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Loan forgiveness is a situation in which a creditor, such as a bank or government entity, decides not to require repayment of a loan that has been issued to a company. This means that the company is able to keep the funds provided by the loan without needing to repay the creditor.
Loan forgiveness is often granted in order to provide financial assistance to companies that are facing difficult circumstances, such as during an economic downturn or a natural disaster. For example, during the COVID-19 pandemic, the U.S. government created the Paycheck Protection Program (PPP) to provide financial assistance to small businesses. As part of the program, businesses were eligible to receive forgivable loans as long as the funds were used for specific purposes, such as covering payroll costs, and certain covenants were met.
Loan forgiveness can be a valuable financial tool for companies that are struggling to meet their financial obligations. It allows them to receive financial assistance without having to worry about repaying the loan, which can help them to weather difficult times and keep their operations going.
Examples of COVID-19 Government Loan Forgiveness
- SBA Loan Forgiveness (PPP Loan Forgiveness) – United States – 100% Forgiveness
- Canada Emergency Business Account (CEBA) Loan Forgiveness – Canada – Up to $20,000 Forgiven
When a loan is forgiven, it is considered income to the business.
It is important that proper accounting occurs at various intervals, including:
- Loan receipt date
- Loan forgiveness date
- Loan repayment date (if applicable)
Journal Entries for Loan Forgiveness
Journal entry for a government support loan received
When a business receives a loan from a bank or government entity, the Cash asset account is debited for the amount received, and the Government Loan Payable liability account is credited for the amount received.
Depending on the type of loan received, the liability accounts may need to be bifurcated between a long-term liability account (amount due later than one year) and a short-term liability account (amount due earlier than one year). The net impact on the balance sheet is the same, however, the difference may be important for financial reporting standards.
Example: ABC Landscaping Inc. received a $100,000 loan from the government on January 1, 2022. The loan is interest-free and if used to cover payroll expenses for the year, it is forgiven. The journal entry to recognize the receipt of the loan funds is as such:
January 1, 2022
|Government loan payable
Journal entry for a government support loan forgiven
When conditions for loan forgiveness have been met, a journal entry must be made to recognize the amount forgiven as income to the business. The Government Loan Payable liability account is debited for the amount forgiven (to reduce the balance of the liability), and Other Income – Loan Forgiveness revenue account is credited for the amount forgiven (to recognize the amount forgiven as income).
Example: ABC Landscaping Inc. received a $100,000 loan from the government on January 1, 2022. The loan is interest-free and if used to cover payroll expenses for the year, it is forgiven. ABC Landscaping Inc. used all the funds to cover payroll expenses for the year, and received approval from the government for loan forgiveness. The journal entry to recognize the forgiveness of the loan is as such:
December 31, 2022
|Government loan payable
|Other income – loan forgiveness