Tag: PPP Loans

Part 1

I recall from my college days when Dr. Baker, the dean of the business administration department, casually mentioned that we would have a quiz the very next class. So I prepared for a quiz, which was barely any preparation at all. As it turned out, the “quiz “was a 200-question mammoth examination, weighted to be half our course grade. Holy drop-the-course, Batman.

Well, here’s an accounting quiz for you. But it’s not 200 questions, you do not have to prepare for it, and you will not be graded. You will find what I consider to be the best answers at the end. Here we go.

1. If the SBA forgives my company’s PPP loan, will I pay federal income tax on the forgiven amount?
• a. Yes. Because the related expenses are not deductible. This effectively makes it taxable.
• b. No. The loan forgiveness income is not taxable, and the related expenses are deductible.
• c. It depends. If your company’s taxable income exceeds $2 million, exclusive of the PPP loan forgiveness amount, then yes, it is taxable.
• d. Maybe. If the company fails to make the first loan payment on the date stipulated in the lender’s promissory note, the entire amount that the SBA would potentially forgive is deemed taxable income by the IRS.
2. If my company accounts for our PPP loan as an in-substance government grant under IAS 20, can the grant income be presented as operating income in our GAAP basis income statement?
• a. No. Receipt of the grant income is ancillary to the company’s primary operations.
• b. No. GAAP prohibits its presentation as income from operations because it is both unusual and infrequent.
• c. Yes. IAS 20 requires its presentation as income from operations.
• d. Maybe. It’s permissible to classify PPP grant income as either operating or nonoperating income, depending on the company’s policy election.
3. Our company’s PPP promissory note stipulates that our first loan payment is due on the seventh month after the note’s date. However, we expect the SBA will forgive the entire debt, so we have made no payments, even though we are three months past the due date. Are we in default, and, if so, how should this default be disclosed in our financial statements?
• a. Yes. The bank elected not to revise the promissory note and did not extend the loan deferral date. Disclose the default, and if you account for the PPP loan as debt, it all becomes current.
• b. Yes. The Paycheck Protection Flexibility Act of 2020 extended the payment date, but this extension did not apply to loans made before the Flexibility Act. Disclose the default, and if you account for the PPP loan as debt, it all becomes current.
• c. No. The Paycheck Protection Flexibility Act of 2020 retroactively extended the deferral period for loan principal and interest payments.
• d. Maybe. Under the Paycheck Protection Flexibility Act of 2020, companies must formally apply and received an extension from the bank.
4. If my company treats our PPP loan as debt for financial statement presentation, how do we determine the classification between current and long-term debt if we are confident the SBA will forgive the loan after application for forgiveness?
• a. Since the expectation is that the debt will be forgiven and not paid, the entire debt should be classified as long-term because it will not be paid within one year.
• b. Since the expectation is that the debt will be forgiven and not paid, the entire debt should be classified as current because it will be settled within the next year.
• c. The debt should be classified as current or noncurrent under ASC-470-10-45, without regard to the expectation that the debt will be forgiven.
• d. The company should make it simple and present an unclassified balance sheet.
5. If my company decides to account for the PPP loan by analogy to IAS 20, the company must conclude that it is reasonably assured (i.e., ”probable”) it will comply with the forgiveness term of the CARES Act and SBA rules. Under GAAP, probable means:
• a. A 75% or greater likelihood.
• b. More likely than not.
• c. A very high threshold.
• d. Likely to occur.

Here are the answers:

1. 1b. No. The loan forgiveness income is not taxable, and the related expenses are deductible.
   

   Under the CARES Act, the congressional intent was that the PPP debt forgiveness income be non-taxable, and the expenses that the PPP income defrayed be deductible. Unfortunately, Congress was silent about the deductibility of the expenses to be defrayed by the PPP loan. But the IRS was not quiet. The IRS opined that other areas of the tax code and regulations prohibited the deductibility of those expenses. Congress later corrected this in the Consolidated Appropriations Act, 2021 (“the Act”), signed into law on December 27, 2020. Under provisions of the Act, qualifying expenses related to PPP debt forgiveness are retroactively deductible. Therefore, the PPP debt forgiveness income is not taxable, and the costs defrayed are deductible.

2. 2d. Maybe. It’s permissible to classify PPP grant income as either operating or non-operating income, depending on the company’s policy election.
   

   GAAP is somewhat opaque as to the classification of items in the statement of income. Therefore, it becomes a matter of the company’s policy. Suppose the company presents income from operations as a subtotal in the statement of income. In that case, we believe it is acceptable to include the grant income in that subtotal. Since the grant income is intended to defray certain operating expenses (payroll, rent, utilities, etc.), we believe it is acceptable to present the grant income as a separate line item to operating income. For example, you can show PPP grant income below general and administrative expenses in a section captioned Other Operating Income.

   However, the company’s accounting policy may call for the grant income to be presented as non-operating income. In that case, the grant income can be presented as a separate line item below income from operations in the Other Income section.

3. 3c. No. The Paycheck Protection Flexibility Act of 2020 retroactively extended the deferral period for loan principal and interest payments.
   

   Under the CARES Act, the principal and interest deferral period ends six months from the date of the note. Accordingly, many early PPP promissory notes stipulated that payments were to begin on the seventh month. However, the Paycheck Protection Program Flexibility Act of 2020, enacted in June 2020, (Flexibility Act) retroactively extended the deferral period for payment of principal and interest on all PPP loans to either:

   1. The date that the SBA remits the borrower’s loan forgiveness amount to the lender,
   2. Or, if the borrower does not apply for loan forgiveness, ten months after the end of the covered period. (Note: The “covered period” is either the 8-week or 24-week period after the loan is made, during which the borrower must incur the qualified expenses).

   The SBA required lenders to give immediate effect to the deferral period’s statutory extension under the Flexibility Act and to notify the borrowers of the change. However, the SBA did not require a formal modification to the promissory note. Therefore, many PPP promissory notes may have incorrect dates for when payments commence.

4. 4c. The debt should be classified as current or noncurrent under ASC-470-10-45, without regard to the expectation that the debt will be forgiven.
   

   Even if the SBA forgives the entire PPP loan after year-end and before the financial statements are issued, the debt should be classified as current and long-term based on the promissory note’s terms, as modified by the Flexibility Act. The Flexibility Act makes the initial payment date uncertain. As described above, the Flexibility Act specifies that the deferral period for payment of the PPP loan ends on either:

   1. The date that the SBA remits the borrower’s loan forgiveness amount to the lender,
   2. Or, if the borrower does not apply for loan forgiveness, ten months after the end of the covered period. (Note: The “covered period” is either the 8-week or 24-week period after the loan is made, during which the borrower must incur the qualified expenses).

   Determining the initial payment date requires significant judgment and is based on facts and circumstances specific to the company. Of course, this determination will impact how much of the debt, if any, will be classified as current.

5. 5d. Likely to occur.
   

   Under GAAP, probable means likely to occur. Probable is understood (though not defined this way in GAAP) as a very high threshold to clear. Many CPAs consider probable to be a 75% or greater likelihood of occurring, but this percent is not mentioned in GAAP. Therefore, if the probability of loan forgiveness does not rise to this high threshold, then the PPP loan should probably be accounted for as debt.

   Given the current environment of perceived loan application misstatements of the good-faith certification, the SBA may put loans of $2 million or larger under greater scrutiny for compliance after the submission of the forgiveness application. Therefore, larger loans may find it more difficult to reach the high hurdle of forgiveness probably.

Next month, we’ll have Part 2 of this accounting quiz. It will focus on construction accounting.