As we are all aware by now, the COVID-19 pandemic has had countless effects on businesses and individuals everywhere. Much focus has understandably, and rightfully, been placed on how to navigate through the provisions of the CARES Act, Paycheck Protection Program, Consolidated Appropriations Act and the tax consequences of these initiatives.
For those businesses that have financial reporting requirements to meet, it is also important to understand how their audited or reviewed financial statements will be affected by the current environment. While each and every business will certainly have unique factors to consider, the three matters outlined below will be of significant importance to most small and medium-sized businesses.
Accounting for Paycheck Protection Program (“PPP”) Loans
In June 2020, the AICPA issued guidance on how to account for PPP loans under Generally Accepted Accounting Principles (“GAAP”). Most businesses, aside from governmental entities, are given two options. The first option is to account for the PPP loan as regular debt, meaning that the funds received would be recorded as a liability on the balance sheet (notes payable), and interest would be accrued at the rate and over the term provided for in the loan. If and when all or part of the loan is forgiven, the liability would be reduced by the amount forgiven, and a “gain on extinguishment” would be recorded. The gain on extinguishment would be presented as an item of Other Income on the entity’s income statement or statement of operations, below Operating Income.
The second option is to account for the PPP loan as though it were a government grant. Under this method, the funds received would initially be recorded as a deferred income liability on the balance sheet. Then, the entity would evaluate whether there is reasonable assurance of the following:
- Any conditions attached to the loan will be met
- Forgiveness will be obtained
If the entity believes that reasonable assurance exists for both criteria, then the funds can be recognized (reclassified from deferred income to income) on a systematic basis as the entity incurs qualified expenses, as defined by the PPP. As is the case under the first option, any income recognized would be presented as an item of Other Income on the entity’s income statement or statement of operations.
A not-for-profit entity may also follow a model similar to the second option, in which the PPP loan would initially be recorded as a deferred income liability on the balance sheet, and then systematically recognized as a contribution as the conditions of the loan are met (as the entity incurs qualified expenses).
Deferral of new Revenue Recognition and Lease Accounting Standards
Financial statement issuers have likely heard about a couple of major standards updates that have been in the pipeline over the past few years. First, the new revenue recognition standards, which represents a complete overhaul of the previous standards and will be relevant to virtually all revenue-generating entities, were set to become effective for fiscal years beginning after December 15, 2018 (meaning that implementation would have been required for all 2019 financial statements). Second, the new lease accounting standards, a highly complex set of standards that will affect any entity that leases real or personal property, were set to become effective for fiscal years beginning after December 15, 2020 (implementation required for all 2021 financial statements).
In June 2020, the FASB issued Accounting Standards Update (ASU) 2020-05, which defers the effective date of both standards updates for one additional year, but only for nonpublic entities that have yet to issue financial statements reflecting these updates. Therefore, such entities may elect to push back the implementation of the new revenue recognition guidance until the time comes to prepare their 2020 financial statements. Similarly, the new lease accounting standards may be pushed back until the time comes to prepare 2022 financial statements.
The FASB issued this update in recognition of the fact that, in light of the current environment, many businesses likely do not have the time or resources to study and apply these changes. That being said, it is important to note that the new revenue recognition standards will apply to revenues earned during the current year. It may be worthwhile for businesses to consider now the effects that the new standards will have on their financial statements.
Going Concern Considerations
When undergoing a financial statement audit or review, businesses are required to assess their ability to continue operating as a going concern for at least one year after those financial statements are issued. In light of the pandemic, this question takes on a greater significance, and potentially gives rise to additional reporting and disclosure requirements if the assessment is uncertain. Needless to say, business owners and key managers should always keep track of and document the financial well-being of the business, and its prospects moving forward. However, they may now find their outside accountants or auditors asking for documentation to substantiate their going concern assessment. Such documentation might include cash flow forecasts or operating budgets, minutes of board of directors meetings, and agreements related to financing obtained subsequent to the balance sheet date. Having this documentation complete and ready can go a long way toward having an audit or review run more smoothly.
We are always available to help our clients with each of the above matters and much more, so please feel free to contact us with any questions.
By Joe Bishop