Baseline GAAP for Digital Assets
Bonnie Mann Falk,
Partner, Berdon LLP
Partner, Citrin Cooperman Advisors LLC / Berdon Advisors LLC
05.09.22 | Assurance Chat
Digital Assets (DA) is defined as, “Any asset that is purely digital, or is a digital representation of a physical asset.”1 DAs are formatted into a binary source and have a right of use or an obligation, thus creating value to for the owner. Examples include cryptocurrency, NFTs, designs, data, art, music, and other virtual property (could be word files, spreadsheets, presentations, pdfs, etc.). So, how are we supposed to account for these assets under GAAP? Tough question, since only non-authoritative guidance exists on the subject to date.2
What’s the deal for specialized industries, like investment companies or broker-dealers?
Specialized industries, like an investment company under FASB ASC 946, Financial Services – Investment Companies, or a broker-dealer who has proprietary transactions under FASB ASC 940, Financial Services, Brokers and Dealers, conduct transactions and hold assets or incur liabilities for the purpose of investing activities to generate income from capital appreciation, investment income, or both. Basically, an investment company whose investments or a broker-dealer whose proprietary transactions include DAs would treat those transactions like any other investment. Initial measurement is at the transaction price, including commissions and other costs to make that investment. The investments would then be measured at fair value, with realized gains and losses and changes in unrealized gains and losses flowing through the P&L, unless an exception applies that requires consolidation or the equity method. (Click here for the 10-K of a publicly traded investment company)
With a lack of formal markets, how can fair value be measured?
Fair value accounting calls for looking to the principal or most advantageous market where an orderly transaction occurs between willing participants. There are so many markets to buy/sell DAs, ; identifying the right market focuses on the reliability and sufficiency of information available, including trading volume, from a particular market. If volume is low, indicative of an inactive or disorderly market, look to the AICPA valuation guides and adjust the valuation. Since DAs trade 24/7, suggestions for establishing a consistent cut-off time for the valuation include, the end of the business day for the company, setting a fixed time, or following the time a traditional market closes. The key here is consistency.
Entities whose substantive activities do not fall into a specialized industry, cannot record DAs as investments.
For Non-specialized industries, it’s confusing. If DAs are not Investments, what are they? Currencies? Financial assets? Tangible assets? Intangible assets?
Let’s start with what DAs are not:
- Currencies – They are not considered legal tender in the US and are not backed by a sovereign government.
- Financial assets – They are not a currency or represent an ownership in an entity, nor the right to receive cash or another financial instrument.
- Tangible assets – They are not in physical form with a finite life and monetary value.
That leaves us with intangible assets, which are defined in the FASB ASC Master Glossary as assets (not including financial assets) that lack physical substance and are accounted for under FASB ASC 350, Intangibles – Goodwill and Other. In most instances, FASB ASC 350 guides us to conclude that most DAs have an indefinite life, since there are no factors limiting the useful life over the foreseeable future.
Now that I have a DA classified as an intangible, how do I initially record it?
If purchased with cash, the DA is measured at cost. If received in satisfaction of a sale, the DA is treated as noncash consideration in an exchange under FASB ASC 606, Revenue Recognition, and recorded at its estimated fair value. If an arrangement calls for the future receipt of a DA, the DA could be considered derivatives or embedded derivatives and accounted for under FASB ASB 815, Derivatives and Hedging, and recorded at its estimated fair value. (Click here for the 10-K of a publicly publicly-traded company, that is not an investment company or broker-dealer, that holds digital assets)
What about subsequent measurements?
An intangible asset with an indefinite life is not amortized, but is assessed for impairment annually or more frequently upon a triggering event. One way of conducting this assessment is by monitoring and evaluating relevant information, such as pricing information from the DA’s principal or most advantageous market or exchanges. If found to be more likely than not to be impaired, the DA is written down with a loss recognized. Subsequently, if conditions improve and the DA is no longer impaired and/or the value increases, the loss is not reversed, and the impairment value remains the carrying value of the DA. Since, DAs tend to be unique, bundling similar DAs is generally not appropriate as valuations could be skewed.
What if the DA is sold?
If an indefinite life digital asset is sold for fiat currency (aka, cash), the counterparty and purpose determine the accounting treatment. If sold to a customer, the sale is recorded as revenue under FASB ASC 606. If the counterparty is not a customer, then the transfer of the DA is recorded under FASB ASC 610-20, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets, or FASB ASC 845, Nonmonetary Transaction, depending on the facts and circumstances of the transfer, where the gain/loss upon derecognition would be presented net, outside of revenue.
Accounting for DAs is complex due to the diversity of types and uses of DAs, the rapidly changing DA environment, and the lack of authoritative guidance, and the diversity of types and uses of DAs. Stay tuned: On May 11, 2022, the FASB will meet to decide to add a project on exchange-traded digital assets and commodities to its technical agenda.
Questions? I can be reached at 516.806.1193 | BMannFalk@BERDON.COM or reach out to your Berdon advisor.
Bonnie Mann Falk is a Partner in the Quality Control (QC) Department of Berdon with over 30 years of experience in public accounting and expertise in a variety of areas including quality management, compliance, and risk management. As a QC Partner, Bonnie advises the Firm on policies and procedures to enhance quality, increase efficiency, and elevate communication.
1 National Institute of Standards and Technology, U.S. Department of Commerce, https://csrc.nist.gov/glossary/term/digital_asset
2 Some examples of non-authoritative guidance are: AICPA – Accounting for and Auditing of Digital Assets Practice Aid; SEC – The Division of Examinations’ Continued Focus on Digital Asset Securities; SEC – Staff Accounting Bulletin No. 121