Accounting and Auditing Cryptocurrencies

Article 1 in a 3 part series

What financial managers need to know about accounting for digital assets

As cryptocurrency and other digital assets have soared in popularity, business owners and accountants have raised questions about how these assets should be reported on their financials. While there is currently no official guidance specific to digital assets from the Financial Accounting Standards Board (FASB), the AICPA formed the Digital Assets Working Group to provide nonauthoritative guidance on how to account and audit digital assets and have issued a practice aid to help practitioners with determining appropriate treatment.

This is not to say the FASB is ignoring this need: based on feedback from practitioners and accountants, the FASB have added a digital asset guidance project on their agenda and it is moving forward with priority. However, formal guidance is likely still months – or longer – away.

Until new guidance is formally issued, following the nonauthoritative guidance set forth by the working group is recommended. In this and other articles, we discuss the guidance provided by the working group.

Currently, the accounting for digital assets depends on whether or not specialized industry guidance (such as Accounting Standards Codification (ASC) topic 946, Financial Services – Investment Companies) is applied.

This article discusses the accounting for digital assets when specialized industry guidance does not apply.

Cryptocurrency: Intangible Asset Treatment

Cryptocurrency and other digital assets are not recognized as legal tender by the United States government. Digital assets also experience significant market volatility, with unpredictable and substantial market value swings of individual assets. These considerations preclude them from being considered cash or cash equivalents.

In addition, digital assets do not represent an ownership right in an entity nor a contractual right to receive cash or other consideration in the future; this precludes them from being considered financial instruments or financial assets.

The most appropriate treatment under current generally accepted accounting principles (GAAP) is as an indefinitely lived intangible asset.

Initial Measurement

The initial measurement of the digital asset depends on how the entity came to own the digital asset. If the asset was purchased, it is valued and recorded at the cost. However, a growing number of entities are accepting cryptocurrency in consideration of services performed or goods delivered. When digital assets are received as a component of revenue, entities should treat it as noncash consideration and record it in accordance with ASC 606 – that is, record it at its estimated fair value at the inception of the related contract.

Changes in the fair value of the asset after the commencement of the contract but potentially before receipt of the digital asset would not impact the revenue recognized or the value of the digital asset recorded. If the fair value of the digital asset is not reasonably estimable, the entity should measure the stand-alone selling price of the goods or services offered to the customer and use this as a basis for the value of the noncash consideration.

Subsequent Measurement

An indefinite-lived intangible asset it regularly carried at the same value as the initial recognition; it does not amortize. However, the recorded asset should be tested for impairment at least annually and more often if events or changes in circumstances indicate an impairment is more likely than not. If an impairment is recorded, the value of the asset should be marked down and an impairment loss recorded. The impairment loss and value of the asset are not subject to recovery, even if the market for the digital asset improves.

As previously mentioned, markets for digital assets can be volatile. A decline in the market for identical digital assets may be an indicator of impairment. Entities need to monitor and evaluate the source, quality, and relevance of information that may indicate impairment is appropriate. Paragraphs 18B and 18C in ASC 350-30-35 provide examples of facts and circumstances that may indicate impairment.

Derecognition of Digital Assets

Entities may be purchasing and selling digital assets often. Entities should track the value of individual units of these digital assets (or partial units thereof) upon purchase or receipt. To facilitate derecognition, management should develop a reasonable methodology for determining which unit(s) of digital assets are being sold. For instance, management may choose to use a first-in, first-out methodology to identify which units of digital assets are being sold. Any methodology should be applied consistently.

If the sale of digital assets is a regular and central part of an entity’s ongoing operations, the counterparty may be a customer, and the sale of digital assets constitutes revenue. In this case, the revenue should be recognized once the control of the digital assets has transferred. The revenue should be recognized in accordance with ASC 606. If the sale is not a component of revenue, management will typically recognize any net gain or loss as a component of other income.

Use of a Custodian

Many entities use third-party wallet services that are hosted on servers external to the entity. When this is the case, management needs to determine on which set of books the digital assets should be recorded. This will ultimately be based on the specific facts and circumstances of the relationship between the entity and its custodian, but is based on who has control of the digital asset. There are many factors to consider, and it may be prudent for entities to consult with legal counsel.

If the custodian has control of the digital asset, the custodian would recognize the digital asset on its books and record a liability to return the asset to the depositor.  This is consistent with guidance from the Securities and Exchange Commission – Staff Accounting Bulletin No. 121, effective April 11, 2022. The depositor would recognize a right to receive the digital asset from the custodian.

If the depositor has control of the digital asset, it should recognize and account for the assets as described above.

As digital assets continue to evolve and gain acceptance in the business community, the appropriate accounting for digital assets will continue to evolve. Before management pursues a digital asset strategy, it should be aware of some of the accounting complexities.

Businesses should also be aware of new tax considerations and reporting requirements for crypto and other digital assets. Contact your Keiter Opportunity Advisor or Email | Call: 804.747.0000 with questions regarding crypto accounting or tax compliance.

Additional Resources

• AICPA Practice Aid on Accounting and auditing of digital assets
  • Non-authoritative but provides insights on how to apply GAAP to crypto assets
• FASB – Accounting for and Disclosure of Digital Assets
  • In early stages – added to agenda on May 11, 2022