Congress passed programs to provide financial assistance to companies during the COVID-19 pandemic, including the employee retention credit (ERC). The ERC provides eligible employers with credits per employee based on qualified wages and health insurance benefits paid.
Not-for-profits account for government grants under FASB Accounting Standards Codification (ASC) Subtopic 958-605. For-profit entities do not have specific guidance in U.S. GAAP to apply to account for ERCs. Instead, they can look to one of the following standards for accounting for grants, by analogy:
- ASC Subtopic 958-605, Not-For-Profit Entities — Revenue Recognition,
- IAS 20, Accounting for Government Grants and Disclosure of Government Assistance, or
- ASC Subtopic 450-30, Contingencies: Gain Contingencies.
There are differences in timing of recognition and financial statement presentation.
"Companies have questions about which model to apply and whether their ERC accounting policy must be consistent with accounting policies they applied in accounting for Paycheck Protection Program (PPP) loans," said Robert Durak, CPA, CGMA, the AICPA's director of Private Company Financial Reporting and the Center for Plain English Accounting (CPEA). "This is an area where professional judgment must be applied. Companies who have an accounting policy for government assistance previously received should probably be consistent with that policy, but for companies that do not have an accounting policy, these programs are dissimilar enough to justify different accounting policy elections."
In December 2021, the CPEA issued Employee Retention Credit (ERC): Financial Reporting & Disclosure Examples. The paper includes background on the ERC and practical guidance for applying the two accounting models and the financial statement presentation and disclosures.
Background on the ERC
ERCs were established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, in March 2020 to help businesses retain employees. Eligible businesses, both for-profit and not-for-profit, that experienced a full or partial government-ordered suspension of operations or a "significant" decline in gross receipts in any quarter (more than 50% decrease in 2020 from 2019, and more than 20% in 2021) could receive a quarterly refundable payroll tax credit. ERCs are claimed primarily on federal payroll tax forms.
The Infrastructure Investment and Jobs Act, P.L. 117-58, which was signed late in 2021, retroactively cut short the timing of the credit to periods ending Sept. 30, 2021, not Dec. 31, 2021, as originally provided.
Accounting for ERCs
"Employee retention credits are payroll tax credits, not income tax credits," said Melisa Galasso, CPA, CGMA, founder and CEO of CPE provider Galasso Learning Solutions. "The FASB [Accounting Standards] Codification has extensive guidance for accounting for income taxes in ASC 740, but it does not have similar guidance for payroll taxes." In addition, Galasso noted that because ERCs are refunds of payroll taxes, not loans from the government, ASC Topic 470, Debt, does not apply as it did for certain PPP loans.
"In determining which accounting model to apply, including the requirements for gross versus net presentation, for-profit entities may consider the timing of recognition, what financial ratios are important to them, and whether they want to present a grant income line," Galasso said.
When applying the revenue recognition model under Subtopic 958-605, ERCs are treated like conditional contributions. Companies must have "substantially met" the program's eligibility conditions to record revenue, and no amounts would be recorded until all criteria are evaluated and substantially met.
"ASC 958-605, as updated by [FASB Accounting Standards Update (ASU) No.] 2018-08, provides the basics of conditional contribution accounting, which include both barriers that must be overcome and a right of return to the contributor or right of release from the promisor," Galasso said. "For the ERC, the concept of a barrier includes the measurable performance-related barriers of gross receipts decreases to qualify for the credit and the qualifying payroll expense amounts." She notes that each quarter, as the requirements are met, the revenue and related accounts receivable are recorded.
"Companies must apply judgment about whether they have met eligibility requirements and overcome barriers to revenue recognition," Durak said.
Subtopic 958-605 requires that gross revenue be recorded and does not permit any netting of revenue against related expenses.
Not-for-profit entities are not eligible to apply the IAS 20 model because they are subject to the guidance for accounting for grants in Subtopic 958-605. When applying IAS 20, for-profit entities do not recognize the ERC until the "reasonable assurance" threshold is met related to ERC conditions and receiving the credit. "Reasonable assurance" is similar to "probable" under U.S. GAAP and is less difficult to satisfy than "substantially met" in Subtopic 958-605.
IAS 20 permits the recording and presentation of either the gross amount as other income or netting the credit against related payroll expense. Each quarter when a company is reasonably assured it meets the recognition criteria, it records a receivable and either other income or net expense. "In practice, the AICPA has seen more public companies applying this model are presenting the credit net," Durak said.
"Both not-for-profit and for-profit entities applying FASB ASC 958-605 should follow the disclosure requirements in that standard," Durak said. These include details of the ERC program and amounts, the accounting method applied, and where the amounts are included in the financial statements. Entitles applying the IAS 20 model must provide details of their accounting policy and financial statement presentation, along with any contingencies related to amounts recognized.
FASB ASU No. 2021-10, Government Assistance (Topic 832): Disclosures by Business Entities About Government Assistance, was issued in November 2021. It is effective for financial statements issued for annual periods beginning after Dec. 15, 2021, but early application is permitted. Once adopted, it provides the required disclosures about receipt of government assistance for business entities but does not apply to not-for-profits. The disclosure requirements of ASU 2021-10 are similar to those in IAS 20, Durak said.
One complicating factor in accounting for ERCs is timing of applying for and receiving the credit. Companies may record receivables for credits they are eligible for but have not yet received, or liabilities for credits received in advance of when the related payroll costs are incurred.
"A significant issue is that companies didn't think they were eligible for ERCs in 2020 if they had PPP loans, but this was subsequently clarified by the CAA [Consolidated Appropriations Act, 2021, P.L. 116-260], which meant companies had to retrospectively ask for funds for 2020 in 2021," Galasso said. "This was a whole different calendar year, and for some companies it was also a different fiscal year, which raised the question of how to account for the credit and whether to apply grant accounting under ASC 958-605."
The CPEA paper provides a view about retrospectively applying the ERC credits received in subsequent periods. This approach is analogous to a loss recovery model under U.S. GAAP. "This is CPEA's opinion, but others might have a different approach," Durak said. The CPEA's view, which applies only to 2020 periods, is that the recovery of amounts previously paid and expensed to an employee (with no expectation of recovery at the time) is best analogized to a loss recovery.
The CPEA wrote that:
"Prevailing practice in financial reporting for a loss recovery is to use guidance in FASB ASC 410, Asset Retirement and Environmental Obligations, specifically FASB ASC 410-30-35-8, which indicates that a claim for recovery should be recognized only when the claim is probable as it is defined in FASB ASC 450, Contingencies, more specifically in FASB ASC 450-20-25-1. Accordingly, if an entity feels that it is probable that it is entitled to recover amounts previously paid in 2020 via the ERC, then the entity should recognize a receivable for amounts to be received for the amounts paid in 2020 to be recovered via the ERC. Any uncertainties related to qualifying for the ERC should be assessed as to whether the claim for the credit is probable."
In April 2022, the CPEA issued a special report, Noncompliance With ERC Eligibility Requirements: Accounting & Auditing Considerations. "There were issues for companies who applied for and received ERCs but, in their auditors' judgment, did not meet the eligibility criteria because they inadvertently did not comply with the regulations," Durak said. "For the auditors, it is similar to evaluating a misstatement in any other account, along with considering potential noncompliance with regulations, and they have to consider whether companies should record a liability until the matter is resolved."
Because of the lack of specific U.S. GAAP guidance for accounting for ERCs for for-profit entities and the complex timing issues, there is diversity in practice and uncertainty for many financial statement preparers. "The FASB has not issued specific guidance on other COVID-related accounting issues in the past and has instead relied on AICPA guidance," Galasso said.
The AICPA has not issued a Technical Question and Answer (TQA) on ERCs, as it did for PPP loans and Shuttered Venue Operators Grants, but readers can look to those TQAs for analogies when accounting for ERCs.
FASB, meanwhile, is planning an Invitation to Comment to solicit feedback on whether the requirements in IAS 20 should be incorporated into U.S. GAAP.
— Maria L. Murphy, CPA, is a senior content management analyst, Accounting & Auditing Products for Wolters Kluwer Tax & Accounting North America and a freelance writer based in North Carolina. To comment on this article or to suggest an idea for another article, contact Neil Amato at Neil.Amato@aicpa-cima.com.