Accounting for the Payroll Protection Program
Companies are quite creative when it comes to accounting for unusual items such as the Payroll Protection Program (“PPP”). By the time we all arrive at year end accounting and related adjustments, many lenders will have already made decisions based on interim inhouse financial statements.
What to Watch For?
Let’s consider a company that receives $1.8 million under the payroll protection program. And, let’s assume the company’s performance remains unchanged from the prior year. In the first accounting option, the company reports its revenue and expenses in the same manner as the prior year, and records the PPP loan forgiveness as an extraordinary item. In the second accounting option, the company reports its revenue in the same manner as the prior year, and reduces its expenses for payroll, rent and utilities by the amount of funds attributed to the calculation for each category.
While at the end of the year, outside accountants may require all companies to report the PPP in essentially the same manner, the creativity for inhouse accounting statements could result in misleading information being presented to and reviewed by a lender.
The table shows a sample company, its prior year performance and its current year performance under two reporting options.
Using option 1, the company reports an EBITDA of $4.5 million, consistent with prior year performance. Using option 2, the company reports improved performance with an EBITDA of $6.3 million.
A lending decision made during the year when the second option is used, could be based on perceived improved performance which did not actually occur. While the company did receive cash from the PPP to offset expenses, performance did not improve and future results would be more in line with the prior year’s performance.
This example is a clean example, which would be more easily identified. In reality, the accounting will not be that clear. Changes in payroll could be impacted by short term layoffs, furloughs, reduced sales and related direct costs. Changes in rent and utilities could be impacted by moving locations, temporary shut downs, or other matters.
What should a lender or reviewer of financial statements watch for?
Asking questions is going to be very important. Here is a short list of questions to ask:
-How much did the company receive under the PPP?
-How was this amount allocated between:
Other payroll related expenses
-How much of the loan has been or is expected to be forgiven?
-How was the forgiven amount allocated between these same expenses?
-What were the debits and credits used for accounting for the PPP loan?
-What were the debits and credits used for accounting for the PPP loan forgiveness?
If anything you ask and have answered is not clear, ask for further clarifications.
It is not that a borrower will intentionally mislead a lender, but accounting is not black and white. As a user of the financial information, you need to be sure you understand how the PPP program is impacting financial performance.
Are there additional areas to ask about?
Understanding the impact of Covid-19 on sales and expenses is key. Encourage your borrowers to be prepared to discuss sales and expenses with you going forward. When possible, require reporting in various categories such as:
-Reduced sales by customer. Prior year run rate versus current year run rate.
-Expected sales recovery by customers.
-Adjusted product lines – new products added, products removed.
Describe layoffs, furloughs, ongoing employment by division, cost of goods sold, operating expenses, department, etc.
Describe any changes to benefits.
How are future payroll expenses expected to act?
Were all rents paid?
What is outstanding to landlords?
Did landlords forgive any rents?
Were all leases paid?
What is outstanding or past due to leaseholders?
Have any lease payments been forgiven?
How has your business expense been impacted?
What happened to transportation expenses?
Were any expenses increased?
How did you deal with the work at home and shelter in place impacts?
Lenders and investors are going to hear the Covid-19 excuse for the foreseeable future. We all know there are positive and negative impacts to businesses as a result of the virus and none of us should make light of the seriousness of the virus and the impact on business.
But, as readers of financial statements, we all need to make sure we don’t hear what we want to hear or make excuses for performance that are unfounded. Ask questions.
Focus Management Group is available to assist in developing tracking mechanisms with businesses that can help clarify performance impacts and working capital impacts. Call us to discuss what you are seeing and the questions you have.