Category Archives for "Accounting"

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 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

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?

The FASB Codification (321-10-35-3) states the investment 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.

How is the impairment 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.

debt covenant violations
Nov 17

Debt Covenant Violations: How to Report

By Charles Hall | Accounting

How does a debt covenant violation affect the presentation of debt on a balance sheet? If a waiver from the lender is obtained, should the violation be disclosed? In this article, I will tell you how to report debt covenant violations.

debt covenant violations

Lenders commonly include debt covenants in loan agreements. Those covenants might require certain profitability, liquidity, or cash flow ratios. A violation of such requirements can make long-term debt callable. And, by definition, the debt becomes current since it is now due within one year of the balance sheet date. 

If a debt covenant violation occurs, the debt should be classified as current unless the lender provides a waiver for more than one year from the balance sheet date. (See an exception below when there are subsequent measurement dates within one year of the balance sheet date.)

How should debt be classified if a cure occurs prior to the issuance of the financial statements? Debt is shown as noncurrent if the company is able to cure a violation subsequent to the balance sheet date but before the issuance date (or date available for issuance) of the financial statements.

Additionally, some loans provide for a grace period. If the violation is cured during the grace period, the debt will be reported as long-term. Also if the cure has not already occurred but the company demonstrates it is probable that the cure will occur within the grace period, then the debt will be reported as long-term.

Reporting Debt Covenant Violations

When a violation occurs, the main consideration in classifying long-term debt is whether the amount is due or callable within one year of the balance sheet date. If the loan is due or callable within the year after the period-end, the amount generally should be reported as current. If a debt covenant violation is timely cured within a grace period, then the debt is no longer callable and will, therefore, remain long-term. Noncurrent classification is also appropriate if the creditor provides a waiver that extends more than one year beyond the balance sheet date.

Waivers do not, however, guarantee long-term debt classification, particularly if there are other measurement dates within the year after the period-end. 

Subsequent Measurement Dates

470-10-45 of the FASB Codification provides the following guidance:

Some long-term loans require compliance with quarterly or semiannual covenants that must be met on a quarterly or semiannual basis. If a covenant violation occurs that would otherwise give the lender the right to call the debt, a lender may waive its call right arising from the current violation for a period greater than one year while retaining future covenant requirements. Unless facts and circumstances indicate otherwise, the borrower shall classify the obligation as noncurrent, unless both of the following conditions exist:

a. A covenant violation that gives the lender the right to call the debt has occurred at the balance sheet date or would have occurred absent a loan modification.
b. It is probable that the borrower will not be able to cure the default (comply with the covenant) at measurement dates that are within the next 12 months.

If both of these conditions exist, then the debt is shown as current.

Consider a scenario where a company has a covenant violation on December 31, 2019, and it obtains a waiver from the lender that lasts through January 1, 2021. If a September 30, 2020 measurement date is required by the loan agreement and it is probable that the company will not be in compliance, then the loan is classified as current on December 31, 2019, even though the waiver was obtained. Why? The new violation would make the loan callable within one year of the balance sheet date. (The prior waiver was in relation to the December 31, 2019 violation, not a subsequent violation.)

Is Disclosure Required if a Waiver is Obtained?

If a company obtains a waiver for more than one year from the balance sheet date, must the financials disclose this fact (that a waiver was obtained)?

The AICPA answers this question–in Q&A section 3200 (paragraph 17)–with the following:

The authoritative literature applicable to nonpublic entities does not address disclosure of debt covenant violations existing at the balance-sheet date that have been waived by the creditor for a stated period of time. Nevertheless, disclosure of the existing violation(s) and the waiver period should be considered* for reasons of adequate disclosure. If the covenant violation resulted from nonpayment of principal or interest on the debt, inability to maintain required financial ratios or other such financial covenants, that information may be vital to users of the financial statements even though the debt is not callable.

*Emphasis added by CPAHallTalk

Translation: It is wise to disclose the debt covenant violation and the existence of the waiver.

FASB’s Current Work on a New Debt Standard

The FASB has an ongoing project regarding the classification of debt. The FASB issued a revised Exposure Draft on September 12, 2019, Debt (Topic 470): Simplifying the Classification of Debt in a Classified Balance Sheet (Current versus Noncurrent). Comments were due October 28, 2019. It has taken FASB over two years to deliberate this topic. So you call tell the classification decision is not an easy one.

Additional Information About Auditing Debt

See my post regarding the audit of debt.

financial statement references
Nov 03

Financial Statement References

By Charles Hall | Accounting , Preparation, Compilation & Review

What financial statement references are required at the bottom of financial statement pages? Is there a difference in the references in audited statements and those in compilations or reviews? What wording should be placed at the bottom of supplementary pages? Below I answer these questions.

financial statement references

Audited Financial Statements and Supplementary Information

First, let’s look at financial statement references in audit reports.

While generally accepted accounting principles do not require financial page references to the notes, it is a common practice to do so. Here are examples:

  • See notes to the financial statements.
  • The accompanying notes are an integral part of these financial statements.
  • See accompanying notes.

Accountants can also–though not required–reference specific disclosures on a financial statement page. For example, See Note 6 (next to the Inventory line on a balance sheet). It is my preference to use general references such as See accompanying notes.

Audit standards do not require financial statement page references to the audit opinion.

Supplementary pages should not include a reference to the notes or the opinion.

Preparation, Compilation, and Review Engagements

Now, let’s discuss references in preparation, compilation, and review engagements. 

Compilation and Review Engagements

The Statements on Standards for Accounting and Review Services (SSARS) do not require a reference (on financial statement pages) to the compilation or review report; however, it is permissible to do so. What do I do? I do not refer to the accountant’s report. I include See accompanying notes at the bottom of each financial statement page (when notes are included). This reference to notes, however, is not required, even when notes are included. (Notes can be omitted in compilation engagements.)

You are not required to include a reference to the accountant’s report on the supplementary information pages. Examples include:

  • See Accountant’s Compilation Report.
  • See Independent Accountant’s Review Report.

What do I do? I include a reference to the accountant’s report on each supplementary page. But, again, it’s fine to not include a reference to the report.

Preparation of Financial Statement Engagements

Additionally, SSARS provides a nonattest option called the preparation of financial statements (AR-C 70). This option is used by the CPA to issue financial statements that are not subject to the compilation standards. No compilation report is issued. AR-C 70 requires that the accountant either state on each page that “no assurance is provided” or provide a disclaimer that precedes the financial statements. AR-C 70 does not require that the financial statement pages refer to the disclaimer (if provided), but it is permissible to do so. Such a reference might read See Accountant’s Disclaimer.

If your AR-C 70 work product has supplementary information, consider including this same reference (See Accountant’s Disclaimer) on the supplementary pages.

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