays off the loan. When the loan is forgiven and the borrower gets legal release, the borrower then reduces the liability by the amount forgiven and records a gain on extinguishment.
Existing GAAP does not provide explicit rules for reporting government assistance. So, if a business borrower expects to meet the PPP eligibility criteria and concludes that its PPP loan is forgivable, the AICPA recommends reviewing analogous guidance in International Accounting Standard (“IAS”) 20, Accounting for Government Grants and Disclosure of Government Assistance. Under IAS 20, government assistance is not recognized until it is probable that any conditions attached to the assistance will be met and the assistance will be received. (The term “probable” under international accounting standards is analogous to “reasonable assurance” under GAAP.)
That means, when there is reasonable assurance that the conditions of forgiveness will be met, the earnings impact of government grants should be recorded “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.” Given this, a company would record the cash from the PPP loan as a deferred income liability. After the initial recognition, the company would reduce the liability with the offset through earnings as it recognized the related cost to which the loan related, for example, compensation expense.
The AICPA identified two other sources of guidance on this issue: ASC 958, Not-for-Profit Entities, and ASC 450-30, Gain Contingencies. The AICPA recommends that, if a business chooses not to follow ASC 470, it should account for the forgivable loan according to Subtopic 958-605, Not-for-Profit Entities-Revenue Recognition, as a conditional contribution.
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The COVID-19 crisis will have widespread effects on financial reporting in 2020. PPP loans are just one example of the novel arrangements that accountants are currently grappling with, in some cases along with updated interpretative guidance.
The AICPA and Financial Accounting Standards Board (FASB) will continue to evaluate questions about the PPP program and other COVID-related issues to determine whether further guidance is needed. Your CPA is atop the latest developments and can help with any additional questions that may arise.