FASB and SEC Developing Accounting Rules for Digital Assets

With the growing use and acceptance of crypto assets, there is an increasing need for guidance on how businesses should treat these assets for accounting purposes. While the AICPA has released a nonauthoritative practice aid on the accounting for and auditing of digital assets, the FASB has not yet issued formal codified guidance on the application of accounting standards to digital assets.

Recently, the FASB added the accounting and reporting of exchange-traded digital assets and exchange-traded commodities to its research agenda in December 2021, and the FASB Board added this topic to its technical agenda in May 2022. The FASB’s decision is the first step toward possible new rules around accounting for digital assets that would provide greater transparency for investors. Movement by the FASB follows a March release of a SEC staff bulletin that provides reporting guidance for entities that safeguard digital assets.

Current Accounting Practices and Challenges

Digital assets are generally accounted for as indefinite-lived intangible assets under Accounting Standards Codification (ASC) Topic 350-30, Intangibles – Goodwill and Other – General Intangibles Other Than Goodwill. However, the price volatility of digital assets presents notable difficulty with this accounting treatment. ASC Topic 350-30 requires crypto assets to be recorded at cost and then tested for impairment, which occurs when an asset’s fair value is less than the recorded value.

Impairment tests are generally performed annually, and interim impairment tests are required when there are market changes or other events that could indicate a potential impairment. If the asset is determined to be impaired, a company will reduce the intangible asset’s carrying value on the balance sheet and recognize an irreversible loss on the income statement. Accordingly, companies with significant digital asset holdings could be required to report material impairment losses in response to market volatility, permanently incurring negative impacts to the balance sheet even if digital asset prices increase at a later point in time.

Because digital assets are new, unique and fundamentally different than other types of investible assets, perhaps there should there be new accounting rules that provide more specific guidance. Does ASC 350-30 accounting treatment necessarily fit for digital assets? Is it informative to the investors and reflective of the underlying assets to report impairment losses but not subsequent gains? Should digital asset investments be marked to market? These are the questions the FASB must navigate in setting forth new digital asset accounting standards.

Another important consideration is whether accounting guidance issued now would become unsuitable for digital assets in the future. New use cases such as NFT offerings, tokenization solutions, decentralized governance structures, and decentralized information exchange are nascent and establishing their places in the world. The crypto industry evolves rapidly and has historically outpaced regulatory development, so it is quite possible that any accounting standards set forth currently will need to be modified and updated in future years to align with new industry advancements.

SEC Guidance on Custodial Obligations for Digital Assets

The SEC also took a step in its formalization of digital asset reporting with the March 2022 issuance of Staff Accounting Bulletin (SAB) No. 121, which provides guidance on the measurement of liabilities and obligations to safeguard crypto-assets that an entity holds for platform users. The SEC issued the guidance due to the increase in the number of entities that provide custodial services and the unique technological, legal, and regulatory risks and uncertainties specific to safeguarding crypto-assets.

Reporting Requirement

A custodial entity responsible for safeguarding cryptocurrencies for its users should report custodied cryptocurrencies as liabilities on the balance sheet and simultaneously recognize a corresponding asset. The cryptocurrencies and associated liabilities should be valued at fair value at the initial recognition date and on each subsequent reporting date.

Reporting Format

The custodial entity should include in the notes to the financial statements clear disclosure on the nature and amount of crypto assets that it is responsible for holding. There should be a separate disclosure for each significant crypto asset and disclosure of any vulnerabilities from any concentration of crypto-asset types.

The custodial entity is also required to include disclosures regarding fair value measurements with the accounting for the liabilities and assets described in the footnotes to the financial statements. Additionally, the entity should consider disclosure about who holds the cryptographic key information, who maintains the internal recordkeeping of those assets, and who is obligated to secure the assets and protect them from loss or theft.

The SEC may also require disclosures on the significant risks and uncertainties associated with the custodial entity, including within the description of the business, risk factors, or management’s discussion and analysis of financial condition and results of operation.

Applicability

SAB 121 applies to custodial entities that file reports with the SEC, entities that have submitted or filed a registration statement that is not yet effective, and certain other entities and financial statements as defined in SAB 121. Entities that file reports with the SEC should apply the guidance no later than its financial statements covering the first interim or annual period ending after June 15, 2022. There is retrospective application as of the beginning of the fiscal year to which the interim or annual period relates. The guidance is required to be applied retrospectively to the beginning of the fiscal year in which the interim or annual period relates (January 1, 2022 for calendar year-end public companies). Other entities should apply the guidance beginning with their next submission or filing with the SEC.

AICPA Questions and Answers

In June 2022, the AICPA published a set of nine questions and answers in response to SAB No. 121 in its practice aid on “Accounting for and auditing of digital assets.” The Q&As explain interpretive matters in the SEC staff guidance that range from the definition of a “crypto asset” to determining a safeguarding obligation to a third party and financial reporting. We will provide an in-depth discussion of these Q&As in an upcoming publication.

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