The Paycheck Protection Program (PPP) loans, issued by the Small Business Administration (SBA), have provided substantial relief for businesses and organizations navigating through the pandemic. In this article, we will touch on the two ways PPP loans can be accounted for under generally accepted accounting principles (GAAP).
The guidance for accounting for PPP loans is based on the American Institute of Certified Public Accountants’ (AICPA) Technical Q&A 3200.18, Borrower Accounting for a Forgivable Loan Received Under the Small Business Administration Paycheck Protection Program, which was prepared in consultation with the Financial Accounting Standards Board (FASB) staff. This technical guidance from the AICPA states there are two options to account for the PPP loan funds: 1.) as debt; or 2.) as a governmental grant.
Option 1: Debt Accounting
The first option is to account for the PPP loan as debt under FASB Accounting Standards Codification (ASC) Topic 470. This accounting option is appropriate for the PPP borrower regardless of whether the loan is expected to be repaid or forgiven.
Interest for this method is accrued in accordance with FASB ASC 835-30. While the interest rate is 1%, the AICPA indicates the borrower is not required to impute additional market rate interest, because transactions where interest rates are prescribed by governmental entities are excluded from the imputed interest requirement.
Once the PPP loan is legally forgiven, the borrower removes the liability from the balance sheet and records a gain on debt extinguishment. If the borrower does not receive full loan forgiveness, only the forgivable portion is recorded as a gain and the remainder is treated as a regular loan liability, reduced monthly for each payment made.
Option 2: Grant Accounting
Both commercial and not-for-profit (NFP) entities may account for the PPP loan as a governmental grant under FASB ASC 958-605, the guidance for conditional grants and contributions.
Under this option, borrowers recognize income before the loan is legally forgiven. To use this option, the borrower should expect to meet the PPP loan forgiveness eligibility criteria and conclude that the loan is, in substance, a governmental grant. Under this option, the borrower initially records the loan as a liability. Then the borrower identifies the barriers to entitlement (conditions) to receive forgiveness of the PPP loan. Once those conditions are substantially met, the liability is removed from the balance sheet and revenue is recognized.
For the PPP loan, the barriers to entitlement include the incurrence of the qualifying expenses (including payroll, rent, and utilities), reduced for any downward adjustments due to reductions in full-time equivalents (FTEs) and/or salaries and hourly wage rates for certain employees. Borrowers must use judgment to determine whether the lender and SBA review and approval process also constitute a barrier to entitlement or is just an administrative process.
Commercial entities have an additional option for treating the loan as a governmental grant. Instead of using the FASB’s approach above, they may follow the International Accounting Standards (IAS) guidance for forgivable governmental loans. The IAS guidance is located in IAS 20 Accounting for Government Grants and Disclosure of Government Assistance. IAS 20 allows the borrower to recognize revenue when there is reasonable assurance the conditions will be met and the loan will be forgiven. Once there is reasonable assurance for these two factors, revenue is recognized on a systematic basis over the period(s) in which the borrower recognizes the funded expenses. The revenue recognized each month during the covered period is measured based on qualifying expenses incurred, less any estimated reductions in FTEs and/or salary and wage adjustments. Similar to ASC 958-605, using IAS 20 results in the commercial entity recording income earlier than the date the loan is legally forgiven. IAS 20 also allows entities to record the credit to the income statement as either: a.) revenue, or b.) a reduction to the related expenses funded by the PPP loan.
Don’t Forget the Disclosures
The AICPA guidance stresses that adequate footnote disclosure is important, regardless of the option selected for accounting. Footnotes should include the key terms of the PPP loan and a description of the accounting option selected and applied by management. If debt accounting is selected, all applicable debt disclosures are required, such as the repayment schedule. If grant accounting is selected, the borrower should disclose how much of the grant, if any, has been recognized as revenue and how much is still outstanding as a loan.
As with anything, there are pros and cons with each accounting option. The benefit to using the Debt Accounting option is that it is the most conservative treatment, since no gain is recorded on the books until the borrower receives approvals from the lender and SBA. The downside is that the gain on debt extinguishment could be recorded in a different reporting year than when the loan was obtained.
For the Grant Accounting option, please keep in mind that it is a key management judgment in determining if the downward adjustments are estimable during the course of the covered period or if the entity must wait until the end of the covered period to determine these amounts. In addition, it is a matter of management judgment in deciding on whether all barriers to entitlement are met. As such, the amount of revenue recognized and the amount of PPP loan forgiven may or may not fall in the same fiscal year.
In practice, it does not appear one option is more popular than the other. Both commercial and NFP clients are utilizing both options. With two options available for a borrower to choose from, be sure to exercise careful judgment to select and apply the option that is best for your facts and circumstances. If you need assistance or have specific questions regarding accounting for PPP loans, please reach out to your advisor at Clark Nuber for guidance.
This is the fourth post in a series of articles on Paycheck Protection Program loan forgiveness. Click here to read Part I: The Covered Period, Part II: Eligible Expenses, Part III: Maintaining Wages and Employees, and Part V: The Application.
Grace Chu is a manager in Clark Nuber’s Accounting and Consulting Services team.
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