*This article has been updated to reflect the second round of PPP loans that opened in January 2021.
For many businesses, government aid has provided much-needed relief from the financial blow dealt by coronavirus. However, finance chiefs are now finding that 2020’s $2.2 trillion CARES Act and the Coronavirus Response and Relief Supplemental Appropriations Act of 2021 both present an accounting conundrum: How do we classify the aid on financial statements: as a loan or as a grant?
Unfortunately, lacking a U.S. Generally Accepted Accounting Principles (GAAP) standard that specifically addresses accounting by business entities for forgivable government assistance, there is no clear answer.
Accounting Standards Codification (ASC) 105-10-05-2 states that, “if the guidance for a transaction or event is not specified within a source of authoritative GAAP for that entity, an entity shall first consider accounting principles for similar transactions or events within a source of authoritative GAAP for that entity and then consider nonauthoritative guidance from other sources.”
In layman’s terms: Analogize the current situation regarding coronavirus aid to similar accounting models the business has used in the past and/or refer to the “nonauthoritative” guidance issued by sources like the Financial Accounting Standards Board and the American Institute of Certified Public Accountants (AICPA).
Even in the spirit of the “unprecedented” theme of 2020 that has trickled into 2021, accounting pros are scratching their heads and even analogizing beyond U.S. GAAP.
“In my experience, it doesn’t happen often,” said Faye Miller, a partner with the national professional standards group at audit, tax and consulting advisory firm RSM. “Sometimes you have to do a lot of interpretation to apply guidance to certain things. But, it’s kind of unusual when you can’t find something in the U.S. GAAP that, in some way, shape or form, directly addresses it.”
In response to the confusion, the AICPA issued Technical Question and Answer (TQA) 3200.18 to provide nonauthoritative guidance on how a nongovernmental entity should account for a forgivable loan received under the Small Business Administration Paycheck Protection Program (PPP).
The guidance advises companies to refer to one of four existing accounting models to address the PPP aid: Accounting Standards Codification (ASC) 470, International Accounting Standard (IAS) 20, ASC 958-605 or ASC 450-30. Let’s break down these options for presenting a forgivable government loan on financial statements.
ASC 470 refers to debt and thereby would classify the PPP aid as a financial liability. Under this designation, the liability would accrue interest in accordance with the interest method under ASC 835-30.
It is permissible to use the ASC 470 accounting model whether your business plans to repay the PPP loan or expects it to be forgiven.
It is also considered acceptable for use by both business and not-for-profit entities. Under this model, the loan would be recorded as a liability until it is forgiven, in part or wholly, and the debtor has been “legally released” or the loan is paid off.
“It’s always acceptable and perhaps the safest to follow ASC 470,” said Miller. “With 470, you would treat it as debt until basically you receive notification from the lender that it’s been forgiven.”
IAS 20, or “Accounting for Government Grants and Disclosure of Government Assistance,” is not considered applicable to not for profits. However, for other business entities, IAS 20 can be used by analogy to account for a PPP loan, rendering it akin to a government grant. In this case, however, the company must qualify for the loan and expect to meet the conditions for forgiveness of the loan by the SBA. PPP expenses are tax-deductible, so business owners shouldn't get taxed on the loan they receive as long as it's considered a grant.
Assuming the company has reasonable assurance that it will meet the conditions for forgiveness, the cash inflow from the PPP loan would be recorded as a deferred income liability and released into income as the company is incurring and recognizing the qualifying payroll and other operating costs.
ASC 958-605 is for those classified as “Not-for-Profit Entities — Revenue” and addresses accounting for contributions by not-for-profit organizations. Technically, its scope does not apply to contributions made by government entities to for-profit businesses. However, the FASB staff deemed that “entities scoped out of that guidance are not precluded from applying it by analogy when appropriate.”
ASC 958-605 should only be applied when a company determines that it does qualify for the loan and has reasonable assurance that it will meet the conditions for forgiveness. Under this standard, the PPP loan should be accounted for as a conditional contribution and recognized as a refundable advance until the conditions for forgiveness are met or explicitly waived. The entity would then reduce the advance and recognize the contribution once the conditions of release have been substantially met or explicitly waived.
ASC 450-30 is a gain contingency model applicable to for-profit businesses. Again, it should be applied only when your company qualifies for the loan and expects to meet the conditions for forgiveness. ASC 450-30 dictates that proceeds from the PPP loan will initially be recorded as a liability. It would remain recorded as a liability until all uncertainty is removed (that is, all conditions are met). It would then be recognized as a contingent gain.
While this is considered nonauthoritative guidance by GAAP standards, it does have backing from the SEC. The SEC’s Office of the Chief Accountant has indicated that it, “would not object to an SEC registrant accounting for a PPP loan under FASB Accounting Standards Codification (ASC) 470, or as a government grant by analogy to International Accounting Standard (IAS) 20, provided certain conditions are met.”
In response, major accounting firms have released consistent guidance based on AICPA’s TQA.
When it comes to choosing an approach, RSM’s Miller recommends considering the circumstances of the loan and your own past practices.
“Let’s say that the entity decides that they want to choose one of the [non-debt] approaches that have been mentioned as acceptable,” said Miller. “They might want to first consider if they have any existing accounting policies for something similar. You know, this might be an entity that has applied IAS 20 in the past. And in that case, it would probably make sense for them to continue to apply IAS 20 to a similar transaction.”
Companies that accepted loans over $2 million as part of the first round of PPP loans or first-time borrowers that will be receiving over $2 million as a part of the second round (second-draw PPP loans cannot exceed $2 million) have a trickier path. On Oct. 31, 2020, the SBA released new “pre-audit” information forms and related instructions requiring borrowers with PPP loans of $2 million or more to provide additional information related to their PPP loans. The Loan Necessity Questionnaire, according to the SBA, will help the SBA evaluate a certification borrowers made when they applied for aid. Additionally, it advised these companies to start compiling records for an audit.
“We have this element of subjectivity and uncertainty in knowing where the SBA may come down with the audit,” said Miller. “And it could be that the borrower will be required to pay it back because it’s determined that they really didn’t need the funds as certified.”
The latest relief act appropriated $50 million directly to PPP auditing and fraud mitigation purposes, reaffirming the SBA’s intent to investigate some loans in the coming years.
There’s also still some level of uncertainty about how much of first-draw PPP loans will be forgiven, as companies and their tax professionals have struggled with the guidance. Many tax professionals held off on applying for forgiveness on first-draw loans to see if their clients could benefit from new provisions in the year-end Coronavirus Response and Relief Supplemental Appropriations Act. Those who did submit their loan forgiveness application have been waiting an extended period of time for their application to be processed due to a backlog in the SBA process.
In October 2020, the Treasury Department released a simpler loan forgiveness application for loans of $50,000 or less. The second round of PPP loans also promises simplified forgiveness processes for loans under $150,000. Borrowers that receive a PPP-2 loan of $150,000 or less shall receive forgiveness if the borrower signs and submits to the lender a certification that is not more than one page in length, includes a description of the number of employees the borrower was able to retain because of the loan, the estimated total amount of the loan spent on payroll costs and the total loan amount.
Borrowers are required to retain relevant records related to employment for four years and other records for three years, as the SBA may review and audit these loans to check for fraud.
As guidance continues to develop, companies should think carefully about whether to classify a loan within a debt or grant model — and, in the case of the latter, reassess frequently to ensure eligibility and loan forgiveness criteria are met.