Accounting for the ERC can be complicated.
The Employee Retention Credit (ERC) was created under the CARES Act to help businesses who have been negatively affected by COVID-19 retain their employees. For those who utilized the ERC, it is important to understand when the credit should be recognized as revenue and the proper accounting treatment and disclosures surrounding the recognition of the credit.
When Should an Entity Record Revenue for the ERC
An entity should recognize revenue and a receivable for the expected ERC when they determine that receipt of the credit is probable, that is, the future event or events is likely to occur. Entities that have performed an analysis to determine whether they are eligible to receive the ERC at the time the financial statements are issued (or available to be issued) have met the probability criteria and should record revenue and a receivable for any portion of the ERC that pertains to qualifying wages incurred during the period covered by those financial statements.
How to Determine the Proper Accounting Treatment for the ERC
After a company takes the necessary action to apply for and receive the tax credit, an entity must determine the proper accounting treatment. Newly released accounting standards update 2021-10 Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance (ASU 2021-10) implements disclosure requirements for business entities receiving government grants, but U.S. generally accepted accounting principles (U.S. GAAP) does not provide a business entity with specific accounting treatment for government grants. Therefore, business entities receiving government grants must rely on other accounting guidance by analogy.
U.S. GAAP and ASC 958-605
Within U.S. GAAP, a common standard used to account for government grants is ASC 958-605. This standard recognizes contributions received by a not-for-profit (NFP) entity. While the scope of this guidance is designed for NFP entities, business entities can follow this guidance for government assistance programs by analogy.
Under this standard, contributions are “recognized when the condition or conditions on which they depend are substantially met” (ASC 958-605-25). The conditions for the ERC include, but are not limited to:
- An entity that is adversely affected by the COVID-19 pandemic
- An entity has not used qualifying payroll for both the Paycheck Protection Program (or other federal funds) and the ERC (no double-dipping)
- An entity that incurred payroll costs to retain employees
There are specific criteria for this program, so an entity should carefully consider whether they met the qualifications for this credit.
An entity can recognize the Employee Retention Credit income in the period that they determine the conditions have been substantially met, which will require an assessment to determine whether the process for filing for the credit is more than or only an administrative barrier to receiving the credits. Once an entity has determined that the conditions have been met, they can recognize the Employee Retention Credit as income in that period. Entities should remember, however, that their application for the credit could be denied even if the entity believes they have met the program’s conditions.
International Accounting Standards IAS 20
Another standard that could be followed for a business entity is the International Accounting Standard, IAS 20, Accounting for Government Grants and Disclosure of Government Assistance. Recognition is discussed in IAS 20 paragraph 12 which states, “government grants shall be recognized in profit or loss 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.” This guidance may be applied in situations that lack specific guidance in U.S. GAAP for government assistance.
Be Careful to Comply with the Accounting Standard You Choose
An entity should follow the presentation and disclosure principles under the accounting guidance followed for recognizing the ERC. In U.S. GAAP, netting the income with the expenses incurred to obtain the income is not encouraged because GAAP generally does not permit net presentation in financial statements. In IAS 20, there is an option to either show the income as “Other Income” or to net the income against the expenses.
Under either method, entities must consider whether the presentation would be misleading to the financial statement user, and adequate disclosure should be made about the amount and nature of the credits received. Entities should also be sure that specific disclosures required by the standard they choose to follow are included in the financial statements.
Additionally, business entities should include the disclosures required by ASU 2021-10. The amendments in ASU 2021-10 require certain disclosures about transactions with governments that are accounted for by applying grant or contribution accounting models by analogy to other accounting guidance. Disclosure requirements for these entities include (1) information about the nature of the transactions and the related accounting policy used to account for the transactions, (2) the line items on the balance sheet and income statement that are affected by the transactions, and the amounts applicable to each financial statement line item, and (3) significant terms and conditions of the transactions, including commitments and contingencies.