The CARES Act created the Paycheck Protection Program (PPP), which provides loans to small businesses with fewer than 500 employees, or a maximum tangible net worth of $15 million as of March 27, 2020, and an average net income of $5 million or less over the previous two fiscal years. Now that many eligible companies have applied for a PPP loan, and some have started to receive their loan proceeds, we have developed the following “Best Practices” to help track and record the receipt and use of the funds.
Best Practices for PPP
- Consider opening a new bank account solely for the receipt of the SBA loan proceeds. This would be helpful for tracking the receipt and expenditure of funds but is not required.
- Track the use of the funds in the same manner as if you were an employee submitting an expense report to an employer. Have supporting schedules with the backup documentation for every dollar spent. The lender will ultimately require this when you apply for loan forgiveness. The following are eligible expenses:
- “Payroll costs,” including salary, wages, and commissions (up to a maximum annualized amount of $100,000 per employee), group health care benefits, medical or sick leave, retirement benefits, and state or local taxes assessed on the compensation of employees. Payroll costs should also include severance pay and bonuses, subject to the annualized cap, subject to further SBA guidance.
- Interest on mortgage obligations (for mortgages originated prior to February 15, 2020)
- Rent under a lease agreement (for leases in force prior to February 15, 2020)
- Utilities (electricity, gas, water, transportation, telephone and/or internet – placed in service prior to February 15, 2020)
- We recommend setting up the following general ledger accounts
- Cash SBA Funds (Current Asset)
- SBA Loan (Liability)
- Debt Forgiveness (Other Income)
- Let’s talk journal entries, here are the debits and credits of recording transactions.
- When funds are received
- Debit – Cash SBA Funds
- Credit – Liability – SBA Loan
- When expenses are paid (record as you normally would)
- Debit – Expense
- Credit – Cash Operating
- When funds are formally forgiven by the bank (see items 5 and 6 below)
- Debit – Liability – SBA Loan
- Credit – Debt Forgiveness Income
- When funds are received
Other important notes:
- Under federal law, loan forgiveness generally counts as taxable income. However, under the CARES Act, the amount forgiven will be tax-free for federal purposes (note that some states and localities could tax this income).
- At least 75% of the loan proceeds must be used for eligible payroll costs, and up to 25% can be used on the other costs referenced above.
- If there are not enough eligible expenses, you could have a remaining balance in the SBA Loan account. If this portion of the loan is not eligible to be forgiven, the remaining amount of the loan is due and payable within two years, accruing interest at 1% per annum. Interest and principal payments are deferred for a six-month period from the date of the loan, though interest will accrue during that six-month deferment period.
- The SBA is required to issue final guidelines on loan forgiveness within 30 days of March 27, 2020, the day the CARES Act was enacted. M&A will provide more information when this guidance is published.
Start considering whether or not your payroll costs and other eligible costs will be enough to obtain full loan forgiveness. The documents and information used to apply for the loan can be helpful in doing this analysis. It is important to note the payroll costs are capped at the $100,000 annualized amount per employee.
Let’s walk through an example:
For more information on PPP, accounting considerations surrounding the CARES Act, and the impacts to Title IV aid amid the COVID-19 crisis, please reach out to us.