The term “digital assets” refers to the digital records made by using cryptography for verification and security on a distributed ledger called a blockchain (see Strategic Finance, “From the Mainframe to the Blockchain.)” This decentralized ledger, the blockchain, securely records information that’s duplicated across user systems. A crypto key allows users to access a platform that connects into the blockchain. A user creates, or mints, a digital asset by adding new information to the blockchain, but existing entries remain unaltered. Through these entries, users can exchange newly created or existing digital assets.
An entity may use digital assets, depending on their underlying arrangement, for a variety of purposes, including as a means of exchange for goods or services or for financing. The variety of arrangements makes it important to consider the specific terms and risks in determining how to account for them.
Fast-paced market trends with respect to digital assets are creating challenges in developing and delivering timely and meaningful accounting guidance. Moreover, the diversity in the types of digital assets makes setting guidance a complex proposition for regulators such as the U.S. Securities & Exchange Commission (SEC) and standard setters the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) to set accounting rules that are meaningful. A useful criterion, however, is whether the digital assets are exchangeable. While some can be used to conduct transactions, others, such as NFTs (nonfungible tokens), allow the user access to an underlying, unique digital item such as collectible artworks.
ESTABLISHING CONSENSUS
The FASB’s Emerging Issues Task Force (EITF), the American Institute of Certified Public Accountants’ Digital Assets Working Group, and similar professional groups have been examining the various types of digital assets to consider the accounting issues. These assessments have resulted in a consensus that digital assets, falling outside the definition of cash and cash equivalents, financial instruments, and inventory, are indefinitely lived intangible assets.
Following this consensus, digital assets are accounted for under U.S. Generally Accepted Accounting Principles (GAAP) under Accounting Standards Codification (ASC) Topic 350, Goodwill and Other Intangibles. But this raises a problem. Although the value fluctuates, as intangible assets, they’re measured at historical cost. The holder doesn’t reflect changing value unless the recorded amount is considered impaired, meaning permanently unrecoverable. After recognizing an impairment, subsequent recoveries in value aren’t reflected in the accounts.
Many consider this accounting inadequate and irreflective of the economic conditions of holding these assets. “It’s been an interesting journey since I first saw these instruments come out,” remarked FASB Chair Rich Jones at the December 2022 FASB board meeting. “Initially I was told that they would be used generally to facilitate exchanges, or possibly hedges against inflation.” But, he noted, at the end of the day, these assets are seemingly a “speculative investment” and that users will benefit from a “true reflection of volatility.”
Stakeholder outreach accelerated the FASB’s attention to the area. The FASB received requests from certain U.S. congressional members and feedback from users in the financial services sector. Certain FASB stakeholders also raised this as a priority (FASB, 2021 Agenda Consultation).
After staff research and recommendations in late 2022, the FASB decided to issue an exposure draft in early 2023 of proposed guidance that covers a narrow group of crypto assets that:
1. Meet the U.S. GAAP definition of an intangible asset;
2. Do not provide the asset holder to enforceable rights to, or claims on, underlying goods, services, or other assets;
3. Reside or are created on a distributed ledger (i.e., blockchain);
4. Are secured through cryptography; and
5. Are fungible (Scott Muir, “FASB addresses crypto asset presentation and disclosure,” KPMG).
Under the FASB’s pending guidelines, if adopted, holders would measure assets that satisfy these criteria at fair value with unrealized gains and losses in net income. The entity would determine fair value by following ASC Topic 820, Fair Value Measurement, and other related standards.
If adopted, an entity would also present the aggregate amount of its crypto assets separately from other intangibles; it would similarly present gains and losses separately from other income statement items related to intangibles, such as amortization or impairment losses. On the statement of cash flows, an entity effectively would report the receipt of noncash crypto assets that it converts to cash almost immediately as operating cash flows (foregoing treatment as noncash items). This accounting would apply to all entities; there would be no carveout or a phased-in approach for nonpublic entities.
WAIT AND SEE
The IASB, unlike the FASB, has taken more of a wait-and-see approach. For the moment, the International Financial Reporting Standards Interpretations Committee has determined that reporting entities should apply International Accounting Standards (IAS) 38, Intangible Assets, to its accounting for crypto assets, unless they hold these digital assets for sale in the ordinary course of business. In the latter case, the entity reports this under IAS 2, Inventory. The IASB, thus far, has decided not to add a project on cryptocurrencies and related transactions. As IASB Chair Andreas Barckow said during a joint session with the FASB in September 2022, “Has the use of digital assets become pervasive on a global scale? Not yet, but we are monitoring.”
The general view by the IASB is that the area is complex and changing, and standard setting may be premature, particularly as policy makers address broader issues than just accounting. The debate remains on whether digital assets, and the narrower category of crypto assets, should be within the scope of a standard that generally addresses intangibles. The IASB has a broad project regarding intangible assets in its research pipeline, and it may consider the most meaningful way to address cryptocurrencies as it addresses the broader issues.
TRANSPARENCY CONCERNS
In the United States, the SEC is bringing attention and resources to the varied issues around digital assets. For example, operating a crypto asset platform creates verification and security obligations (that is, potential liabilities), and the SEC is concerned about transparency by entities with such safeguard responsibilities (SEC, Staff Accounting Bulletin No. 121). Among other issues, the SEC is concerned about the use of crypto assets to raise capital (SEC, “Spotlight on Initial Coin Offerings (ICOs),”) and lending transactions of crypto assets. Due to the need for specialized attention, the SEC announced in September 2022 the formation of a new Office of Crypto Assets within the Division of Corporation Finance’s Disclosure Review Program.
The acceleration of technology-based transactions highlights the need for regulators, standard setters, corporate accountants, and other stakeholders to respond with agility to respond to risks and provide transparency.
February 2023
