How to Ensure Proper Accounting for PPP Funding and Loan Forgiveness

April 28, 2020 | Article

By Matthew Neir

The Payroll Protection Program (PPP) has provided additional relief and resources to fund payroll and certain other expenses due to COVID-19. Now that these funds are being received by many organizations, questions are being raised about proper accounting for the funds and the related loan forgiveness.

The next eight weeks are critical to loan forgiveness under PPP.

Proper Accounting for PPP Funding
There is no specific guidance on how to record government assistance such as grants or loan forgiveness for business entities according to the Accounting Standards Codification (ASC) issued by the Financial Accounting Standards Board (FASB). There is some general guidance within the ASC that can be applied to this situation. There is also further guidance in the International Accounting Standards (IAS) that may help organizations understand how to account for government grants and assistance.

Here are a few common questions and scenarios we’ve received.

How and When Should the Loan Forgiveness Be Recorded in the Financial Statements?

There is specific guidance to follow on the topic within ASC 958 related to exchange and nonexchange transactions. When considered to be an exchange transaction, ASC 606 will be followed and if determined to be non-exchange, ASC 958-605 for contributions will be followed.

In the case of the PPP loans, the government appears to provide the funds “without the intent of exchanging goods or services of commensurate value” and had “full discretion in determining the amount.” Therefore, it would appear these are nonexchange transactions and accounted for as contributions under ASC 958-605.

Nonprofit entities should recognize that the portion of the loan that will be forgiven is dependent on certain future events occurring, which represents a barrier in the agreement resulting in a conditional contribution that should not be recognized until the barrier has been overcome.

The CARES Act will also impact your single audit.

Business Entities
We are in unprecedented times. Since there is no applicable guidance for business entities within the ASC, businesses should instead look to guidance that is reasonably applicable in regard to PPP loans.

  • ASC 450-30: Gain Contingencies - The forgiveness would not be recognized until it is realized, meaning the final forgiveness amount has been determined and forgiveness issued by the government.
  • ASC 470: Debt - This may also be applied because it is a loan from the government that created an obligation to be repaid unless certain criteria are met. In the case of a PPP loan, organizations must use funding for rehiring or retaining employees and using the funds for the payroll expense or certain other business expenses. When the company is legally released from the debt, or forgiveness is granted, the extinguishment would be recognized into income as a separate item.
  • IAS 20, Accounting for Government Grants and Disclosure of Government Assistance - This guidance has been applied in many situations with the lack of specific guidance within ASC for government grants.

“A forgivable loan from government is treated as a government grant when there is reasonable assurance that the entity will meet the terms for forgiveness of the loan.”

IAS 20 Paragraph 10

The PPP loans require the funds to be used for payroll and other certain expenses. Therefore, the company would incur costs to comply with the grant over the applicable eight-week period. Under IAS 20, the entity could recognize the forgiveness over the period the entity incurs the costs based on IAS 20 paragraph 12:

“Government grants shall be recognised in profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate.”

Under this international guidance, the income will be accelerated compared to a contingent gain approach. Careful consideration should be made when applying the IAS guidance for a period in which the grant period crosses year-end because income would be recognized in a period and not fully realized until the following period, and could potentially lead to a reversal of income.

If this practice is followed, an analysis should be completed of compliance with the applicable requirements of the PPP loan and calculation of the amount of expenses incurred that will be forgiven. In addition, disclosure should be included to describe the method used to determine the forgiveness estimate and the actual results could differ once the final settlement is known.

Where Should the Loan Forgiveness Be Classified in the Statement of Operations?
In this unprecedent time of COVID-19, an argument could be made that it constitutes an event that is unusual in nature and indicates an infrequency of occurrence. Under ASC 220-20-45, the costs and income would then be presented as separate components of income.

Consideration of the costs and income to be recorded would likely include items that are directly related to the disruption caused by COVID-19. This may include:

Nonprofit entities could apply similar treatment in their Statement of Activities.

International guidance related to government grants states that the income would be presented “either separately or under a general heading such as ‘other income’; alternatively, they are deducted in reporting the related expense.”

Generally, offsetting is not a preferable method of presentation and would require additional disclosure in the footnote to describe the effect on any line items effected in the income statement. The recommendation is to present the loan forgiveness as a separate line item in the statement of income. In addition, the loan forgiveness is likely to be material and separate presentation is preferable.

Loan forgiveness classification as operating or nonoperating requires judgment, and consideration should be made with how the funds are used. There is no specific guidance on this classification, but generally this would be reflected in a subtotal of operating income because the forgiveness income relates to operations.

Where Should the Loan Forgiveness Be Classified in the Statement of Cash Flows?
The classification within the statement of cash flows requires some judgment, and determination might include consideration of how the funds will be used. Since the PPP loan is a forgivable loan, it could be considered a loan advance, and therefore the original loan proceeds would be classified as a financing activity.

However, an entity may argue that since the loan proceeds will be used for operations and related expenses are recorded in operations, the proceeds should be recorded within operating activities. Either way is a reasonable approach for the portion of the loan that is forgiven. If there is portion of the loan that is not forgiven and repaid, the proceeds and payments would be best reflected as financing activities.

What Disclosure Should Be Included in the Financial Statements for Loan Forgiveness?
In November 2015, the FASB issued a proposed ASU addressing disclosure for governmental assistance.  While the project is still under deliberation, we believe it provides a reasonable framework for disclosure that includes four elements as follows:

  1. Information about the nature of the assistance, including a general description of the significant categories and the related accounting policies adopted or the method applied to account for government assistance.
  2. Which line items on the balance sheet and income statement are affected by government assistance and the amounts applicable to each line item.
  3. Significant terms and conditions of the agreement, including commitments and contingencies.
  4. Unless impracticable, the amount of government assistance received but not recognized directly in the financial statements.

Impact of PPP Loans Beyond Initial Forgiveness
Relief provisions and funding come at a much-needed time for many organizations. But this is not simply free money. Knowing how to document and account for these funds and their subsequent loan forgiveness provisions will be essential long-term.

Have questions about how these loans will affect your audit?

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