As most know, the current pandemic created from the COVID-19 virus has caused Federal, State and Local governments to assist many small entities with new income tax benefits and incentives, and contingent low interest deferred loans that might convert to potential grants. This assistance leads to the question of how to record such assistance in an entity’s financial statements. To date, U.S. Generally Accepted Accounting Principles (“GAAP”) does not provide authoritative guidance on the financial reporting of government assistance for typical business entities. There is industry specific guidance outlined in Accounting Standards Codification (“ASC”) 958 – Not-for-Profit Entities, for such entities, however this does not typically apply to your ordinary business. The Financial Accounting Standards Board (“FASB”), currently has an ongoing project, “Disclosures by Business Entities About Government Assistance”, in which FASB issued a Proposed Accounting Standards Update – Government Assistance (Topic 832) in November 2015 which received feedback that disclosure alone is not sufficient guidance, there has not been much traction on this project and, as of March 2019, the project is currently in the exposure draft deliberations stage. This ASU would require disclosures about material existing government assistance agreements, but does not speak of any specific financial reporting, such as when to recognize and how to measure government assistance.
We will focus on Title I of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), specifically the Paycheck Protection Program (“PPP”), and offer a common sense approach on how to record and when to report government assistance. In general, as the current law stands today, loans under the PPP program would be forgivable if the loan proceeds are used to cover payroll and other costs including mortgage interest, rent and utility costs over the eight week or twenty four week period after the loan is made, and employee and compensation levels are maintained. If this is not abided by, then the loan will be a low interest loan payable over five years. The program is administered through financial institutions on behalf of the Small Business Administration.
We will cover and answer the following questions:
- At what point do the anticipated or realized benefits represent assets?
- Do anticipated obligations represent liabilities?
- Are the benefits received to be recorded as either revenue or potential gains?
- If there are benefits, when would you recognize such income?
- What disclosures are needed?
At what point do the anticipated or realized benefits represent assets? For the PPP, the benefit would be the loan that is to be received. Once the government performs on a promise, then the entity has a right to future economic performance and an asset would generally be created. Throughout the process of applying for a PPP loan there was uncertainty as to whether an entity would receive such loan. Due to the uncertainty of receiving such loan, an entity should not record an asset until the actual cash is received, and not when the loan is approved.
When the asset is recorded, i.e. when the cash is received, a liability for this obligation should be recorded. The main issue at hand is the subsequent reporting of such liability. The American Institute of Certified Public Accountants (“AICPA”) has issued a technical question and answer regarding such matter. In essence, there are three possible scenarios for a business entity (that is a For-Profit entity):
- Treat the PPP loan as debt. Under this scenario, the Company would record interest expense (based upon the stated rate per the PPP loan), and would not extinguish such liability and recognize income from forgiveness until the Company is legally released as the primary obligor. This would likely be when the Small Business Administration approves such forgiveness. The AICPA has stated that this scenario can be used regardless of the situation of the entity.
- An entity may also analogize to the International Accounting Standards and recognize a deferred income liability upon receiving the PPP loan. In this situation, if the Company believes there is reasonable assurance (which under GAAP would essentially mean probable) that the loan will be forgiven, they can then recognize income ratably over the period the expenses are incurred. This would allow the entity to recognize income earlier then scenario one.
- An entity may also treat the PPP loan as a gain contingency. Under this model, the Company would recognize a liability and would not recognize income until the gain is realized or realizable. This would essentially result in income being recorded at a similar time as scenario one (when legally released).
Each of these scenarios and the accounting recognition of the PPP loan require management’s judgment. As of now, there is no one size fits all answer, and an entity must make the determination on how to account for the transaction based upon its own facts and circumstances.
Please note that a NFP could essentially either treat the PPP loan as debt (under scenario one) or under FASB’s NFP guidance and treat the forgivable loan as a conditional contribution.
As noted, the FASB issued a proposed ASU to discuss the disclosure requirements of material government assistance. It is our belief that full disclosure of any and all such material activities should be made so that the reader can fully understand what assistance was obtained and could carefully compare similar entities if need be.
There is a question as to a gross vs. net reporting. For example, should the PPP loan benefit be netted with payroll expense, or should such transactions be recorded on a gross basis. Typically, the entity is providing for the services that the government is assisting with. Gross presentation is appropriate in this case. Without gross reporting, when comparing the financial statements with similar companies, the analysis could be distorted.
The PPP loan also brings up the issue of an entity receiving low interest rate loans. Under ASC 835 – Interest, there is guidance for when interest should be recorded in excess of the stated rate. In the case of low interest loans in connection with government assistance, the imputation of any interest in excess of the stated rate would not be appropriate. The applicable guidance excludes transactions where interest rates are affected by the tax attributed or legal restrictions prescribed by a governmental agency. The foregoing discusses the financial reporting implications of PPP loans, and clearly indicates when such transactions should be recorded. Until there is formal guidance issues by the FASB in the future, entities should follow such suggestions on financial reporting of any material government assistance transactions. We at Janover are here for you. Feel free to reach out with any of your financial reporting questions or needs.