Your entity may have been able to take advantage of the Employee Retention Credit (ERC) program, which was created under the CARES Act. The purpose of the ERC is to help businesses who have been negatively affected by COVID-19 retain their employees. If your entity has been able to utilize the ERC, you may be wondering what the proper accounting treatment is for this refundable credit.
Not surprisingly, as we saw with the Paycheck Protection Program (PPP) under the CARES Act, generally accepted accounting principles (GAAP) does not provide specific guidance for accounting for ERC’s. The ERC can be considered similar to a government grant, which is a subject not addressed by GAAP for a for-profit entity. As a result, a for-profit entity must look to other accounting guidance.
How to Record ERC for For-Profit or Not-For-Profit Entities
The accounting treatment will depend on if the entity is a for-profit or a not-for-profit entity. A not-for-profit entity will account for this “government grant” under ASC 958-605, as discussed below. A for-profit entity can decide between two methods as follows:
- ASC 958-605 Government Grant Model: Under this guidance, specifically ASC 958-605-25, contributions are recognized when the condition(s) on which they depend are “substantially met”. Under the ERC, this would include conditions such as an entity that is adversely affected by the pandemic; hasn’t used qualifying payroll already for the PPP (so as not to double-dip); and has incurred qualifying expenses/payroll costs to retain employees. Under this guidance, a refund receivable and income would be recognized in the period the entity determines the conditions have been substantially met (for example, the only remaining ‘barrier’ is the administrative step of filing for the credit).
- If the conditions haven’t been substantially met as of the financial statement period end, and the entity received the ERC as an advance, it would record a liability for the cash received until such time that the conditions to earn the ERC are substantially met. Once conditions are met, under this guidance a not-for-profit is required to record the income as revenue, while a for-profit entity may record the amount as grant revenue or other income.
- Under this method, netting the income with the expenses incurred to obtain the income is not permitted.
- International Accounting Standard 20 Accounting for Government Grants and Disclosure of Government Assistance (IAS 20): Under this guidance, an entity would recognize government assistance once they are reasonably sure that it will comply with the conditions attached to the refundable credit and that the credit will be received. In this situation, the entity would recognize the ERC as income by using a systematic basis over the periods in which the entity recognizes the expenses for which the ERC is intended. IAS 20 does not define reasonable assurance; however, it is thought to be analogous to “probable” under GAAP. (Note that reasonable assurance is generally considered a lower threshold than the “substantially met” threshold that applies under Subtopic 958-605 discussed above).
- If a for-profit entity is uncertain as of the financial statement period end if it complied with the ERC requirements, then it would recognize the amount of the ERC received as a liability until the reasonable assurance criteria has been met.
- Under this method, there is an option to either show the income gross as “other income” or to net the income against the related expenses
Additional Notes on Recording ERC
- If an entity previously choose to follow IAS 20 to account for PPP funds, that entity should also elect that method to apply to the ERC funds. However, if an entity accounted for PPP funds under the debt model they can elect either method above for ERC funds.
- Regardless of which method is used for ERC, financial statement disclosures should include information on which method was selected, significant terms of the program, along with the amounts recognized in the financial statements.
The employee retention credit (ERC) has been a valuable tool for businesses of all sizes during the COVID-19 pandemic. By working with trusted advisors and staying up-to-date on changing regulations and guidelines, businesses can maximize the benefits of the ERC and position themselves for long-term success. If there’s anything above you’d like to discuss further, please contact us.
