Category Archives for "Accounting"

Cash flow statement errors
Dec 31

Three Steps to Correct Cash Flow Statement Errors

By Charles Hall | Accounting

Do you struggle with creating cash flow statements? Would you like to know how to correct cash flow statement errors? Below I explain how. We'll also discuss when you can omit cash flow statements and if it’s desirable or undesirable to do so. 

Cash flows are the lifeblood of any entity. Therefore, we must ensure the correctness of cash flow statements. For many small businesses, the auditor creates and audits this statement. So we need to make sure we do so correctly. 

Cash flow statement errors

Correcting Cash Flow Errors

Cash flow statement errors can be challenging, but, in many cases, there is a simple solution.

Example from My Office

This morning a staff member came to my office and said, "Something is out on my cash flow statement, and I don't know how to fix it. It has to do with PPP loan forgiveness of $280,000." (Most people know where the problem is, but they don't know how to correct the outage.)

So I told him what I've said to many over the years. "Imagine there are three physical buckets: operating, investing, financing. Then pretend the transaction in question is the only one of the year." Next, ask, "was cash received, and if yes, how much?" And finally, "in what bucket should I place the cash?" Mentally you are placing physical dollars in the three physical buckets even though cash is received electronically and physically.

Returning to my conversation with my staff member, I asked, "did the business receive any PPP money in the current year?" He said, "no, all came in the prior year." My next question was, "how much cash belongs to any of the three buckets in the current year?" And he said, "none." 

The PPP money was a cash inflow that went into the financing bucket in the prior year. In the current year, there is no cash, only forgiveness. It's a noncash transaction. Now, think about the journal entry to recognize the loan forgiveness: the company debited the loan payable and credited a revenue account. 

So if the company uses the indirect method in its cash flow statement, it begins with net income. We know $280,000 of PPP loan forgiveness is in net income. If we pretend that's the only transaction, then net income is $280,000. And how much cash was received in the current year? Yes, $0. So we know we need to subtract $280,000 from net income to get to $0 cash flows from operations. Just below net income, we'd include a line titled "PPP loan forgiveness," subtracting the PPP amount to arrive at $0. 

There's the answer to this problem, and this example explains how to correct cash flow statement errors. 

Isolate Cash Flow Problem

The mistake most people make in solving cash flow problems is trying to think about several different transactions simultaneously. Try to focus on one transaction at a time.   

The cash flows from investing and financing are usually easy to determine. Why? Because we reflect the actual cash inflows and outflows in those sections of the cash flow statement. Problems commonly arise in the operating area because of the indirect method (starting with net income and backing into cash flow from operations). When they do, see if you can determine the net change in each of the three buckets. You can back into the net change for operations if you know the net cash change and the net changes for investing and financing: subtract the net amounts for investing and financing from the net cash change. Then you can work from there to see why cash flow from operations is out (if that is the troublesome area).

Three Steps to Correct Cash Flow Statement Errors 

From there, use these three steps to correct cash flow statement errors:

  1. Pretend the transaction is the only transaction for the year
  2. Determine how much cash was received for that transaction, if any
  3. Determine whether the amount in question is operating, investing, or financing

Spreadsheet with Balance Sheet Changes

Of course, I also recommend you place the current year balance sheet with comparative prior period numbers in an Excel spreadsheet. That way, you can see the changes in the numbers. Identify the investing and financing changes such as the investment and debt balance sheet lines. The remaining balance sheet changes are operating lines. The cash change on the spreadsheet is your net cash change on the statement. 

Cash Flow Statement Importance

We, as auditors, pay less attention to cash flows than we should. We often focus on revenues, net income, or equity, but not cash flows. Why? I believe it's our training: our trainers tell us revenues, net income, and equity are most important. But if you were buying a business or loaning money to the company, would you pay attention to cash flows? Almost certainly. What if you were valuing the business? Would you pay attention to cash flows? Yes, again.

Cash flows from operations might be the most crucial number in the financial statements since it is the entity's lifeblood. Show me a business that generates no cash flow from operations, and I'll show you a company that will go under (in most cases). 

In evaluating going concern, the company and auditors review cash flows. After all, the going concern assessment is about whether a company can meet its ongoing obligations to pay its future bills. So cash flow information is crucial for companies with continuing losses or deficit equity positions. 

Financial statements sometimes don't contain a cash flow statement. But should they?

Omitting Cash Flow Statements

Omitting cash flow

It is permissible to omit the cash flow statement in a compilation--and most accountants do. True even for financial statements created under generally accepted accounting principles. (You may not omit the statement from audited or reviewed financial statements if GAAP is in use unless the auditor's report is modified.)

And special purpose financial statements such as tax-basis don't require a cash flow statement even if audited or reviewed. 

But is it wise to omit this statement? Maybe not. All businesses, even small ones, need to know how much cash is coming in or going out by category--not just net income. And I'm sure lenders appreciate cash flow information: that's how businesses pay loans.

Of course, the decision to include or omit the statement (when it's optional) for small businesses is a cost/benefit decision. Creating the cash flow statement requires an increase in the fee for compilations, for example. And the owners may not desire to pay the additional amount. 

Businesses usually don't need cash flow information for interim compilations, such as monthly financial statements. But the company owners or management might find value in annual cash flow statements. 

Cash Flow Information

Use the three steps listed above to hone in on cash flow statement outages. Hopefully, doing so will aid you in making corrections. And consider including cash flow statements in all financial statements, if desired by your client.    

GASB 87 Lease Accounting
Jul 15

GASB 87 Lease Accounting

By Charles Hall | Accounting , Local Governments

Are you looking for GASB 87 lease accounting information? Are you a government that leases assets? Then you're in the right place. Below I provide information about lease terms, discount rates, accounting entries, and disclosure requirements.

GASB 87 Lease Accounting

Removal of Bright-Line Criteria

Historically governments have followed the guidance in FASB 13, Accounting for Leases. Lease classifications (i.e., operating or capital) were based on bright-line criteria such as whether the government leased an asset for more than 75% of its economic life. 

GASB 87, Leases, removes the bright-line criteria and calls for more judgment. (The words reasonably certain appears thirty-nine times in GASB 87.)

The new lease standard provides for various accounting alternatives. Let's see what they are.

Three Potential Accounting Alternatives

Regarding leases, there are now three accounting alternatives:

  1. Short-term leases
  2. Contracts that transfer ownership
  3. Contracts that do not transfer ownership

Before we dive deeper, here are three quick points about these alternatives:

First, know that short-term leases do not create a lease liability.

Second, understand that contracts that transfer ownership are a financed sale.

Third, know that contracts that do not transfer ownership create a lease liability. This third category is a catchall for arrangements that don't qualify for short-term lease treatment and don't transfer ownership.

Now, let's see how GASB defines a lease.

Definition of a Lease

GASB defines a lease this way:

A lease is defined as a contract that conveys control of the right to use another entity’s nonfinancial asset (the underlying asset) as specified in the contract for a period of time in an exchange or exchange-like transaction.

There are five points to this definition:

First, the lease must be a contract. 

Second, the contract must provide control of the right to use.

Third, this control is in relation to a nonfinancial asset.

Fourth, the control of the nonfinancial asset must be for a period of time.

And finally, the lease is an exchange or exchange-like transaction.

I think the terms contract, period of time, and exchange are easily understood. But the terms control and nonfinancial assets might cause some confusion. So let's clarify those.

Control

A government controls an asset if it has the right to the present service capacity and the right to determine the nature and manner of use of the asset.

In other words, the government must have the right to the benefits generated from the asset. A city can drive a leased police car. That is the benefit, the present service capacity.

Additionally, Nature and manner address whether the government controls the use of the asset. A city police officer can, for example, drive a leased police car at 3:00 a.m. And she can drive it as far as she likes. The police department determines the nature and manner of use.

Nonfinancial Asset

And what is a nonfinancial asset? It's generally anything that is not a financial asset (e.g., cash, receivable). Examples of nonfinancial assets include buildings, land, vehicles, and equipment. There are exceptions, however. 

GASB 87 Scope Exclusions

GASB 87 does not apply to:

  • Leases of intangible assets (e.g., rights to explore for oil and gas)
  • Leased biological assets (e.g., timber)
  • Inventory that is leased
  • Service concession arrangements
  • Leases in which the underlying asset is financed with outstanding conduit debt (unless the underlying asset and the conduit debt are reported by the lessor)
  • Supply contracts (e.g., power purchase agreements)

Now let's see how to determine the lease term.

Lease Term

Prior to GASB 87, the minimum lease payments determined the lease term. Not so any more. In some cases, GASB 87 provides for a more subjective determination of a lease's term, one based on what is reasonably certain.

Lease Options

Under GASB 87, lease terms are not just the noncancelable portion of the agreement. Governments add the following to the noncancelable period:

  • Periods covered by a lessee’s option to extend the lease if it is reasonably certain, based on all relevant factors, that the lessee will exercise that option 
  • Periods covered by a lessee’s option to terminate the lease if it is reasonably certain, based on all relevant factors, that the lessee will not exercise that option 
  • Periods covered by a lessor’s option to extend the lease if it is reasonably certain, based on all relevant factors, that the lessor will exercise that option  
  • Periods covered by a lessor’s option to terminate the lease if it is reasonably certain, based on all relevant factors, that the lessor will not exercise that option.
Reasonably Certain Factors

In determining what reasonably certain is, the government considers factors such as the economic impact of not exercising an option or how the government has acted in the past.

Once the lease term decision is made, document your basis for doing so. Why? So there is a record of the decision. (Your auditors may want to see this. Additionally, the record provides valuable information regarding future lease term decisions.)

Fiscal Funding Clauses Affect on Term

Additionally, you may be wondering if fiscal funding clauses affect leases. (Fiscal funding clauses allow a government to cancel a lease if the government does not appropriate funds for the payments.) If a government is reasonably expected to exercise such a provision, then this factor can impact the lease term. Personally, however, I've never seen a government terminate a lease through such a provision. Fiscal funding clauses will usually not affect lease terms.

So, should governments ever reassess the term period?

Reassessment of Term

Government will generally not reassess the lease term decision. 

Nevertheless, reassessment will occur in some cases. Consider this example. The government enters into a fifteen-year lease with a five-year lease extension. The government believes that it will not exercise the five-year extension. But then in year fifteen, it does so. Now the government binds itself for another five years. Therefore, the lease is extended. And the additional five years is added to the lease term. 

Now that you know about lease terms, you may be wondering about short-term leases. How does a government account for those?

Short-Term Leases

Treat leases with a maximum possible term of twelve months or less as short-term leases. And do not capitalize such leases. 

One word of caution: if there are renewal options, include those in making the short-term lease classification decision, regardless of probability. If, for example, the lease is for twelve months with an option to renew for another six months, then the lease is not short-term. Even if the government believes it will not exercise the option.

So, how do you record short-term lease payments? As expenses.

Contract that Transfers Ownership

If an agreement transfers ownership of the asset to the lessee by the end of the contract, then the contract is a financed purchase. For the lessee, the government records the purchased asset (not an intangible) and the related debt (not a lease liability).

So, what about a lease agreement with a bargain purchase option? Should it be treated as financed purchase? The answer is no. The presence of a bargain purchase option in a lease contract is not the same as a provision that transfers ownership of the underlying asset.

Multiple Components of a Lease Contract

If an agreement has lease and non-lease components, split the transaction. 

A government might, for example, lease floors four and five of a ten-story building. In doing so, it is required to pay for common area maintenance. Split this transaction into a lease and a maintenance contract. Record the lease exclusive of the maintenance payments. If, however, it is not practicable to determine the separate price allocation, the government should account for the transaction as a single lease.

If a lease involves multiple underlying assets (say a police car and a water tank), the government should account for each as a separate lease component. 

Lessee Accounting

If the government is leasing an asset, then it will use the following guidance. (An exception exists if the lease is short-term as explained above.)

GASB 87 Lessee accounting

Initial Recognition

At commencement, the government recognizes an (1) intangible right-to-use asset and (2) a lease liability. 

So the government does not recognize the asset itself (e.g., tractor), but the right to use the asset. This is an intangible asset.

Now let's see how to compute the lease asset.

1. Lease Asset 

So. what goes in the lease asset calculation?

The government should include:

  • Initial lease liability (see below)
  • Payments made to lessor at or before commencement less any lease incentives received from the lessor at or before the commencement of the lease term
  • Initial direct costs that are ancillary charges necessary to place the lease asset into service

So what costs are not included in the intangible asset? Governments should exclude any debt issuance costs.

Notice that the lease asset can be greater than the lease liability. The lease asset starts with the lease liability and increases if, for example, the government makes a payment to the lessor prior to commencement of the lease term.

In governmental funds (e.g., general fund), the initial accounting entry is a debit to capital outlay and a credit to other financing sources. In full accrual funds (e.g., enterprise fund), the initial entry is a debit to the intangible lease asset and a credit to the lease liability.

So, how should the lease asset be amortized?

Lease Asset Amortization

Amortize the lease asset in a systematic and rational manner over the shorter of the lease term or the asset's useful life. Usually this will be straight-line amortization.

And what are the journal entries for recording the lease asset?

Lease Asset Accounting

The government records the lease asset and then amortizes it using an entry such as the following (for full-accrual funds; e.g., water and sewer fund):

Account
Amortization Expense
Accumulated Amortization - Right-of-Use Asset
Debit
XX


Credit


XX

GASB 87 says to report the amortization as an outflow of resources (e.g., amortization expense). The amortization expense can, for financial reporting purposes, be combined with the depreciation expense of other capital assets. 

Modified accrual funds (e.g., general fund) will not record an amortization entry. Why? The asset does not appear on the balance sheet.

2. Lease Liability 

How does a government compute the lease liability?

Simply put, the lease liability is the present value of everything you think you're going to pay. Prior to GASB 87, governments used the present value of minimum lease payments. Now governments include payments that are reasonably certain. (See information above regarding what is reasonably certain.)

The computation is made up of the present value of:

  • Fixed payments
  • Variable payments that depend on an index or a rate (e.g., consumer price index) measured using the index or rate as of the commencement of the lease
  • Variable payments that are fixed in substance
  • Amounts that are reasonably certain of being required to be paid by the lessee under residual value guarantees
  • The exercise price of a purchase option if it is reasonably certain that the lessee will exercise that option
  • Payments for penalties for terminating the lease
  • Any lease incentives receivable from the lessor
  • Any other payments that are reasonably certain of being required based on an assessment of all relevant factors
Variable Payments Based on Future Performance

Governments will not include payments based on future performance or usage in the lease liability. Expense such payments in the period incurred. 

For example, if a government leases a vehicle with a provision for 12,000 miles annually but the car is driven 15,000 miles, expense the payment for the additional mileage as incurred.

So, where does the discount rate come from?

Discount Rate

Use the rate charged by the lessor if specified in the agreement. If not specified, use the incremental borrowing rate for the government. This is the estimated rate the government would pay if, during the life of the lease, it borrowed the funds for those lease payments.

Lease Liability Accounting

Once the initial lease is recorded as a liability, the government will begin making periodic payments to the lessor. The effective interest rate method will be used. Record the payments as follows (for full-accrual funds; e.g., water and sewer fund):

Account
Lease liability
Interest Expense

Cash

Debit
XX

XX

Credit


XX

Post the payments to principal and interest expenditures in modified accrual accounting funds (e.g., general fund).

GASB 87 Disclosures

The following disclosures are required for lessees:

  • A general description of its leasing arrangements 
  • The total amount of lease assets, and the related accumulated amortization, disclosed separately from other capital assets
  • The amount of lease assets by major classes of underlying assets, disclosed separately from other capital assets
  • The amount of outflows of resources recognized in the reporting period for variable payments not previously included in the measurement of the lease liability
  • The amount of outflows of resources recognized in the reporting period for other payments (e.g., termination penalties) not previously included in the measurement of the lease liability
  • Principal and interest requirements to maturity, presented separately, for the lease liability for each of the five subsequent fiscal years and in five-year increments thereafter
  • Commitments under leases before the commencement of the lease term
  • The components of any loss associated with an impairment 

Transition

Apply GASB 87 retroactively, if practicable, for all periods presented. Use the facts and circumstances existing at the beginning of the implementation period to record the leases.

The notes to the financial statements should disclose the nature of the restatement and its effect. 

GASB 87 says that the provisions of this statement need not be applied to immaterial items.

GASB 87 Effective Date

The effective date of GASB 87 is for reporting periods beginning after December 15, 2019. On May 8, 2020, the Governmental Accounting Standards Board (GASB) issued Statement No. 95Postponement of the Effective Dates of Certain Authoritative Guidance. This standard postponed GASB 87 by eighteen months.

So GASB 87 is effective for fiscal year-ends of June 30, 2022 (years starting after June 15, 2021) and calendar year-ends of December 31, 2022 (again, years starting after June 15, 2021). 

Cash overdraft
Jan 21

Cash Overdrafts: Negative Cash Accounting

By Charles Hall | Accounting

How should you account for cash overdrafts (also called negative cash balances) on a balance sheet and in a cash flow statement? There are different ways to do so. I explain those accounting methods below. 

It is year-end and your audit client has three bank accounts at the same bank. Two of the accounts have positive balances (the first with $50,000 and the second with $200,000). The third account has a negative cash balance of $400,000. Since a net overdraft of $150,000 exists, how should we present cash in the financial statements?

Cash overdraft

Cash Overdraft in Balance Sheet

In the balance sheet, show the negative cash balance as Cash Overdraft in the current liabilities. Or you can also include the amount in accounts payable.

If you are netting the three bank accounts, consider using the Cash Overdraft option. If you bury the overdraft in accounts payable, the financial statement reader may think, “there is a mistake, where is cash?” Using Cash Overdraft communicates more clearly. (The right of offset must exist in order to net bank accounts. The right of offset commonly exists for multiple bank accounts with one bank.)

Some companies have multiple bank accounts with multiple banking institutions. In such cases, the net balance of one bank might be positive and the net balance of the second bank might be negative. Then the company would reflect the positive balance as cash and the negative cash balance (of the second bank) as an overdraft.  

Suppose a company has bank accounts with two different banks and the net balance of the first bank is $1,350,000 and the net balance of the second bank is an overdraft of $5,000. Then show cash as one amount on the balance sheet ($1,345,000). The $5,000 is not material.

Cash Overdraft in Cash Flow Statement

Some companies do not include overdrafts in the definition of cash; instead, they include it in accounts payable. Consequently, the company treats the overdraft as an operating activity (change in accounts payable). So, the company includes the negative cash as a change in a liability in the operating section of the cash flow statement. (Some accountants treat overdrafts as a financing activity, but they clear quickly. Therefore, an operating activity classification is more appropriate.)

Alternatively, include the negative cash in the definition of cash (rather than in accounts payable). In doing so, you combine the cash overdraft with other cash (that with positive balances) in the cash flow statement. The beginning and ending cash–in the cash flow statement–should include the negative cash amounts.

FASB ASC 230-10-45-4 requires that the total amounts of cash and cash equivalents in the cash flow statement agree with similarly titled line items or subtotals in the balance sheet. If negative cash is included in the definition of cash, the cash captions in the statement of cash flows should be revised accordingly (e.g., Cash (Cash Overdraft) at end of year).

If the balance sheet contains a positive cash balance in assets and a cash overdraft in liabilities, provide a reconciliation at the bottom of the cash flow statement (or in a disclosure). In the reconciliation, show the composition of the balance–one line titled Cash, one line titled Cash Overdraft, and a total line titled Total Cash (Cash Overdraft)

One Other Consideration

If checks are created but not released by year-end, reverse the payment. Merely printing checks does not relieve payables. Payables are relieved when payment is made (checks are printed and mailed, or electronic payments are processed).

See my post about auditing cash.

PPP and EDIL Accounting Solutions
Jul 03

PPP and EIDL Accounting Solutions

By Charles Hall | Accounting

Are you wondering about PPP and EIDL accounting? Well, you've come to the right place. Below I provide you with accounting alternatives for these COVID-19 related funds. 

PPP and EDIL Accounting Solutions

PPP and EDIL Accounting Confusion

At the stroke of midnight December 31, 2019, I toasted the new year and dreamed of better days. Little did I know that COVID-19 would rattle us all. Yes, I was aware of its existence. But I thought it’s was just another scare. Like SARS and Ebola. Nothing to concern me. I see differently now.

Congress, to its credit, provided lifelines to businesses and nonprofits around the country. Some breathing room, if you will. Money to tide them over. But with the money came surprising challenges, even for accountants.

As the Paycheck Protection Program (PPP) and Economic Injury Disaster Loans (EIDL) were made, few were thinking about accounting. They just wanted the money. But once the funds arrived, accountants began to scratch their heads. What is this? A loan, a grant, or something else? So they checked the FASB Codification. But there was no direct guidance for some situations such as federal loans to private businesses that would later be forgiven. And so, the accounting became challenging.

If there is no direct FASB guidance, what is to be done? ASC 105-10-05-2 says “first consider accounting principles for similar transactions or events within a source of authoritative GAAP for that entity and then consider nonauthoritative guidance from other sources.” So, we look for similar accounting guidance. That might be in the FASB Codification or in the international standards. 

Below you’ll see three PPP loan scenarios and three different accounting alternatives. Then you'll see a summary of the EIDL programs and related accounting guidance. Once done, you'll have a much greater understanding of PPP and EIDL accounting.

PPP Loan Accounting

First, I’ll start with the most common loan scenario: PPP loans are received and are expected to be forgiven.  

1. PPP Loans Expected to be Forgiven

When loans are expected to be forgiven, consider three different possible accounting approaches. (I am providing the options I like best.)

The first accounting alternative we’ll consider is ASC 958-605. 

ASC 958-605, Revenue Recognition

A small business or nonprofit receives the PPP loan. Those funds are placed in the entity’s checking account, increasing cash. And the entity records a liability, a refundable advance. As the entity substantially meets the conditions of the agreement, contribution revenue is recognized. The revenue is usually shown separately and can be titled “Forgiveness of PPP Loan” or “PPP Grant.” The contribution revenue is recorded as the entity incurs qualifying expenses. At the same time, the refundable advance (liability) decreases by a like amount. 

So what guidance supports this approach? ASC 958-605, Revenue Recognition. (See my article ASU 2018-08: Nonprofit Revenue Recognition.) While 958-605 is a not-for-profit section, FASB says businesses can “analogize.” And using this approach, the entity treats the loan as a conditional contribution to the business or nonprofit.

The revenue recognition section applies to “cancellations of liabilities,” according to ASC 958-605-15-5. And some grants are recognized “to the extent that the expenses are incurred,” per ASC 958-605-55-21. So, the entity will consider the SBA PPP loan program conditions and determine if they are “substantially met.” If they are, then contribution revenue is recognized. And, again, this can be done as the expenses are incurred.

Now, let’s look at a second accounting alternative, ASC 470, Debt

ASC 470, Debt

A business or a nonprofit can record the PPP funds as a loan using ASC 470. The entity would not impute interest at market rate. (ASC See 835-30-15-3e.) And the loan remains as a liability until it is paid or until the entity is “legally released” from the obligation. (See ASC 405-20-40-1b.) Forgiven amounts are recorded as a gain on extinguishment. 

Next, we’ll examine a third accounting alternative, IAS 20.

IAS 20, Accounting for Government Grants and Disclosure of Government Assistance

A business could use of IAS 20, Accounting for Government Grants and Disclosure of Government Assistance. This method calls for recording the PPP loan as deferred income (a liability). Then grant revenue is recognized when there is “reasonable assurance” (similar to “probable” in U.S. GAAP) that conditions will be met and the assistance will be received. The revenue is recorded “on a systematic basis over the periods in which the entity recognizes as expenses the related costs.” One significant difference in this approach is the earnings can be shown as a reduction of the related expenses or as other income. 

Now let’s move to the second scenario: PPP loans are expected to be partially forgiven. 

2. PPP Loans Expected to Be Partially Forgiven

Larger PPP loans will be subject to greater scrutiny. Treasury Secretary Mnuchin stated that all PPP loans greater than $2 million will be audited by the SBA prior to forgiveness. If forgiveness is questionable, ASC 470 may be preferable. Why? It’s a more conservative posture. This model is dependent upon the business or nonprofit being “legally released” by the SBA. If the entity is legally released from the loan, then a gain on extinguishment is recognized and the loan balance is reduced. Amounts not forgiven remain on the books until paid.

Still, ASC 958-605 and IAS 20 are available for businesses. And ASC 958-605 is available for nonprofits. But ASC 470 may be the better model when partial forgiveness is expected. Again, the uncertainty about the forgiveness amount may merit the more conservative approach in ASC 470.

And now the last scenario: PPP loans are not expected to be forgiven. 

3. PPP Loans are not Expected to Be Forgiven

When a business or nonprofit expects to repay the PPP loan or expects that the loan will not be forgiven, record the funds as a loan in accordance with ASC 470. Reduce the loan as it is paid. Finally, include the normal financial statement debt disclosures.

Which Policy is Best?

As you can tell from the above information, the accounting choice depends on the entity’s preferences and on some factors beyond the entity’s control. Regardless of the approach, the entity should clearly disclose the accounting policy. Clarity is key, especially given the lack of direct FASB guidance in some situations. 

Now, let's consider the effects of PPP funds on Single Audits, if any.

PPP Loans and Single Audit

Are PPP funds subject to the Uniform Guidance single audit requirements? The answer is no. The Small Business Administration (SBA) has informed the AICPA that PPP loans made to nonprofits are not subject to single audit requirements.

Next, let’s shift gears and discuss Economic Injury Disaster Loans (EIDL). 

EIDL Accounting

EIDL Accounting

Economic Injury Disaster Loan Accounting

Some small businesses have received funds under the Economic Injury Disaster Loan Emergency Advance program. The SBA website states that small business owners can apply for an EIDL advance of up to $10,000. The site states “This loan advance will not have to be repaid.” Therefore, these funds can be recorded as grant revenue or other income. 

Additionally, some small businesses and nonprofits have received loan funds under the COVID-19 Economic Injury Disaster Loans program. Such funds are working capital loans and should be recorded accordingly (as debt). The term of the loan can be up to thirty years. And loan amounts can be up to $2 million.  

Economic Injury Disaster Loans and Single Audit

The Economic Injury Disaster Loan Emergency Advance program is not subject to single audit requirements. The CFDA number for this program is 59.072 according to the Governmental Audit Quality Center of the AICPA

The COVID-19 Economic Injury Disaster Loans program, however, is considered a direct loan (that is, payments are made by a federal agency). They are, therefore, subject to single audit requirements. (The SBA, a federal agency, disburses EIDL funds directly to recipients. Banks disburse PPP loans.) The CFDA number for this program is 59.008 according to the Governmental Audit Quality Center of the AICPA

2020 New Year's Eve

Well, I’m hoping that the coming New Year’s Eve will usher in a better year. There is, however, one silver lining in the current one: COVID-19 has given CPAs a great opportunity to aid their clients in a time of need. I hope this information about PPP and EIDL accounting is useful to you as you continue to assist them. 

ASU 2016-01
Feb 14

ASU 2016-01 – Accounting for Equity Securities

By Charles Hall | Accounting

Are you aware of the coming changes in accounting for equity securities with ASU 2016-01?

In the past, FASB required that changes in the fair value of available-for-sale equity investments be parked in accumulated other comprehensive income (an equity account) until realized--that is, until the equity investment was sold. In other words, the unrealized gains and losses of equity investments were not recognized in net income until the investments were sold. This is about to change.

Changes in equity investments will generally be reflected in net income as they occur--even before the equity investments are sold. 

The guidance for classifying and measuring investments in debt securities is unchanged.

ASU 2016-01

Changes in Accounting for Equity Securities - ASU 2016-01

First, ASU 2016-01 removes the current guidance regarding classification of equity securities into different categories (i.e., trading or available-for-sale)

Secondly, the new standard requires that equity investments  generally be measured at fair value with changes in fair value recognized in net income (see exceptions below). Companies will no longer recognize changes in the value of available-for-sale equity investments in other comprehensive income (as we have in the past).

Exceptions

ASU 2016-01 generally requires that equity investments be measured at fair value with changes in fair value recognized in net income. There are some equity investments that are not treated in this manner such as equity method investments and those that result in consolidation of the investee.

Is the accounting for equity investments without readily determinable fair values different? It can be.

Equity Investments without Readily Determinable Fair Values

An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment.  This election should be documented at the time of adoption (for existing securities) or at the time of purchase for securities acquired subsequent to the date of adoption. The alternative can be elected on an investment-by-investment basis.

Why make the election to measure equity investments that do not have readily determinable fair values at cost minus impairment? Because of the difficulty of determining the fair value of such investments. This election will probably be used by entities that previously carried investments at cost. 

ASU 2016-01 requires that equity investments without readily determinable fair values undergo a one-step qualitative assessment to identify impairment (similar to what we do with long-lived assets and goodwill). 

At each reporting period, an entity that holds an equity security shall make a qualitative assessment considering impairment indicators to evaluate whether the investment is impaired. Impairment indicators that an entity considers include, but are not limited to, the following:

  • A significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee
  • A significant adverse change in the regulatory, economic, or technological environment of the investee
  • A significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates
  • A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the carrying amount of that investment
  • Factors that raise significant concerns about the investee’s ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants.

So what happens if there is an impairment?

321-10-35-3 of the FASB Codification states, "An equity security without a readily determinable fair value that does not qualify for the practical expedient to estimate fair value in accordance with paragraph 820-10-35-59...shall be written down to its fair value if a qualitative assessment indicates that the investment is impaired and the fair value of the investment is less than its carrying value." (820-10-35-59 deals with measuring the fair value of investments in certain entities that calculate net asset value per share.)

How is the change in value to be reflected in the income statement?

If an equity security without a readily determinable fair value is impaired, the entity should include the impairment loss in net income equal to the difference between the fair value of the investment and its carrying amount.

Presentation of Financial Instruments

Entities are to present their financial assets and liabilities separately in the balance sheet or in the notes to the financial statements. This disaggregated information is to be presented by:

  • Measurement category (i.e., cost, fair value-net income, and fair value-OCI
  • Form of financial asset (i.e., securities or loans and receivables)

So, financial assets measured at fair value through net income are to be presented separately from assets measured at fair value through other comprehensive income.

Debt Securities Accounting 

U.S. GAAP for classification and measurement of debt securities remains the same. Show unrealized holding gains and losses on available-for-sale debt securities in other comprehensive income.

Disclosure Eliminated - Financial Instruments Measured at Amortized Cost

ASU 2016-01 removes a prior disclosure requirement. In the past, entities disclosed the fair value of financial instruments measured at amortized cost. Examples include notes receivables, notes payable, and debt securities. ASU 2016-01 removes this disclosure requirement for entities that are not public business entities

Effective Dates for ASU 2016-01

ASU 2016-01 says the following concerning effective dates:

For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.

For all other entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.

Also, the provision exempting nonpublic entities from the requirement to disclose fair values of financial instruments can be early adopted.

Initial Accounting for ASU 2016-01

An entity should apply the ASU 2016-01 amendments by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption.

The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption of ASU 2016-01.

1 2 3 4
>