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PPP Loan Forgiveness: What It Means for Your Financial Reporting and Loan Covenants

November 23, 2020

PPP loan forgiveness has potential financial repercussions; borrowers will want to familiarize themselves with them.

The SBA’s Paycheck Protection Program (PPP) has provided a much-needed lifeboat for many businesses during the COVID-19 pandemic. However, PPP loan forgiveness has potential financial implications that borrowers need to understand.

Financial Reporting for PPP Loan Forgiveness

The unique nature of the PPP has raised financial reporting questions, some of which aren’t directly addressed by current accounting guidance. Debate has arisen, for example, over whether a PPP loan is debt or, in substance, a government grant. The American Institute of Certified Public Accountants (AICPA) has published guidance that provides the following models for accounting for PPP loans:

Debt. Regardless of whether the PPP loan is expected to be repaid or forgiven, any nongovernmental borrower can account for the loan as debt. If recorded as debt, the loan would be reported as a liability until the SBA approves the application for forgiveness. Once the forgiven amount is determined, the borrower would reduce the liability by the forgiven amount and recognize a gain on extinguishment.

Due to the time it can take to receive formal forgiveness of the PPP loan, the ultimate recognition of the loan as income will often occur in a different fiscal year than the receipt of loan proceeds and payment of qualifying expenses.

Conditional contribution. If a borrower concludes that the PPP loan represents, in substance, a grant that is expected to be forgiven, it should account for the loan as a conditional contribution. Under this model, a PPP loan is initially recorded as a refundable advance and is reduced, and recorded as income, when the conditions of the PPP are “substantially met,” based on what has taken place as of the balance sheet date. It’s possible to recognize partial forgiveness of the loan, depending on whether certain conditions (such as maintaining headcount) have been met in stages as of the balance sheet date.

Here are some factors to consider when assessing whether to use the conditional contribution model for PPP loans:

  • Any amounts recognized as income as conditions are substantially met could be reversed based on the final forgiveness calculation.
  • An increase in audit fees is likely since the evidence supporting the conclusion that conditions have been substantially met would require evaluation by the auditors.

The conditional contribution model is prescribed by not-for-profit (NFP) accounting guidance. Although the AICPA permits this guidance to be applied by for-profit entities by analogy, the use of the conditional contribution model by for-profit entities to date is uncommon.

Government grants. International Accounting Standard (IAS) 20 outlines a model for accounting for government assistance, including forgivable loans. Although IAS 20 isn’t a U.S. Generally Accepted Accounting Principle (GAAP) standard, PPP loan recipients are permitted to apply it by analogy. Under this model, a PPP loan can be recognized as grant income when there’s “reasonable assurance” the forgiveness conditions will be met. A borrower would initially record the PPP proceeds as a deferred income liability and reduce it on a systematic basis as it recognizes the related expenses. The reduction of the liability is recorded either as income or an offset to expenses.

The IAS model isn’t available for NFP entities and, to-date, has been infrequently used by PPP borrowers.

Gain contingency. Under current guidance, a gain contingency isn’t recognized as income until it is “realized or realizable.” Therefore, under this model, forgiveness of a PPP loan wouldn’t be recognized until all uncertainties regarding forgiveness have been resolved. Practically, this is unlikely to occur before formal forgiveness by the SBA takes place, similar to the debt model.

The model used to account for a PPP loan should be selected using judgment based on your specific facts and circumstances. Financial statement disclosures describing the accounting methodology used will be critical to the reader’s understanding of the loan’s effect on your financial statements.

Potential Implications for Loan Covenants

PPP borrowers with other existing loans should review their covenants to determine whether PPP debt puts them at risk of defaulting on any covenants. Potential implications include the following:

  • If a borrower treats the PPP loan as debt, the full loan amount will be recognized as a liability on its balance sheet and potentially be included in covenant calculations, but the forgiveness income won’t be recognized until the debt is extinguished. Do the other existing loans allow the borrower to incur additional debt?
  • If a loan covenant is violated, the debt associated with that loan generally must be classified as current unless the lender provides a waiver extending the payment at least 12 months past the balance sheet date or the violation is cured (or it’s probable it will be cured) within the loan’s grace period. Businesses at risk should contact their lenders to work out a resolution.
  • If the loan is treated as a conditional contribution or government grant, the income from loan forgiveness may be recognized earlier. Under such circumstances, a borrower might enjoy a favorable effect on its covenants.

Proceed with Caution

The PPP has helped businesses stay afloat amidst some rough waters, but the loans can have unforeseen ripple effects. Contact us to help you navigate the uncertainties.

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