According to the AICPA, the borrower has an option: either treat the PPP loan as debt or as a government grant. The fact that there is a choice reflects the current vast diversity of opinions on the question.
The AICPA’s recent Technical Q&A states:
Given the unique nature of the PPP, questions have arisen relating to how a borrower under the program should account for the arrangement. Although the legal form of the PPP loan is debt, some believe that the loan is, in substance, a government grant. Regardless of whether a nongovernmental entity expects to repay the PPP loan or believes it represents, in substance, a grant that is expected to be forgiven, it may account for the loan as a financial liability in accordance with FASB ASC 470, Debt and accrue interest in accordance with the interest method under FASB ASC 835-30.
If an NFP chooses not to follow FASB ASC 470 and it expects to meet the PPP’s eligibility criteria and concludes that the PPP loan represents, in substance, a grant that is expected to be forgiven, it should account for such PPP loans in accordance with FASB ASC 958-605, Not-for-Profit Entities – Revenue Recognition
as a conditional contribution.
If a nongovernmental entity that is not an NFP (that is, it is a business entity) expects to meet the PPP’s eligibility criteria and concludes that the PPP loan represents, in substance, a grant that is expected to be forgiven, the AICPA staff observes it can also analogize to FASB ASC 958-605…
Factors to Consider
With the PPP rules constantly shifting, it is almost impossible to get to a place where everyone is in agreement. So what are some of the factors to consider?
- Treating the PPP loan as debt has the benefit of straightforward accounting. The PPP loan principal is treated as a liability, with interest accrued. Note that imputing of additional interest at a market rate (even though the stated interest rate of one percent may be below market) is not appropriate. This is because transactions where interest rates are prescribed by governmental agencies are excluded from the scope of the accounting guidance on imputing interest. The liability remains until either forgiven or repaid. If forgiven (either wholly or in part) and legal release has been received from the lender, the amount forgiven is recorded as a gain on extinguishment of debt. The downside is the timing of the recognition of the gain from forgiveness. With many borrowers now opting for the extended 24-week covered period under the Paycheck Protection Program Flexibility Act of 2020, legal release from the lender will likely only be received in 2021. In addition, borrowers should consider the impact debt might have on loan covenants and have the necessary conversations with lenders in advance.
- Treating the PPP loan as a government grant has less straightforward accounting and requires more judgement. The first step is to determine if the government grant is conditional – in other words, if any barriers exist and if those barriers are tied to a right of return of funds or a release of the resource provider’s obligation. Indicators of barriers include measurable performance-related barriers (or other measurable barriers) as well as the extent to which a stipulation in the agreement limits discretion by the recipient on the conduct of an activity. An example of a measurable barrier is a stipulation that the recipient is only entitled to the funds upon the occurrence of an identified event. Does the requirement for legal release from the lender qualify as such an event or is it merely administrative in nature? The PPP also has requirements related to the maintenance (or restoration) of employee headcount and compensation levels that would appear to meet the definition of a measurable barrier. An example of limited discretion includes a requirement to follow specific guidelines about incurring qualifying allowable expenses. This is the case with the PPP, which has restrictions on both how the funds can be spent as well as what expenses qualify for forgiveness (certain payroll costs and certain non-payroll costs, such as utilities, mortgage interest and rent). Since a conditional contribution is required to be accounted for as a refundable advance until the barriers have been substantially met or explicitly waived by the resource provider, the timing of revenue recognition may, or may not, be earlier than if the PPP loan had been accounted for as debt. As previously noted though, there are a number of barriers to consider: qualifying expenses, maintenance (or restoration) of employee headcount and compensation levels, and possibly the legal release from the lender. And remember that under the clarified accounting guidance for contributions received and contributions made, the likelihood of a condition being met may no longer be considered. In other words, probabilities of events occurring cannot be a factor in assessing conditions and determining the timing of revenue recognition.
Final Thought: Whatever option is chosen, the financial statement disclosures should be clear and comprehensive. In particular, if the PPP loan is treated as a government grant, the assumptions made regarding barriers should be clearly defined so that a reader of the financial statements can understand the pattern of revenue recognition.
If you have any questions on the above, GHJ’s COVID-19 Response Team has as an experienced team of consultants specializing in COVID-related laws and programs and can provide the tools your business needs to help it recover from this business disruption. We are here to assist organizations to succeed in these very challenging times.