Accounting for the Employee Retention Credit
In March 2020, the Employee Retention Credit (“ERC”) was introduced as part of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act to incentivize employers to retain employees during the pandemic by offering a refundable tax credit against employment taxes. In December 2020 and March 2021, the ERC was further expanded and extended. A summary comparison of the 2020 and the 2021 rules is presented on Appendix I.
ERCs are similar to the Payroll Protection Program (“PPP”) loans as they are another form of government assistance. However, whereas PPP loans provided funds requiring recipients to qualify for forgiveness by incurring qualifying expenditures in subsequent periods, ERCs are an employment tax credit if certain expenses are incurred by eligible employers. While ERCs in 2020 and 2021 could have been obtained as an advance (by filing IRS for 7200), most 2020 ERCs were reported by employers by filing an amended IRS form 941-X (as part of an employer’s quarterly payroll tax return). Most employers in 2021 captured ERCs on either a timely filed form 941 or an amended form 941-X.
Both forms of government assistance provide unique challenges as there is little US GAAP guidance, especially as it concerns for-profit business entities receiving this assistance.
As with other forms of government assistance provided under the CARES Act, entities will need to consider the accounting and financial reporting implications of receiving ERCs.
Similar to the PPP, entities may elect to account for ERCs under one of several accounting principles. Unlike PPP, ERCs will not be accounted for under ASC Topic 470: Debt. Rather, the following accounting standards may be leveraged when determining the appropriate accounting of ERCs:
- International Accounting Standards (IAS) 20, Accounting for Government Grants and Disclosure of Government Assistance
- ASC 958-605, Not-for-Profit Entities — Revenue Recognition
- ASC 450-30, Contingencies
Determination of Appropriate Accounting Principle
Business entities should account for ERCs using one of these standards after considering which standard would provide the most transparency to the users of their financial statements.
ERCs, unlike PPP loans, are structured as a refundable credit and not a loan. If an entity accounted for their PPP loans under IAS 20 or ASC 958, there is a presumption that they will utilize the same guidance to account for their ERCs. Entities that accounted for their PPP loans under ASC 470, Debt will have to determine the appropriate guidance to reference from the options enumerated above.
Accounting under IAS 20
Pursuant to IAS 20, a business entity would recognize ERCs on a systematic basis over the periods in which the entity recognizes the payroll expenses for which the grant (i.e., tax credit) is intended to compensate the employer when there is reasonable assurance (i.e., it is probable) that the entity will comply with any conditions attached to the grant and the grant (i.e., tax credit) will be received.
IAS 20 permits presentation as a credit in the income statement (either separately or under a general heading, such as “other income”) or as a reduction of the related expense (with appropriate disclosure in the footnotes regarding key features of the grant). This guidance is not available to not- for-profit entities.
Accounting under Subtopic 958-605
If the entity receives ERCs as an advance, it will record a liability for the cash received until such time that the conditions to earn the credit are substantially met. When conditions are met, a not-for-profit entity is required to record the income as revenue, while a for-profit entity may record the amount as grant revenue or other income. Subtopic 958-605 does not permit an entity to net the grant against qualifying costs.
The evaluation of whether all conditions are substantially met will require the use of judgment. Uncertainty regarding whether an entity qualifies for the credit would generally indicate that the conditions were not substantially met at period end. Since the accounting model under Subtopic 958-605 requires that substantially all conditions are met to recognize the grant into income, entities will need to consider whether preparing and submitting the filing is a “more than administrative task” that would defer recognition until such time that the filing with the Internal Revenue Service is made.
Under Subtopic 958-605, the entity would present the amount of an employment tax refund receivable or an unearned refund advance as a current asset or liability.
All not-for-profit entities that receive government grants should apply ASC 958-605. Application of IAS 20 or ASC 450 would be appropriate only for for-profit enterprises.
Accounting under Subtopic 450-30
Application of ASC 450-30 may also be appropriate for for-profit enterprises. Under ASC 450, entities would treat the ERCs (whether received in cash or as an offset to current or future payroll taxes) as if they were gain contingencies. When applying ASC 450-30, entities would not consider the probability of complying with the terms of the ERC program but, rather, would defer any recognition in the income statement until all uncertainties are resolved and the income is “realized” or “realizable”. This approach will likely result in later recognition than in the other approaches discussed herein.
The auditor should consider the risks of material misstatement for ERCs in the design of the audit approach. ERCs in excess of tolerable misstatement are a required consultation matter. If you meet this threshold, you are required to send the client’s support for their claimed ERCs to Marty Karamon and/or Deb Walker for their review.
Similar to disclosure requirements for PPP loans, the entity should disclose its accounting policy for ERCs and their impact on the financial statements. Disclosures should include information about the accounting model applied, significant terms of the program, and a description of the relevant line items and amounts recognized within the financial statements. When amounts have not been recognized in the income statement because conditions have not been substantially met, these conditions should be disclosed. This includes any amount expected to be received and any amounts recognized on the balance sheet if estimable.
Accounting for ERCs (and similar government support payments for for-profit entities) has little US GAAP guidance. Accordingly, management will have to exercise judgment in selecting the appropriate framework under which to record and report ERCs. If applicable, ensure that the framework selected by management to account for ERCs is the same as the framework selected for PPP loans. While there may be no “right” answer, we should ensure as much as possible that the approach taken is consistent and the disclosures regarding ERCs clearly communicate the details of the transaction to the users of the financial statements.