Accounting for Government Grants: General
The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided substantial funds as economic incentives to qualifying businesses. Two main programs established as part of the CARES Act are Paycheck Protection Program (PPP) and Employee Retention Credits (ERC).
U.S. GAAP does not have specific accounting guidance relating to government grants. Generally, reporting entities account for government assistance by analogy to IAS 20, Accounting for Government Grants and Disclosure of Government Assistance.
Based on IAS 20, government grants can either relate to assets or income. Grants related to assets are grants whose primary condition is that an entity should purchase, construct, etc. long-term assets. IAS 20 defines grants related to income as all grants that are not related to assets.
IAS 20, par. 29 provides that grants related to income can be presented in one of two ways:
- A credit in the income statement, either separately or under a general heading, such as “other income”;
- A reduction to the related expense;
Grant proceeds are not reported as part of entity’s revenue/sales from customers.
According to IAS 20, grants related to asset are to be presented on the balance sheet using one of two methods. Grants can be recorded as deferred income when they are received. The deferred income is then recognized in the income statement on a systematic basis over the useful life of the related asset.
Under the second method, grant funds are deducted from the carrying amount of the related asset. This results in the asset being recorded at a lower amount and, therefore, a reduction of depreciation over the life of the asset.
Generally, entities should disclose the effect of grants on entity’s financial statements including balance sheet and the income statement. Entities are also required to disclose the nature of government grants received in the footnotes to their financial statements.
Accounting standard does not prescribe which method should be used. Entities should select one of the two accounting treatments as part of their accounting policy. Selected treatment should be applied consistently to all similar transactions.
Accounting for Employee Retention Credit
Under ERC program, an eligible entity may take a credit against employer’s portion of Social Security taxes withheld on qualified wages. The amount of credit is limited to employment taxes equal to 50 percent of the qualified wages an eligible employer pays to employees after March 12, 2020, and before January 1, 2021. An entity is eligible for the ERC if it has not received a PPP loan and certain other conditions were met. Overall, ERC program represents a government grant/assistance.
The ERC grant appears to be related to income as it provides a credit against certain payroll taxes.
As noted above, entities are allowed to either present ERC credits as a reduction of eligible payroll costs or as a separate line-item (credit) reported in the income statement. In either situation, a reporting entity would recognize ERC credit on a systematic basis over the same period that the entity recognizes related payroll taxes.
Accounting for PPP Loans
Paycheck Protection Program (PPP) was created by the CARES Act to provide certain small businesses with liquidity they need to support their operations during the pandemic. According to the terms of the program, entities have to meet certain eligibility requirements to receive PPP loans. The loans may also be forgiven if all employee retention criteria are met, and the funds are used for eligible expenses.
PPP loans have the interest rate of 1%. Loans issued prior to June 5 have a maturity of 2 years. Loans issued after June 5 have a maturity of 5 years.
Current accounting practice is as such that it is acceptable for an entity that received a PPP loan to account for it as debt under ASC 470, regardless of whether or not the entity expects the loan to be forgiven. The above accounting is based on the notion that the legal form of a PPP loan is debt.
However, an entity that expects to meet the loan forgiveness criteria may elect to account for the proceeds using government grant accounting model. Since PPP loans were designed to provide a direct incentive for small businesses to keep their workers on the payroll, the grant will be classified as related to income. Entities that do not expect to meet the PPP forgiveness requirements must account for the proceeds as debt.
Companies that that expect to meet the forgiveness requirements, may report the debt proceeds as either reduction of relevant payroll expenses or a credit in the income statement, reported separately. Entities following this approach will need to continually reassess their ability to meet the forgiveness requirements. Only portion of the loan expected to be forgiven may be recognized in entity’s income statement, either separately or as a reduction of eligible payroll costs. A reporting entity may have to reverse previously recognized income if it can no longer support a conclusion that it expects to meet the forgiveness requirements.
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