As the second quarter of 2020 draws to a close, many companies that received Paycheck Protection Program (PPP) loans are unsure of how to account for them on their financial statements. Since PPP includes a lending and a forgiveness component, borrowers may wonder if the funds should be listed as a grant or a loan.
At the time of this writing, there have not been any formal authoritative pronouncements specifically related to this topic. However, there are different approaches for loan and grant treatment. Below, we outline these two approaches and look at other elements to consider related to PPP and June 30 financial statements.
Approach A: Account for PPP loan as debt
For most companies, PPP loans will be accounted for as debt instruments. On June 10, the American Institute of Certified Public Accountants (AICPA) published a technical Q&A on PPP loan forgiveness, providing non-authoritative input guiding nonprofit entities and public and private companies to record the funds as a debt instrument on a company’s balance sheet and treat the cash inflow as a financing activity for cash flow statement presentation.
- Balance sheet presentation: The company should recognize the entire loan amount as a financial liability (if a classified balance sheet is presented, the liability will be classified as current or noncurrent under current standards), with interest accrued as an additional liability and expensed over the term of the loan.
- Cash Flow statement presentation: The company should present the receipt of the PPP funds as a cash inflow from financing activities. Any interest paid will be presented as a cash outflow for operating activities, and any principal repaid will be presented as a cash outflow for financing activities. In addition, if any loan amount is forgiven, it would be disclosed as a non-cash financing activity.
Approach B: Account for PPP loan as government grant
To account for the forgivable loan as a government grant, borrowers must conclude on the basis of their particular facts and circumstances that they qualify for PPP and are reasonably assured that they will comply with the loan forgiveness conditions.
International Accounting Standard (IAS) 20, Accounting for Government Grants and Disclosures, provides the most comprehensive accounting model for government grants, and it has been widely applied to government grants received by business entities. IAS 20 addresses forgivable loans, and an entity may conclude that the application of IAS 20 to PPP would best reflect the substance of the forgivable loan.
If a company has a pre-existing accounting policy for accounting of similar government grants, it should generally apply it. However, if there is not a preexisting accounting policy or the grant is not similar to grants received in the past, borrowers should carefully consider applying a model that would faithfully depict the nature and substance of the government grant.
Accounting for other PPP elements on financial statements
Origination costs incurred: Costs paid to third parties in conjunction with securing the debt, such as document preparation costs or advisor fees, should be considered debt issuance costs and reflected as a direct reduction from the carrying amount of the debt. These costs are deferred and amortized into interest expense over the term of the debt.
Interest expense: While the loans provide for a six-month deferral of interest and principal payments, interest should be accrued for on a monthly basis applying the interest method under FASB ASC 835, Interest. It is possible that the interest will be forgiven, but until confirmed, it should be recorded.
Forgiveness of PPP loan debt: Under current accounting standards, a debt instrument is considered extinguished only if the borrower is legally released from being the primary obligor. As it relates to PPP, this means that the obligation should be derecognized only when the debt is formally forgiven. Financial institutions have 60 days to review submissions, and the Small Business Administration has 90 days to approve forgiveness, so it could take up to at least five months from the date forgiveness calculations are submitted to lender to get legal release from the debt.
The gain that results from forgiveness will be measured based on the net carrying value of the PPP loan, which should include accrued interest (if forgiven) and deferred financing costs relating to the forgivable portion of the loan. Within the income statement, this gain is presented as a separate line item. Given that current standards do not specify where in the income statement debt extinguishment gains and losses should be presented, there is diversity in practice. Clarifying guidance is expected.
Gross or offset expenses: Even if a PPP loan is forgiven, the related qualified expenses should continue to be accounted for in earnings. Payroll, rent, utilities and mortgage interest are costs that should be shown in the income statement as usual, not as reductions of PPP (i.e. – netted), during the forgivable measurement period.
Accounting methods should be carefully considered and applied in conjunction with your third party advisor, who can help answer any questions related to suitability, required disclosures and tax impact. Contact your RKL professional to start the conversation or reach out using the form below. Find more insights and guidance in our Business Recovery Resource Center.