8.18.20 | Vision 2020 – COVID-19 Update
Previously, Berdon LLP published an article on accounting for Paycheck Protection Program (PPP) loans, which can be used to pay operational costs like payroll, rent, interest, and health benefits. In this article, the focus will be the accounting treatment of expenses paid out of the PPP loan proceeds, COVID-19 related expenses, business interruption insurance recoveries and rent concessions for books maintained in accordance with the generally accepted accounting principles in the United States of America (GAAP) and income tax basis of accounting.
Expenses Paid Out of PPP Loan Proceeds
Under GAAP, operational costs paid out of the PPP loan proceeds would be recorded to their respective expense categories such as salaries and wages, payroll taxes and employee benefits, rent and interest. However, it is prudent to keep track of these expenses separately in order to aid in the calculation of the PPP loan forgiveness. As mentioned in the linked article above, if the entity elects to account for loan forgiveness using an analogy to International Accounting Standard 20, it has an option to reduce these expenses by the amount of the PPP loan forgiven.
The accounting and presentation under the tax basis of accounting would be similar to GAAP. However, as previously mentioned in the article referenced above, unless Congress acts, or the IRS reverses its published position, expenses paid with forgiven PPP loan proceeds are not deductible for tax purposes, which should be disclosed in the financial statements.
Expenses Directly or Indirectly Related to COVID-19
Many entities would incur additional costs in response to the COVID-19 pandemic such as providing Personal Protective Equipment (PPE) to employees, additional cleaning and sanitizing, additional security and increased screening of employees and visitors, just to name a few. The Financial Accounting Standards Board (FASB) eliminated the concept of extraordinary items; however, under Accounting Standards Codification (ASC) 220-20-45, the nature and financial effects of a material event or transaction that an entity considers to be unusual in nature or occurring infrequently or both must be reported as a separate component of income from continuing operations or disclosed in the notes to the financial statements.
An event or transaction is considered to be of “Unusual Nature” if it possesses a high degree of abnormality and is unrelated to, or only incidentally related to, the ordinary activities of the entity. An event or transaction is considered to be “Infrequent” if it would not reasonably be expected to recur in the foreseeable future.
Based on these definitions, most entities would consider the COVID-19 pandemic to be unusual or infrequent or both, and as such, any costs associated with it should be presented as a separate line item in the income statement, and the nature and related effects should be disclosed in the financial statements, if material.
The accounting and presentation under tax basis of accounting would be similar to GAAP.
Business Interruption Insurance Recoveries Related to COVID-19
If COVID-19 is a covered event under the entity’s business interruption insurance policy, such business interruption insurance claims should be accounted for under ASC 450-30, “Gain Contingencies”, which provides that the gain contingencies should be recognized when the gain is realized or realizable. In this case, the gain is realized or realizable when the business interruption insurance claim is settled (i.e. when a confirmation of claim proceeds is received from the insurer). Under ASC 220-30-45, the above guidance on COVID-19 related expenses would also apply to presentation and disclosure of business interruption insurance recoveries resulting from COVID-19.
The accounting and presentation under tax basis of accounting would be similar to GAAP.
Rent Concessions Resulting from COVID-19
Under ASC 840 and 842, subsequent changes to lease payments that are not stipulated in the original lease agreement are generally accounted for as lease modifications. Some lease agreements may contain explicit or implicit enforceable rights and obligations that require lease concessions if certain circumstances arise that are beyond the control of the lessors and lessees. If a lease agreement provides enforceable rights and obligations for concessions and no changes are made to that agreement, the concessions are not accounted for under the lease modification guidance. However, if concessions granted by lessors are beyond the enforceable rights and obligations in the agreement, they are accounted for in accordance with the lease modification guidance in ASC 840 or 842.
In view of the widespread lease modifications occurring as a result of the COVID-19 pandemic, applying the above guidance could be a costly and complex affair for both lessors and lessees. As a result, the FASB issued guidance that would allow the entities to make an election to account for the rent concessions resulting from the pandemic consistent with how those concessions would be accounted for under ASC 840 and 842 as if enforceable rights and obligations for those concessions existed (i.e., these concessions are not accounted for as lease modifications). This election is available for rent concessions that do not result in a substantial increase in the rights of the lessor or the obligations of the lessee. For example, this election is available for concessions that result in the total payments required by the modified lease agreement being substantially the same as or less than total payments required by the original agreement.
Some concessions provide a deferral of payments, but the total amount of the consideration is substantially the same as that required by the original lease agreement. In this situation, the FASB provided two options to account for such deferral:
- Account for the deferral as if no changes were made to the lease agreement;
- Account for the deferred payments as variable lease payments.
In June 2020, the FASB issued Accounting Standards Update (ASU) 2020-05, which deferred the effective date for adopting ASC 842 for nonpublic entities to fiscal years beginning after December 15, 2021. For a nonpublic entity that continues to account for leases under ASC 840 and makes the above election to not treat the rent concessions as lease modifications, there will be no change to the straight-line rent calculation for lessor and lessee, if the lease is considered to be an operating lease. In this situation, the rent concessions should be accounted for as follows:
If the lease is considered to be an operating lease and rent for a particular month or months is forgiven, the lessor should record rent concession (which would offset the originally recorded rent income) and credit rent receivable. Similarly, the lessee should record a negative rent expense (which would offset the originally recorded rent expense) and debit rent payable.
If the lease is considered to be an operating lease and rent for a particular month or months is deferred, under option 1 above, the lessor should continue to recognize rent income and receivable. Similarly, the lessee should continue to recognize rent expense and payable. The rent receivable or payable will be relieved when a payment is made by the lessee.
Under option 2 above, the lessor should record rent concession and credit rent receivable similar to accounting for rent forgiveness mentioned above. Similarly, the lessee should record a negative rent expense and debit rent payable. The rent income or expense will be recognized when the rent payment becomes due and payable.
The FASB further provided that an entity should disclose material concessions granted or received and the accounting effects, to enable users to understand the nature and financial effect of these rent concessions.
Under the income tax basis of accounting, rent is not straight-lined. If the rent is forgiven for a particular month or months that has been accrued (i.e. rent for previous periods), the lessee who deducted the rent may have income inclusion and the lessor may have a bad debt deduction. If the rent is forgiven for a particular month or months that has not yet accrued (i.e. rent for future periods), the lessor and lessee should not recognize rent income or expense for those month/s. If the rent for a particular month or months is deferred and not forgiven, the lessor and lessee should recognize the respective rent income or expense and the corresponding receivable or payable. However, similar to GAAP, an entity should disclose material concessions granted or received and the accounting effects in the tax basis financial statements.
For more information on this topic or any other matter related to the COVID-19 pandemic, please contact your Berdon advisor and visit Berdon’s COVID-19 Information Center.
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