RECOGNIZING THE ALPHA AND BETA OF CRYPTO ASSETS – FASB TO THE RESCUE!
Over the last decade, we’ve witnessed significant advancements in blockchain technology and the growing acceptance of cryptocurrencies as valuable mediums of exchange and alternative investment options. While the number of public companies holding cryptocurrencies globally is relatively low, and our examples focus on generic cryptocurrencies, the landscape of crypto asset transactions is evolving quickly.
We anticipate that more companies will encounter new forms of crypto assets in the future. Consequently, we provide a thorough analysis of current financial reporting practices for cryptocurrencies to better comprehend the challenges and considerations associated with them. The digital asset market has not only experienced significant growth but has also seen an expansion in the diversity of market participants.
Individuals from various industries are now entering the market and introducing new products associated with digital assets. With a wider approach, the crypto industry has been long demanding to introduce special accounting standards that recognize its unique characteristics and make financial reporting relevant as well as useful for all stakeholders.
U.S. GAAP presently lacks specific authoritative guidance or rules pertaining to the reporting or disclosure of corporate crypto holdings. Financial statement users, such as analysts and investors, have expressed growing concerns about the challenges posed by intangible asset accounting when assessing companies with significant crypto holdings. Their concerns suggest that the current accounting approach was not aligning with the FASB’s Conceptual Framework’s objective (Bloomberg 2021).
The Financial Accounting Standard Board (‘FASB’) recently approved the mark to market crypto accounting practice and made an announcement for companies dealing with crypto asset transactions to adopt a fair market valuation accounting method. It is an accounting method used to find out the current worth of the assets and liabilities. It is a more reliable method because it represents the current value rather than historical cost. This methodology permits showcasing a transparent picture of the value of the asset and financial health of the companies.
This rule is set to commence formally from 2025, however, companies may adopt the rule earlier which is more of a likelihood. Subject to positive results of crypto regulation, growth in market cap and wide scale adoption with retail investors, the high price volatility may reduce gradually.
Previously, companies holding crypto digital assets needed to report them as intangible assets like goodwill and Intellectual Property (IP). If the value of these intangibles dipped, a loss was reported. However, if the value of the intangible shot up, these companies were not allowed to declare a gain of asset values.
Under the impairment model, the value of the asset is its historical cost, so the same will be reflected in the financial statement of the company. This complicates the whole accounting process and makes it stagnant. For example, if a company bought Ethereum on October 1, 20XX for $23,000 and the price drops to $18,000 on October 30, 20XX, the company needs to recognize a loss and impair the Ethereum on the balance sheet by $5,000.
On December 31, 20XX, the next balance sheet date, the price of Ethereum has increased to $26,000. As companies can only recognize decreases in the value of digital assets resulting from impairment, the company will not be able to recognize the $8,000 increase in this example until the assets are transferred to another party. It was overall an unfair practice in the crypto industry as the negative downside was reflected in the balance sheet, but not the positive upside.
Many companies would eventually complete two forms of financial statements including fair value reporting to present to the senior management of the company in order to take business decisions. Digital asset impairments have been perplexing accountants, practitioners, and all other users of relevant financial information since they would capture one-sided economic changes to crypto assets. It was grossly misrepresenting business realities, leading to wrong investment decisions and in extreme cases, even bankruptcies.
Scope and Applicability of FASB Change
Following is the criteria which applies to holdings of crypto assets:
- Meet the definition of intangible assets as defined in the Codification Master Glossary
- Do not provide the asset holder with enforceable rights to, or claims on, underlying goods, services, or other assets
- Are created or reside on a distributed ledger based on blockchain technology
- Are secured through cryptography.
- Are fungible (NFTs are excluded since they are complex and nuances assets)
- Are not created or issued by the reporting entity or its related parties.
Fair(est) Value Measurement
Utilizing the fair value measurement approach for crypto assets as per Generally Accepted Accounting Principles (GAAP) could enhance the alignment between financial and tax reporting. Presently, there is a need for additional effort in tax reporting to track losses, considering both the lowest price of a crypto asset and its price at the end of a specific period,
in order to accurately calculate the deferred tax asset associated with crypto asset holdings and the corresponding valuation allowance. With the adoption of the fair value measurement methodology, both the deferred tax asset and its related valuation allowance would be determined solely based on the end-of-period price of the crypto asset. Furthermore, fair value accounting would lead to the recognition of deferred tax liabilities during periods when unrealized gains are reported,
thereby providing a more equitable reflection of the actual economic realities resulting from fluctuations in the fair value of crypto assets. Therefore, by adopting this method it will allow the companies to better assess and manage the fluctuation in the value of the asset. It will provide the investors, regulators and businesses with a clear and correct picture of the financial report and thus the financial health of the company. Unlike the impairment model, alongside the historical data,
the current value which records profit can also be recorded and is not contingent on the fact that such asset has to be transferred to a third party. Changes in fair value reflect how an asset’s worth has shifted over a defined time frame and should not be seen as a mere loss of value or impairment for an asset recorded at its historical cost.
Combining these two types of figures would not offer useful information to financial statement users. This will further eliminate usage of a diverse range of costing and accounting methodology in order to show a better picture of their financial report to prevent losing confidence of its investors. It will even make lending and borrowing of such assets easier. Providing decision-useful information about specific crypto assets at fair value will directly boost investor confidence, ultimately leading to more meaningful investments.
Presentation and Disclosure
For accounting and disclosure purposes, a separate digital asset category has now been created with distinct accounting and valuation rules. Now, the gain or loss based on the acquisition price, would be declared in a mark to market manner. It makes sense to keep crypto assets, along with the gains and losses tied to their value changes, separate from other intangible assets and their associated costs due to differences in how they work economically and how they are measured on financial statements. Cryptocurrencies were not in existence when the Board initially implemented IAS 38 Intangible Assets in 2001. Even with subsequent changes to IAS 38, it does not provide guidance on how to account for the unique characteristics of intangible assets, which are both highly liquid and inherently long-term in nature. Furthermore, it is also proposed to categorize crypto assets received as non-cash consideration in the course of operational business (like currency), which are promptly converted into cash, as part of operating cash flows. It would be beneficial to specify whether the gains or losses should be categorized in the income statement under the operating or non-operating subtotals. Interestingly, Binance US made a vital suggestion on permitting to use judgment in the appropriate classification of cash flows based on the nature of underlying activity.
To enhance transparency, especially when an entity holds a diverse portfolio of crypto assets, the reporting has to be done on cost basis for each ‘significant crypto asset’ in the holdings. If a company is already utilizing a crypto subledger, extracting the cost basis for significant asset holdings should be a relatively uncomplicated process. It will be helpful to get more guidance or formal definitions on the ambit of ‘significant’. Most subledgers typically offer standard cost basis methods like LIFO, FIFO, Weighted Average, or Specific Identification, and the majority of companies will choose one of these options.
Transaction costs (for example, exchange commissions) must be taken into account as expenses. The FASB clarifies that the cost associated with bid-ask orders does not constitute a cost to effect the acquisition or sale of an asset or a liability. This approach offers transparency regarding the fair value status of crypto assets and is both practical and operationally sound.
No real costs, Only Benefits
The FASB also came to the conclusion that the amendments would bring about expected benefits that would ultimately justify expected costs. It has been an unequivocal opinion in the industry that the internal control systems are already in place for most stakeholders in the crypto industry. If companies lack the necessary accounting and internal control systems to deliver the mandatory disclosures, the FASB amendments should serve as a stimulus for them to establish and put those systems in place. The administrative costs involved should not lower the level of disclosures in any manner. In future, the guidance on the scope, reporting, presentation and disclosure is merely going to increase to eventually lend more clarity.
Ask for help!
Cryptographic asset transactions are rapidly evolving. The financial reporting issues are dynamic, diverse and highly dependent on specific facts and circumstances, such as proof-of-stake mining, decentralized finance, various rights of NFTs, etc. There are no uniform or definitive answers. Moreover, the repercussions of incorrect financial reporting is dangerous for the companies as well as the investors. The FASB amendments shall have a significant impact on corporate reporting. Crypto CPAs are subject matter experts that contextually provide customized advice on accountancy and taxes. Don’t do it all alone, especially not now when there is so much ambiguity!