Proper Accounting for PPP Loans
The CARES act provided funds through the Paycheck Protection Program (PPP), administered by the Small Business Administration (SBA), to support businesses and nonprofits that were impacted by the COVID-19 pandemic. Many businesses were successful in being granted these funds. With the modifications to the program, most businesses in our region plan to submit for full forgiveness of their PPP loan. Like the PPP forgiveness application process, the accounting for PPP loans is new and different. No specific guidance exists in US generally accepted accounting principles (GAAP) relating to a potential forgivable loan from the federal government to a commercial business. As there is no specific guidance, we default to relying on guidance that is reasonably applicable based on the facts and circumstances.
This article will outline two methods of accounting for PPP loans that most businesses will elect to follow.
Accounting for PPP loans as debt
Each borrower had to sign a debt agreement after a successful PPP application with their financial institution. PPP loans are a legal form of debt, so reasonably applicable guidance includes FASB Accounting Standards Codification (ASC) 470 Debt. Under ASC 470 Debt, the business records the PPP loan as debt and accrues interest on this loan at the rate set in the debt agreement, which is one percent. A business does not have to impute a market rate of interest (even through a one percent interest rate may be below market rate), as ASC 825-30 Financial Instruments scopes out government guaranteed obligations. The business would record a gain when the debt is extinguished, including a gain on accrued but unpaid interest.
Under ASC 405-20, Liabilities: Extinguishments of Liabilities, the borrower would record income and derecognize the liability when the following conditions are met:
- The debtor pays the creditor and is relieved of its obligation for the liability.
- The debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor.
The legal release would be when the borrower receives forgiveness approval from the SBA via the lender informing the borrower.
The presentation of the PPP loan on the balance sheet if forgiveness is not granted before year end requires thoughtful consideration. If forgiveness is expected in the next fiscal year, the PPP loan would be shown as a current liability. Alternatively, a business can elect to follow the maturity of the loan based on the legal terms of the loan. It would be prudent for a business to talk about PPP accounting with their lender if they have restrictive debt covenants. They should also talk with any outside parties such as bonding companies.
Accounting for PPP loans as government grants
As a second option, a business can make the accounting policy election to follow Internal Accounting Standards (IAS) 20 Accounting for Government Grants and record the PPP loan as a forgivable government grant. Grant income would be recorded on a systematic basis when there is reasonable assurance that the conditions to receive forgiveness will be met. This would generally mean the business would record the earnings over the 8- or 24-week period that the eligible costs are incurred. However, eligible costs are not the sole determination of “reasonable assurance”, and salary and employee levels must also be taken into consideration.
We recommend that businesses review the facts and circumstances of their business when selecting the accounting surrounding the PPP loan.
You can expect additional financial statement disclosures related to the pandemic and any applicable funding the business received, including PPP. Be prepared to visit with your auditors about the business’s ability to continue operations, cash flow and budget projections, investment declines, and the status of any forgiveness application that has been filed. If business continuity is uncertain, the audit opinion letter may include a going concern disclosure that clearly identifies the challenges you face.
If you’re a nonprofit organization, please see our article Nonprofit Accounting for PPP and EIDL Funds on our website.
Don’t let accounting for these unique cash flow streams become frustrating. The experts at Ketel Thorstenson, LLP are happy to assist you in navigating the accounting details summarized in this article!