Topel Forman News

Today’s Accounting and Audit Topic (March 6, 2018)

How to classify shareholder advances

Owners of closely held businesses sometimes need to advance their companies’ money to bridge a temporary downturn or provide extra cash flow for an expansion, a major expense or other purposes. Should you categorize those advances as bona fide debt, additional paid-in capital or something in between? Under U.S. Generally Accepted Accounting Principles (GAAP), the answer depends on the facts and circumstances of the transaction.

Debt vs. equity

The proper classification of shareholder advances is especially important when a company has more than one shareholder or unsecured bank loans. It’s also relevant for tax purposes, because advances that are classified as debt typically require imputed interest charges. However, the tax rules may not always sync with GAAP.

To further complicate matters, shareholders sometimes forgive loans or convert them to equity. Reporting these types of transactions can become complex when the fair value of the equity differs from the carrying value of the debt.

Relevant factors

When deciding how to classify shareholder advances, it’s important to consider the economic substance of the transaction over its form. Some factors to consider when classifying these transactions include:

Intent to repay. Open-ended understandings between related parties about repayment imply that an advance is a form of equity. For example, an advance may be classified as a capital contribution if it was extended to save the business from imminent failure and no attempts at repayment have ever been made.

Loan terms. An advance is more likely to be treated as bona fide debt if the parties have signed a written promissory note that bears reasonable interest, has a fixed maturity date and a history of periodic loan repayments, and includes some form of collateral. If an advance is subordinate to bank debt and other creditors, it’s more likely to qualify as equity, however.

Ability to repay. This includes the company’s historic and future debt service capacity, as well as its credit standing and ability to secure other forms of financing. The stronger these factors are, the more appropriate it may be to classify the shareholder advance as debt.

Third-party reporting. Consistently treating an advance as debt (or equity) on tax returns can provide additional insight into its proper classification.

With shareholder advances, disclosures are key. Under GAAP, you’re required to describe any related-party transactions, including the magnitude and specific line items in the financial statements that are affected. Numerous related-party transactions may necessitate the use of a tabular format to make the footnotes to the financial statements reader friendly.

Need help?

Shareholder advances present financial reporting challenges that can’t be fixed with a one-size-fits-all solution. We can help you address the challenges based on the nature of your transactions and adequately disclose these transactions in your financial statement footnotes.

 

© 2018

About Topel Forman

What makes our firm special

Contact Us

Reach out to Topel Forman

Services

Learn what we have to offer

If you have questions, please reach out to your Topel Forman contact.

 

Related News Posts

Stories From Women In Accounting

Stories From Women In Accounting

For International Women’s Day and Women’s History Month our Women’s Employee Resource Group and our DEI Committee hosted a panel featuring six of our professionals from tax, audit and operations. They had an inspiring and insightful conversation about their unique experiences navigating motherhood, external and self-made expectations, and being able to maintain a balanced life. Here are some highlights from our discussion: 

read more
Proposed Legislation: The Tax Relief for American Families and Workers Act of 2024

Proposed Legislation: The Tax Relief for American Families and Workers Act of 2024

On January 19, 2024, the Ways and Means Committee of the House of Representatives successfully propelled HR 7024 forward, known as the “Tax Relief for American Families and Workers Act of 2024.” The bill is the outcome of an agreement established earlier that week between the Ways and Means Committee’s Chairman Smith and the Senate Finance Committee’s Chairman Wyden.

read more
The standard business mileage rate will be going up slightly in 2024

The standard business mileage rate will be going up slightly in 2024

The optional standard mileage rate used to calculate the deductible cost of operating an automobile for business will be going up by 1.5 cents per mile in 2024. The IRS recently announced that the cents-per-mile rate for the business use of a car, van, pickup or panel truck will be 67 cents (up from 65.5 cents for 2023).

read more