PPP Accounting for Technology and Life Science Companies

Many technology and life science (“TLS”) companies received loans under the Paycheck Protection Programs (“PPP”) in 2020 and 2021. With the appropriated funds for these programs nearly exhausted and the application deadline upon us, such companies have been left with numerous questions as to how to account for these loans for both financial reporting and tax purposes. This is the first in a series of articles to address the key topics regarding accounting for PPP loan proceeds.

Overview

On March 27, 2020, Congress enacted the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. The PPP, established by the CARES Act and implemented by the U.S. Small Business Administration (“SBA”), provided businesses with funds to pay payroll and other costs during COVID-19. On December 27, 2020, the Consolidated Appropriations Act was signed into law. It included a roughly $900 billion COVID-19 relief package, known as the “Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act” (“Economic Aid Act”). The Economic Aid Act made available approximately $284.5 billion in new PPP funding and reopened the PPP for first- and second-draw loans. The American Rescue Plan Act, which became law on March 11, 2021, allocated an additional $7.5 billion in funds to the PPP. The deadline to apply for a PPP loan under the American Rescue Plan Act was March 31, 2021. The PPP Extension Act of 2021, which became law on March 30, extended the PPP application deadline to May 31, 2021. The PPP Extension Act also provided an additional 30 days—until June 30, 2021—for the SBA to finish processing applications received by the May 31 application deadline. On May 6, 2021, the SBA announced that it would only accept new PPP loan applications from community financial institutions, which typically serve underserved communities. PPP funding for loans originated by lenders other than community financial institutions has been exhausted. The Economic Aid Act set aside $15 billion for loans originated by community financial institutions. The SBA will continue to accept applications for loans submitted by community financial institutions until this set-aside is exhausted or May 31, 2021, whichever is earlier.

The PPP was intended to allow eligible borrowers to obtain loans on favorable terms to cover payroll and other eligible expenses. Under the original program, loan proceeds could only be used for payroll costs, rent payments, mortgage interest payments and utility payments. Effective December 27, 2020, PPP loans (including existing loans on that date) could be used for additional categories of non-payroll expenses including worker protection costs related to COVID-19, uninsured property damage costs caused by looting or vandalism during 2020, and certain supplier costs and expenses for operations. This loan program was for the specific purpose of helping eligible borrowers affected by the coronavirus pandemic to continue paying employees and to keep their doors open for business. To the extent the PPP loan was promptly used to pay eligible expenses, the loan may be forgiven and therefore never has to be repaid.

Acceptable Accounting Policies for PPP Loan Proceeds

For financial statements prepared under generally accepted accounting principles (“GAAP”) in the U.S., a TLS company that received proceeds from a PPP loan must first establish an accounting policy for the proceeds received. There are four models to account for PPP loans under GAAP:

1. Account for the PPP loan under FASB Accounting Standards Codification (ASC) 470, Debt.
2. Account for the PPP loan as a government grant by analogy to International Accounting Standard (IAS) 20, Accounting for Government Grants and Disclosure of Government Assistance, provided certain conditions are met.
3. Account for the PPP loan in accordance with ASC 958-605, Not-for-Profit Entities: Revenue Recognition.
4. Account for the PPP loan in accordance with ASC 450-30, Contingencies: Gain Contingency Model.

Each of the accounting frameworks has a different measure for when de-recognition of the loan (liability) will occur.

Accounting Under ASC 470

Regardless of whether a TLS company expects to repay the PPP loan or believes it is expected to be forgiven, it may account for the loan as a financial liability in accordance with FASB ASC 470 and accrue interest in accordance with the interest method under FASB ASC 835-30. An entity would not impute additional interest at a market rate (even though the stated interest rate may be below market) because transactions where interest rates are prescribed by governmental agencies are excluded from the scope of the FASB ASC 835-30 guidance on imputing interest. The proceeds from the loan would remain recorded as a liability until either (1) the loan is, in part or wholly, forgiven and the TLS company has been “legally released;” or (2) the TLS company chooses to pay off the loan to the creditor. Once the loan is, in part or wholly, forgiven and legal release is received, a TLS company would reduce the liability by the amount forgiven or repaid and record a gain on extinguishment, if any.

Accounting by Analogy to IAS 20

If a TLS company 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 may analogize to IAS 20 to account for the PPP loan. IAS 20 outlines a model for the accounting for different forms of government assistance, including forgivable loans. Under this model, government assistance is not recognized until there is reasonable assurance (similar to the “probable” threshold in U.S. GAAP) that (1) any conditions attached to the assistance will be met; and (2) the assistance will be received. Once there is reasonable assurance that the conditions will be met, the earnings impact of government grants is recorded on a systematic basis over the periods in which the entity recognizes as expenses the related costs for which the grants are intended to compensate. Specifically, a TLS company would initially record the cash inflow from the PPP loan as a deferred income liability. Subsequent to initial recognition, a TLS company would reduce the liability, with the offset through earnings presented as a credit in the income statement, either (1) separately or under a general heading such as “other income;” or (2) as a reduction of the related expenses, as it recognizes the related cost to which the loan relates, for example, compensation expense.

Accounting in Accordance with ASC 958-605

The de-recognition threshold for the liability is that the conditions for forgiveness of the PPP loan program are “substantially met.” Unlike the IAS 20 framework, this framework does not allow for a projection of whether the conditions will be met. The conditions for forgiveness need to be “substantially met” based on what has taken place at the balance sheet date without any ability to forecast. Therefore, forgiveness conditions need to be substantially met at the assessment date (such as a balance sheet date) and it would not be appropriate to forecast that conditions will be met after the balance sheet date to derecognize the PPP loan liability. As a result, an entity may have incurred qualifying expenses during an accounting year but not yet satisfied other forgiveness conditions, since the end of the period during which the conditions must be met will not take place until after the accounting year. However, it is possible that partial de-recognition of the PPP liability could take place based on the extent to which the forgiveness conditions had been “substantially met” in stages at the balance sheet date.

Accounting in Accordance with ASC 450-30

FASB ASC 450-30-25-1 indicates that a contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization. Realization is generally interpreted to mean “realized or realizable.” This view is typically based on Statement of Financial Accounting Concepts #5, paragraph 83, which indicates that “revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash.” Accordingly, under this model, the forgiveness of the PPP loan would not be recognized until all uncertainties regarding the final forgiveness of the loan are resolved. This makes the de-recognition of the PPP loan liability close to when the formal forgiveness takes place, similar to the ASC 470 threshold of “legally released” as discussed above.

If the PPP loan is material to the TLS company’s financial statements, the chosen policy should be disclosed in the footnotes of financial statements prepared in accordance with GAAP.

The initial choice of an accounting policy will significantly impact the ongoing accounting for PPP loans through the date of forgiveness or repayment. Future articles will address additional topics related to the accounting and financial reporting for PPP loans, including balance sheet classification, presentation in the statements of operations and cash flows, criteria for “legal release” of the loan, the recognition of forgiveness and the related tax treatment, and the required footnote disclosures for PPP loans.