Accounting for Crypto Assets: Key Concerns and Practical Guidance

The cryptocurrency market is booming, but a lack of accounting standards poses legal and financial risk. Jennifer Hull discusses what stakeholders need to know.

Today’s cryptocurrency market has a total capitalization exceeding $2 trillion. Major retailers like Starbucks, AT&T, and Overstock.com accept cryptocurrencies as payment. Other corporations, like Tesla and MicroStrategy, report holdings in the billions of dollars. Yet as of this writing, there are no binding accounting requirements for these digital assets.

Investors, companies, accountants, and lawmakers alike have called for them, understanding the legal and economic risk posed by not having standards—whether that involves regulatory scrutiny, audit complications, or questions from investors and analysts. Even so, no relevant US generally accepted accounting principles standards are in development; the Financial Accounting Standards Board only recently put cryptocurrencies on its research agenda; and the International Accounting Standards Board has provided limited guidance.

ACCOUNTING STANDARDS 101
Public and private companies are charged with publishing financial statements in accordance with relevant accounting standards, such as GAAP, International Financial Reporting Standards (IFRS), or accounting standards for private enterprises (ASPE). Sometimes, such as when new financial products are developed, companies must make accounting decisions when there are no relevant standards or standards are incomplete. Other times, some guidance exists, but following the guidance produces financial information that does not reflect the asset’s value and/or the economic substance of a transaction. Assets without sufficient accounting guidance are difficult to audit, creating burdens for auditors and management. Assets without sufficient guidance also may trigger additional disclosure requirements and/or the reporting of non-GAAP measures, adding more compliance burdens on management.

For now, most companies classify their crypto holdings as indefinite-lived intangible assets, following nonauthoritative guidance form the American Institute of Certified Public Accountants. But as the following case study demonstrates, questions and concerns arise from this current guidance. Here’s what relevant stakeholders need to know.

Key Issues with Current Cryptocurrency Accounting Guidance

Numerous companies not only invest in cryptocurrency like bitcoin, but lend, buy, and/or sell it. The accounting challenges they face under current guidance are emblematic of the obstacles stemming from a lack of standards. Below are a few key issues to watch.

Principal or agent? Inventory or intangible asset?

If a company offers a service by which customers can buy and sell bitcoin, an important distinction is whether it offers this service as principal or agent. A company acting as principal purchases the bitcoin and adds a margin before selling it to the customer. A company acting as agent arranges for one customer to provide the bitcoin to another and collects a transaction fee.

When a company is the principal in the bitcoin sale transaction, this company is holding bitcoin that has the characteristics of inventory. In other words, the company purchases bitcoin with a plan to resell them. Therefore, they have inventory risk. In the context of the airline industry, this involves the risk of unsold seats on flights. In the context of bitcoin transactions, inventory risk is the probability of not having buyers for your bitcoin inventory.

Despite these characteristics—and due to limited accounting guidance—these companies are required to account for the bitcoin they plan to resell as indefinite-lived intangible assets instead of as inventory. This classification is meaningful, because inventory has different accounting rules than intangible assets.

First, the classification affects the timing and character of income. For example, a broker-dealer’s inventory can be measured at fair value less cost to sell, with increases and decreases in fair value recognized in income (loss). Alternatively, intangible assets are measured at cost less impairment, with impairment charges recognized in income (loss). Impairment losses cannot be recovered until the intangible asset is sold, which specifically affects the timing of gain recognition on an income statement. The longer a reporting entity holds its impaired crypto, the longer it takes for income to reflect the true underlying economics. The table below summarizes the consequences stemming from different accounting classifications:

Second, classification affects the reporting of revenue. As principal, a company must recognize revenue on a gross basis (i.e., what the customer paid for the bitcoin) and the cost of revenue (i.e., the cost of bitcoin it purchased). If an impairment charge was taken on the bitcoin inventory, and that impairment loss was recovered—but not recognized (due to its classification as an intangible asset)—then net revenue earned in a period is inflated.

DEFINING INDEFINITE-LIVED INTANGIBLE ASSETS
Crypto assets do not meet the GAAP definitions for cash or cash equivalents, financial assets, or inventory. Instead, they are classified as intangible assets, which GAAP defines as assets that lack physical substance. As such, unless a reporting entity qualifies for specialized guidance for investment companies or broker-dealers, it accounts for crypto assets as an intangible asset under Accounting Standards Codification (ASC) 350, Intangibles-Goodwill and Other. Because there is generally no limit imposed on the useful life of the crypto asset to the reporting entity, the crypto asset would be classified as an indefinite-lived intangible asset.