Updates to the Accounting Methods for the Paycheck Protection Program Loan

As the U.S. Small Business Administration (SBA) continues to issue interim final rulings with clarifications and illustrations regarding the various aspects of the Paycheck Protection Program (PPP), the accounting methods for the PPP loan and loan forgiveness may offer complexities and confusion to business entities and not-for-profit organizations attempting to address these changes. Companies can greatly benefit from the financial offerings that Congress continuously works on, and as your accounting professionals, we are here to help you understand these programs.

Below is an overview regarding the appropriate accounting methods to conform with the accounting principles generally accepted in the United States of America (USGAAP) and how they affect business entities and not-for-profit organizations.

BUSINESS ENTITIES

USGAAP has limited guidance on the accounting for government assistance, or grants, to business entities. Hence, companies may look to International Accounting Standards (IAS) 20 to determine the appropriate accounting. Alternatively, some borrowers may consider the PPP loan forgiveness to be a non-exchange transaction, in which case Accounting Standards Codification (ASC) 606 would not apply.

Accounting Models

In early June, the American Institute of Certified Public Accountants (AICPA) issued Technical Questions and Answers (TQA) 3200.18 related to the borrower accounting for a forgivable loan received under the PPP loan. The TQA included four different accounting methods, any of which the borrower could adopt to account for the PPP loan forgiveness and conform with USGAAP.

The four different accounting models are:

• Debt (Liability) model (ASC 470) – Recognizing the PPP loan as a Note Payable
• Government Grant model (analogize to International Accounting Standards “IAS” 20) – Recognizing the PPP loan as a Deferred Income Liability
• Contributions model (analogize to FASB ASC 958-605) – Recognizing the PPP loan as a Refundable Advance
• Gain Contingency model (ASC 450-30) – Recognizing the PPP loan as a Note Payable

“Debt” model (ASC 470):

The borrower recognizes the PPP loan as a Note Payable (long-term liability) upon receipt. Subsequently, to derecognize the liability, the following guidance (in FASB ASC 405-20-40-1) would apply. The PPP loan would remain recorded as a liability until either:

1. The PPP loan is forgiven by the lender, in part or wholly, and the borrower is “legally released” of the debt; or
2. The borrower pays off the PPP loan to the lender

When the events noted in the above first item occur, the borrower could recognize a gain on extinguishment of debt with a corresponding offset to Note Payable.

“Government Grant” model (analogize to IAS 20):

Consistent with the provisions of IAS 20, after initial recognition of the loan proceeds, government grants are recognized in the statement of income on a systematic basis. This basis corresponds with the manner that the business entity recognizes the underlying expenses that the government grant intends to compensate.

IAS 20 generally recognizes government grants in the statement of income either on a “gross” or “net” basis. A gross basis recognizes the forgiven portion of the loan amount as “other income” in the statement of income. A net basis recognizes the forgiven portion of the loan amount as an offset against the related eligible expenses.

The borrower recognizes the PPP loan as a Deferred Income (long-term liability) upon receipt of the PPP loan. The PPP loan forgiveness is not recognized until the borrower meets the “probable” threshold in USGAAP, that:

1. Any and all of the conditions attached to the PPP loan forgiveness will be met; and
2. The lender approves the loan forgiveness

Once it’s probable that the two conditions will be met, the PPP loan forgiveness income can be recognized with a corresponding offset to “Deferred Income.”

“Contributions” model (analogize to FASB ASC 958-605):

The borrower recognizes the PPP loan as a Refundable Advance (long-term liability) upon receipt. Subsequently, the PPP loan forgiveness is not recognized until all of the loan forgiveness conditions are substantially met or explicitly waived by the lender.

Once the conditions are substantially met or explicitly waived, the PPP loan forgiveness income can be recognized with a corresponding offset to “Refundable Advance.”

“Gain Contingency” model (FASB ASC 450-30):

Similar to the Debt model, the borrower recognizes the PPP loan as a Note Payable (long-term liability) upon receipt of the loan.

Subsequently, the PPP loan forgiveness is not recognized until all of the contingencies related to the PPP loan forgiveness are met (including the approval of the loan forgiveness by the lender), with a corresponding offset to “Note Payable.”

If a borrower adopts the Government Grant or Contributions model, the PPP loan forgiveness income can be recognized when the borrower meets the “probability” threshold and “substantially met” criteria, respectively.

If the borrower adopts the Debt or Gain Contingency model, it is appropriate for the borrower to wait until at least the lender approves the loan forgiveness, either in part or wholly, to recognize the loan forgiveness income.

The PPP loan forgiveness income can be recognized in the Statement of Income either:

1. As “Other Income” (Gross Basis Presentation); or
2. As a reduction of the related expenses (Net Basis Presentation)

See below for an illustration of the journal entries.

ON RECEIPT OF THE LOAN PROCEEDS:

Debit – Cash

Credit – Note Payable/Deferred Income Liability/Advance Payable (long-term)

Recognize Interest Expense:

Debit – Interest Expense

Credit – Interest Payable

Borrowers can recognize interest expense at an interest rate of one percent (1%), in accordance with the interest method. The borrower would not impute additional interest at a market rate because transactions where interest rates are prescribed by government agencies are excluded from the scope of the guidance on imputing interest.

WHEN EXPENSES ARE INCURRED OR PAID DURING THE 8-WEEK OR 24-WEEK “COVERED” PERIODS:

Debit – Related expense accounts

Credit – Cash

UPON MEETING THE “PROBABLE” THRESHOLD OR “SUBSTANTIALLY MET” CRITERIA, OR APPROVAL OF THE LOAN FORGIVENESS:

The borrower would reduce the Note Payable/Deferred Income/Refundable Advance by the amount forgiven and record a gain on extinguishment of the debt/Income.

As noted above, the journal entries can be recorded either on a gross or net basis presentation, as follows:

For Gross Presentation:

Debit – Note Payable/Deferred Income Liability/Advance Payable (long-term)

Credit – Other Income

(or)

For Net Presentation:

Debit – Note Payable/Deferred Income Liability/Advance Payable (long-term)

Credit – Payroll, Rent, Utilities, Mortgage Interest (as applicable)

NOT-FOR-PROFIT ENTITIES

Not-for-profit (NFP) entities that are eligible to participate in the PPP loan have two options to approach accounting for the loan. Although the legal form of the PPP loan is debt, some take the stance that the loan is, in substance, a government grant. Regardless of the potential for forgiveness, the NFP may account for the loan as debt in accordance with FASB ASC 470, including accrual of interest at the stated interest rate of the loan. It is not necessary to impute additional interest in this case. Alternately, if the eligibility criteria for forgiveness are expected to be met, the NFP may record the loan proceeds and the loan forgiveness in accordance with FASB ASC 958-605 as a conditional contribution.

FASB ASC 958-605 includes specific criteria to consider when determining whether a contract or agreement should be accounted for as a contribution or exchange transaction. It also provides a framework for determining whether a contribution is conditional or unconditional, which impacts the timing of revenue recognition. In accordance with FASB ASC 958-605, the PPP loan will be accounted for as a nonexchange transaction because the government is not receiving commensurate value in return for making the loan. At the inception of the loan, the proceeds are recorded as a refundable advance, as there are conditions for forgiveness of the loan (both a measurable performance barrier and a right of return). The refundable advance would not be recognized as revenue until the conditions are substantially met (incurring qualifying expenses and maintaining the prescribed level of FTEs) or explicitly waived (loan forgiveness).

Not-for-profit entities may routinely receive forgivable loans, and in those circumstances, such entities may not consider the forgiveness of the PPP loan as unusual or infrequent. It may also depend on whether significant COVID-19 related expenses are incurred and reported as unusual or infrequent. Some judgment is involved in this determination.

FASB ASC 220-20-45-1 requires events or transactions that are either unusual, infrequent or both to be presented as separate elements in the statement of activities. It may be reasonable to infer COVID-19-related loan forgiveness could be considered unusual and infrequent and thus be reported separately in the statement of activities.

Accordingly, the loan forgiveness amount would either be presented as a separate amount before the “total revenues, gains and other support” caption in the statement of activities, as a nonoperating item in a statement of activities that distinguishes between operating and nonoperating items or, alternatively, disclosed in the notes to the financial statements.

An illustration of the accounting journal entries are as follows.

ON RECEIPT OF THE LOAN PROCEEDS UNDER FASB ASC 470:

Debit – Cash

Credit – PPP Loan Payable (long-term liability)

ON RECEIPT OF THE LOAN PROCEEDS UNDER FASB ASC 958-605:

Debit – Cash

Credit – Refundable Advance

WHEN EXPENSES ARE INCURRED/PAID:

Debit – Related expense accounts

Credit – Cash

UPON REPAYMENT OF LOAN UNDER FASB ASC 470:

Debit – PPP Loan Payable (Long-term liability)

Credit – Cash

UPON APPROVAL OF THE LOAN FORGIVENESS AMOUNT UNDER FASB ASC 470:

Debit – PPP Loan Payable (Long-term liability)

Credit – Gain on extinguishment (for amount forgiven)

UPON APPROVAL OF THE LOAN FORGIVENESS AMOUNT UNDER FASB ASC 958-605:

Debit – Refundable Advance

Credit – Government Grant Revenue

The PPP loan forgiveness amount is recognized when:

1. The not-for-profit has substantially complied with all of the PPP regulations; or
2. The lender has explicitly approved the loan forgiveness amount.

DISCLOSURES

Disclosures in business entities’ notes to financial statements are required regarding the nature, terms and conditions of the assistance (grants), amounts, a description of the accounting policy selected (i.e. gross or net presentation) and how the amount is reflected in the statement of income/statement of activities.

For not-for-profit entities with material PPP loans, the accounting policy for such loans should be disclosed along with the related impact to the financial statements. The NFP should also include the terms of the outstanding PPP loan, including provisions for forgiveness of the loan. If the NFP accounts for the loan under FASB ASC 958-605, the loan agreement contains a conditional promise to give that should be disclosed in accordance with that guidance.

Our accounting and not-for-profit experts are constantly monitoring changes in legislation to find solutions for your business. Please contact us for insight and assistance navigating this business climate.