The rapid growth of crypto assets has challenged regulators to standardize and issue timely authoritative guidance for crypto accounting. The AICPA has issued guidance outlining how companies should account for crypto assets. Under this guidance, crypto assets are not classified as “cash or cash equivalents” on GAAP financial statements because they are not backed by a sovereign government or considered actual legal tender (although crypto enthusiasts might disagree). Furthermore, this guidance does not allow crypto to be classified as a financial instrument or a financial asset because they are not cash and do not represent any contractual right to receive cash or another financial instrument. Instead, the guidance requires companies to record all cryptocurrency as an intangible asset with an “indefinite life”.
…despite a ready and liquid market for your company’s crypto, you can only reflect losses on your balance sheet, and none of the gains.
Under current accounting guidance, intangible assets cannot be marked to fair market value. Unrealized losses are recorded, but unrealized gains are not. Thus, the value of any crypto assets held by the business can diminish over time without ever reflecting the asset’s true market value. GAAP requires indefinite-lived intangibles to be initially measured at cost, with impairment tested annually. A decline below cost as quoted on a cryptocurrency exchange would be considered an impairment event, and the business would be allowed to “account for it either at cost or revaluation at the fair value on the date of the revaluation less any subsequent … accumulated impairment losses.” This revaluation model can only be applied if the fair value can be determined by reference to an active market, defined as “a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis.”
Under GAAP, cryptocurrency is therefore recorded at historical cost when it is obtained for each currency in each account. Every account and type of currency needs to be recorded separately. Each lot price is determined at the time of the transaction by using either the spot price or the average for the day.
There are two problems with treating cryptocurrency as an intangible asset:
- Traditional accounting for intangible assets does not align with the true substance of a crypto transaction. Leaving GAAP aside for a moment, cryptocurrencies like bitcoin are now relatively liquid and enjoy sufficient market depth to qualify for institutional participation, derivative formation and other similar signals of more mature markets. Accordingly, such assets behave much more like securities, cash and investments from a corporate books and records perspective. The purpose of GAAP financial statements is to provide an accurate, unbiased and uniform picture of the underlying entity’s financial situation. By treating crypto assets as intangible assets, GAAP fails to account for, and thus allow businesses to accurately communicate, the high liquidity of their crypto assets.
- Classifying cryptocurrency as an intangible asset with an indefinite life requires testing for impairment annually, which is a lifetime in the crypto space. If there is a decline in the crypto asset’s value at the end of the reporting period, the asset is written down to the fair market value at such time. However, crypto assets typically experience greater volatility than your traditional “intangible” asset like software, IP, and goodwill, none of which are liquid. When the crypto asset’s value appreciates, it cannot be marked to market. This can result in a significant understatement of crypto assets and prohibits the business from showing the true value of its crypto assets on its financial statements. In most cases, this treatment devalues the business and creates a sharp disconnect with an asset that is increasingly being used to trade, invest, and pay expenses. Put another way, despite a ready and liquid market for your company’s crypto, you can only reflect losses on your balance sheet, and none of the gains. To us, this makes no sense.
Financial instruments, as defined under both IFRS and U.S. GAAP, would appear to be a more appropriate classification for cryptocurrencies. Measuring cryptocurrency at fair market value and thus recording changes in profit and loss would far better reflect the true economic impact of the underlying asset’s volatility, and accordingly, any changes in the financial position of the organization. For financial instruments, GAAP requires mark-to-market accounting under FASB SFAS 157 concerning fair value measurement, in which “fair value measurement” involves adjusting the asset to reflect its current value as determined by actual market value in a liquid market.
Financial instruments, as defined under both IFRS and U.S. GAAP, would appear to be a more appropriate classification for cryptocurrencies.
Under mark-to-market accounting, the asset in question is entered at market value, with unrealized gains and losses recorded at the end of a measurement period. This would provide a more appropriate representation of the value of such assets on the balance sheet, and more accurately reflect the true health of the company. Moreover, the IRS requires gains and losses on each individual coin or token to be tracked by lot, so as to levy capital gains on any profits. This treatment views cryptocurrency as a very tangible asset indeed, and on par with equities, bonds and fiat currencies – not, as currently required under GAAP, an intangible one.
Organizations like the FASB and AICPA should revisit crypto accounting guidance to treat crypto assets as intangibles, and allow companies to account for them as financial instruments under familiar mark-to-market obligations.
Crypto’s rapid ascent from a fringe element to a more mainstream transaction and value medium has left accounting standards in the dust. Organizations like the FASB and AICPA should revisit crypto accounting guidance to treat crypto assets as intangibles and allow companies to account for them as financial instruments under familiar mark-to-market obligations. As more companies embrace crypto assets for investment, operational expenses and fundraising, this step would improve the accuracy and transparency of the corporate financial statements of any business involved in crypto.