Accounting for crypto assets? Here’s what you need to know

Last October, Tesla filed its quarterly financial statement with the SEC with, to some, a curious omission from the balance sheet: an unrealized gain of $570 million. It stemmed from the company’s $1.5 billion investment in bitcoin earlier that year. Under current accounting guidance, Tesla could record only impairment losses, not gains on its bitcoin’s carrying value. That meant that while the fair value of its bitcoin had hit $1.83 billion, Tesla recorded only $1.26 billion (its investment less impairment).

In other words, a $570 million unrealized and not recognized gain.

This is just one example of how current accounting guidance for digital assets creates reporting complications for those who buy, sell, lend and/or invest in the booming cryptocurrency market. These complications invite significant risk, be it involving audit complexities, regulatory scrutiny or questions from investors and analysts.

Everyone from investors and companies to accounting bodies and lawmakers has called for binding accounting requirements for digital assets. Yet as of this writing, no U.S. GAAP standards are in development, and the International Accounting Standards Board has provided limited guidance. Only this past December did the Financial Accounting Standards Board put certain cryptocurrencies on its research agenda — a positive but still nascent step.

Against this backdrop, accounting professionals would benefit from a better understanding of the key issues at play and how they can best address them.

Key issues 

For now, many companies classify their crypto holdings as indefinite-lived intangible assets, following nonauthoritative guidance from the American Institute of CPAs. But this poses several accounting challenges, as discussed below.

Concerns with buying and selling bitcoin: Many companies that are not broker-dealers or investment companies offer a service by which customers can buy and sell bitcoin. For those that act as a principal in such an arrangement (i.e., the company purchases bitcoin and adds a margin before selling it to the customer), the company’s bitcoin holdings have the characteristics of inventory (i.e., it purchased bitcoin with a plan to resell them). Consequently, these companies have inventory risk: the probability of not having buyers for their bitcoin inventory.

Despite these characteristics — and due to limited accounting guidance — such companies must 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.

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.

Fair value: As noted above, when companies like Tesla invest in bitcoin, they must classify it as an indefinite-lived intangible asset. This means they must write down the carrying value of their bitcoin when the observable market price of bitcoin drops below that value. What’s more, they cannot make upward revisions for market price increases until a sale.

Take company “Z.” If it purchased $10 million in bitcoin in the first quarter of 2021, its impairment charges at the start of Q3 might be roughly $7 million. Yet at the same time, the fair value of its investment at this time (based on observable market prices) was roughly $20 million. That’s $17 million higher than Z’s bitcoin’s carrying value.

That’s a problem: Z’s accounting for its bitcoin investment doesn’t reflect the investment’s impact on its financial position. In large part, this occurs because the observable market price of bitcoin is volatile. When it goes below what Z paid for it, the company is forced to recognize an impairment charge; but when it recovers, Z can’t recognize the gain.

Lending: Current accounting guidance also doesn’t accurately reflect the economics of companies that lend their crypto investment to third-party borrowers. That’s primarily because crypto assets don’t meet the GAAP definition of a noncash financial asset; in other words, holding a unit of bitcoin does not give the holder a contractual right to receive cash, nor does the crypto come into existence as a result of a contractual relationship. Instead, these companies have to apply intangible asset accounting to the crypto they lend.

Practical guidance 

In light of the current accounting landscape, digital asset holders can take these steps now to head off potential risk:

• Increase reliance on non-GAAP measures: Investors must look to non-GAAP disclosures to understand the impact cryptocurrencies have on a reporting entity’s financial results. This might entail disclosures of income measures exclusive of crypto asset impairment losses or inclusive of unrecognized gains. With such disclosures, however, comes heightened regulatory scrutiny. Issuers must ensure that non-GAAP measures are presented with lesser prominence to GAAP earnings, reconcile to GAAP-based earnings, and are not misleading, among other SEC criteria.

Recently, the SEC rejected a non-GAAP measure used by MicroStrategy — specifically, the “adjustment for bitcoin impairment charges.” This move by the SEC introduces additional hurdles for an issuer to report about the financial impact of its investments in digital assets.

• Push for fair value accounting: The types of assets addressed by GAAP rules for indefinite-lived intangible assets typically do not have a readily accessible global market like the current bitcoin and Ethereum markets. Intangible assets that are actively traded and held for investment purposes therefore should be accounted for at fair value, and entities should be able to do so. 

• Keep an eye on FASB: On Dec. 20, FASB published its updated technical agenda, and “Accounting for Exchange-traded Digital Assets and Commodities” was included. Stakeholders should watch upcoming developments from the FASB closely. 

Though much remains to be seen in the volatile cryptocurrency market, one aspect seems clear: digital assets are here to stay. Therefore, for companies, investors and accountants alike, understanding the accounting challenges will be vital in ensuring financial success in this exciting new space.