As a quick recap, the Paycheck Protection Program (PPP) was created under the CARES Act to support eligible small businesses impacted by the COVID-19 pandemic. These potentially forgivable loans, which have a two- or five-year term and bear interest at one percent, were provided through SBA-approved lenders to eligible businesses.
As of today, most borrowers who received PPP funds have not completed the forgiveness process yet. And as many businesses are wrapping up their year-end records, questions have arisen on how to account for these loans in the accounting records. The accounting for these loans depends on facts and circumstances that are unique to each borrower.
Below we highlight two different acceptable methods that borrowers can use to account for their PPP loan.
Two Approaches for PPP Loan Accounting
Account for PPP Loan as Debt
The first option is to treat your PPP loan as debt, where interest is accrued based on the terms of the note. The loan and any accrued interest would remain on the books until the forgiveness takes place or the loan is paid off. The loan and related interest is derecognized and taken into income as a gain on debt extinguishment in the period that the loan is formally forgiven.
Account for PPP Loan as Government Grant
In the second approach, a company may treat the PPP loan as a government grant if certain conditions are met. These conditions are met if it is probable that the borrower will meet both the eligibility and loan forgiveness criteria for the PPP loan for all or substantially all of the loan. If the borrower cannot support that it will likely meet both requirements, the PPP loan should be accounted for as debt. The loan would be recorded in the accounting records as a deferred income liability and amortized over the period that the expenses that the grant is intended to offset are recognized. In most cases, all of the income would be recognized in 2020. The income can either be shown separately as other income or recorded as an offset to expenses.
Takeaway from the MGA Experts
The second option will likely be the best choice for borrowers who expect their loan to be forgiven. Many borrowers are struggling in 2020 to meet covenants, especially leverage and debt service covenants. Excluding these amounts from liabilities and including it in income can avoid difficult discussions with lenders.
It is important to remember that the assessment of whether a borrower will meet the eligibility and forgiveness criteria is an ongoing one. Therefore, you should continually monitor developments regarding the SBA’s continued evaluation of the eligibility and forgiveness criteria.
As always, we at MGA will keep you updated on these and other significant developments.