By Scott Lewis, CPA, MSA
The loan funding from the Small Business Administration’s Paycheck Protection Program (PPP) has raised many questions from small businesses and their accounting staff. These include how to account for the initial loans on the books, what approved uses can be paid from these funds and how the forgiveness calculations will be determined. For purposes of this short article, we will review our firm’s interpretations on the accounting of the loan proceeds on the general ledger and financial statements. Formal final guidance from the SBA and the Treasury is still forthcoming on the loan forgiveness calculations; our firm has been preparing detailed programs to calculate these amounts, along with “what-if” scenarios when specific requirements aren’t met, such as shortfalls in the number of full time employees or amount of payroll spending as needed, and how this affects the reduction in forgiveness of the PPP loans. For additional information on loan forgiveness, please contact our offices direct.
In terms of the PPP loan proceeds, we strongly recommend setting up new bank accounts separate from the operating accounts that currently are in place (New account). Take the loan proceeds and deposit in these new account(s). For purposes of the initial transaction on the books, set up a new cash account in the general ledger, or a cash account not being used and ensure it is on the section of cash on any financial statements that are being prepared.
Record a debit (deposit) of the monies to new account and credit a payable to long-term debt. This loan will be considered long term as payments can be deferred for up to two years. In addition, until it is known how much of the loan will be forgiven, leave this account as long term.
When paying approved expenses for loan forgiveness such as payroll, rent, mortgage interest, or utilities, transfer the monies needed from new account via electronic transfer or other mechanism, into the operating bank account or the payroll bank account, wherever these payments are funded in the normal course of business. There is no need to change which account the actual payroll comes from, as an example. The transfer from the new account to move the funds into the regular accounts creates an audit trail for documentation on the usage and needed for loan forgiveness calculations. It would be similar with rent payments, electronically transfer the rent amount from the new account to the operating account and expense the rent as usual. Please note how payroll or any other expenses are being recorded on the books are not changing. The only additional adjustments on the books are to record the loan proceeds needed from the new account to the operating/payroll accounts.
Keep in mind that loan forgiveness is based on at least 75% of the proceeds be used for payroll type expenses, and 25% for the other allowed expenses such as overhead – rent and utilities, etc.
While the loans have the potential to be fully forgiven, and the payments are being deferred for six months, interest is technically accruing on the full amount. We recommend recording a monthly interest accrual based on the full loan amount at the 1% annual interest rate. If the full loan is $200,000 for example, record a monthly adjustment of a $167 ($200,000 loan x (1%/12 months or .0833%) debit to interest expense and credit to interest payable. This will “smooth” out these expenses in the next couple of months. Once the loan forgiveness portion is determined, a portion of this interest expense and accrued liability can be reversed.
In terms of the loan forgiveness amount, once this is known, debit the long-term debt account by this amount and credit other income. If possible, use another income general ledger account that is not being used, and is in the section of other income line on any financial statements. This income is not taxable for federal income tax purposes. There has been not been any clear guidance on whether these monies will be considered taxable by the states.
Once it is determined how much of the loan will not be forgiven, that amount should remain on long term debt, and the current portion that will be due in the next year should be moved to current maturities of long-term debt. This will affect the working capital calculation on the short-term portion, and the debt to equity ratio on the long-term portion. We recommend discussing this with anyone who relies on your financial statements and lenders (if applicable) if this negatively affects any business requirements or loan covenants, and how to address and/or cure.
This is general guidance and we advise consulting with the various internal and external third parties that rely on your books and records, and financial statements on how all accounting entries tied to the PPP loan program and the use of funds should be recorded, if it differs from the above.