Do you expect to receive forgiveness and debt cancellation of a loan, such as the Paycheck Protection Program loans made during 2020? While your business can greatly benefit from the forgiveness of a loan, it also creates an unusual new set of entries on your financing books. Why? Here are five key things to know.
1. Loans Are Actually Liabilities
When you take on a loan, you create both an influx of cash and a new liability. The loan, after all, must be paid back at some point. This is a liability on your books that offsets the new cash. Even a loan you expect not to have to repay starts out its life as a liability, often referred to as deferred income.
2. Loans Are Reduced Over Time
If you must make payments, even if only until the terms of forgiveness are met, these are used to reduce the amount of your liability a little at a time. Most loans see their principal reduced in monthly payments along with some additional interest recorded as an expense. This will help even out your financing books during the duration of the loan's existence.
3. Loans Become Income Upon Forgiveness
When your business fulfills the terms of forgiveness, often called extinguishment, it can then move the funds from being a liability to being unrestricted income. Depending on how you fulfill the terms, you may do this all at once after the terms have been completed, or you might move qualifying funds to income as you go.
4. Loan Forgiveness Can Create Tax Issues
The manner in which you record loans and debt cancellation is vitally important to avoid tax issues. Recording them as income with no accompanying liability can easily result in an abnormally large tax bill. However, removing the liability without proper documentation may cause the cancellation to become a taxable event.
5. Forgiven Loans Should Be Noted
No matter how you handle the bookkeeping of canceled debt, you should make a special note of this in your financial statements. Large single transactions can skew the financial appearance of your business. Good accounting practice is to make these clear through separate line item entries and additional reporting on financials.
Want to know more about managing the accounting entries for a loan that has been or will be forgiven? Start by meeting with experienced accountant services in your state today. they will work with you to ensure that your financing books are as accurate as possible, as transparent as possible, and keep things as simple as possible.