About the Panelists
The second day of the conference kicked off with a panel on digital assets. Beth Paul, Deputy Chief Accountant, PricewaterhouseCoopers Accounting Services Group, moderated the discussion. Alicia A. Manders, assistant director of technical activities at FASB and executive director of the Financial Accounting Standards Advisory Council, and Scott Taub, managing director, Financial Reporting Advisors (FRA), also participated on the panel. The comments made by the panelists represent their own thoughts and views, and are not necessarily representative of their employers or affiliated institutions.
Beth Paul began the panel by answering the question: What are crypto assets? “They are transferable digital representations designed in a way that prohibit their copying or duplication; they are recorded on the blockchain, which is really a digitalized decentralized ledger.”
“The landscape is continuing to evolve, and new assets are being created every day. Many function as a medium of exchange, and those are the ones people are most familiar with, like Bitcoin or Etherium. But some provide rights to products or services, so they might enable you to use a platform or give you rights to an underlying either tangible or intangible product, some provide voting rights, and some provide rights to profits and losses.”
Paul described digital assets as either fungible or nonfungible tokens. “Fungible tokens are exactly what it sounds, interchangeable, they are often the medium of exchange.” She described them as similar to casino chips in that they can be used interchangeably, but generally only in a particular casino (i.e., platform).
“And then we have nonfungible tokens [NFT], which are unique—not interchangeable—digital assets stored on the blockchain,” Paul said. “This market’s really growing rapidly, from about 14 million in 2020 to 2.5 billion in 2021.” NFTs are often sold in marketplaces or at auction, and she noted Christie’s sale of an NFT by the artist Beeple for $69 million. She noted that NFTs are also increasingly used in connection with video games, music, real estate sales, and even educational degrees.
Paul then turned the discussion to the accounting for NFTs. Alicia Manders summarized the history of Financial Accounting Standards Advisory Council (FASAC) and FASB efforts in this area and the importance of getting feedback from entities that are holding those digital assets, that are advising or auditing clients, or that are using financial statements to make capital allocation decisions.
“In terms of the accounting, assuming a company does not apply specialized industry accounting guidance,” Manders explained, “the holders of digital assets generally account for them as indefinite lived intangible assets. If accounted for as intangible assets, digital assets are initially measured at cost. So, they’re treated as indefinite lived intangible assets, because there’s no regular legal regulatory contractual competitive economic or other factors that limit the useful life of intangible assets to the reporting entity. As indefinite lived intangible assets, they should not be amortized, and they should be tested for impairment annually … Impairment losses are presented in net income, so if the fair value of a digital asset subset subsequently recovers, the digital asset’s value cannot be written up and no gain can be recognized for that increase in value.”
“The vast majority of digital assets will not meet the definition of ‘financial assets,’ and the fact that a digital asset like Bitcoin freely trades on exchanges and it feels like a bond or a stock, doesn’t make it a financial asset,” Scott Taub said, going deeper into the accounting issues. “A digital asset will only be a financial asset if there is a right embedded that allows you to exchange it for cash. It could be a variable amount of cash, but it’s cash. In other words, somebody contractually owes you cash, or it happens to be like equity where it gives you a right to the net assets of an entity. If it doesn’t embody one of those two things, then it’s not going to be a financial asset, no matter how active the market is for it.”
“I often feel like people say I like the financial asset accounting; this one feels like, ‘I’m going to use that’—but you can’t get there,” Taub continued. “But for those digital assets that do include a right to be exchanged for cash, that are financial assets, we look to the normal models that apply to other financial assets. So, if the stable coin or other digital asset that is a financial asset meets the definition of a security in GAAP, then we would look to ASC 320 … If it doesn’t meet the definition of a security, then it’s more like a receivable and you’re in ASC 310.”
“The accounting would be much like any other instrument that contains a right to cash,” Taub continued. “I think, in many instances, people feel like those models don’t work well for their digital assets, but the good news is if a digital asset is a financial asset, it will be eligible for the fair value option. … They like the fair value option and then adjust market fair value with changes through the income statement, just like you can do for any other financial asset.”
“I think as preparers or as auditors, you’re going to want to make sure you have these processes and policies in place to make sure we know if you’re in the intangible model or the financial asset model,” Paul added, “and you have really good documentation of the conclusions you’ve reached and the policies you’ve chosen.”
“The challenges around determining the fair value of a digital asset are not unlike the challenges you’ll find with any other asset,” Taub explained. “There may be multiple markets in which your digital asset can trade. According to ASC 820, the right market to look to is the principal market—well, what is the principal market for a digital asset? … For a lot of digital assets, the principal market will be obvious, but for others it will not be. … Now for a lot of digital assets, the principal market is the one you acquired in it, so we don’t need to necessarily overcomplicate this, and the search for the right market does not need to be an exhaustive one. … But where there are multiple different markets, that’s something that needs to be considered.”
Taub described the unusual issues that come from valuing digital assets that may be unique. “This is not dissimilar to any other kind of unusual nonfungible asset,” he said. “We need to consider evidence from recent trades, if there are trades in the same asset or similar assets, make adjustments to the prices in those trades for changes in circumstances or the assets. … As always, we want to maximize observable inputs, but for some of these things, it will be difficult … but the challenges are things that we are used to in other kinds of assets.”
Taub noted that the challenges facing auditors in this area are likewise significant: “It’s not a challenge that I would want, but to the profession’s credit, they’re stepping up and doing it, as they do with any other new business model.”
“There’s also many times where we have to think about difficult estimates or uses of judgment, and we have a process and a policy to work through that,” Paul added. “There’re things you can analogize to … getting familiar with these platforms and understanding the controls around the platforms is really important from an audit perspective.”
Manders described the different models that apply to broker dealers and investment companies, although there is no specific guidance in the accounting guides related to digital or crypto assets.
“Under the broker-dealer guidance, positions resulting from proprietary trading should be measured at fair value with changes in fair value recognized in profit and loss—a very different model from the intangibles,” Manders explained. “The investment company requirements are very similar; they’re generally required to account for changes or fair value and profit or loss. Irrespective of the type of investment, the guidance in Topic 946 requires an investment company to initially measure investments at transaction price … Subsequently, an investment company is required to measure those investments at fair value.”
Paul asked about the accounting for transactions involving cryptocurrencies.
“The fact of the matter is that most companies that accept Bitcoin or other digital assets as a form of payment for goods and services immediately sell them,” Taub noted. “A lot of companies that accept it as a form of payment don’t actually face those challenges, because they’re not interested in holding it, they’re just interested in taking it as a form of payment, much like a credit card or anything else.”
“If you’re buying an asset using crypto, chances are that the asset needs to go on your books at fair value … you’re probably using the intangible asset model, which means that you’ll write it down. The value goes down, but you won’t write it up if the value goes up,” Taub explained. “When that asset is then exchanged for something else, you’re selling a digital asset and buying whatever it is you buy, so you’ll have a gain or loss on the disposition of the digital currency or the virtual asset. And then, whatever you buy will go on the books, so there’s fair value on the selling side.”
“There’s some complications if you’ve got a receivable that’s denominated in a digital asset,” Taub continued. “Most companies don’t run into that now, when they sell something in exchange for digital currency; they get currency immediately, and then they sell it very shortly thereafter. But if there is a delay in payment, the amount of revenue that will be recognized would be determined by the value of the digital asset at the time revenue is recognized, or at the inception of the contract measures. Fluctuations in value after that would not go through revenue … and you do have to evaluate for whether there’s an embedded derivative. So it can be complicated in that regard.” He noted that such issues usually aren’t material unless an entity holds on to the digital asset for a long time.
Loans and Custodianship
The conversation turned to lending and borrowing. “If you own a bunch of Bitcoin, you could loan it to somebody else,” Taub began. “When we think of loan accounting—when you loan somebody cash, you take the cash off your books if you’re in the lender, and the borrower puts the cash on their books, along with an obligation to pay you back. But if you are loaning Bitcoin or some other digital asset, then chances are it will fail derecognition, because in that case you are transferring an intangible asset. That goes under the revenue recognition principles, even if it’s not your central line of business.”
Taub then discussed the guidance in ASC 610-20. “We can actually have the same asset on two sets of books—and that will happen in this case,” he said. “But I find it easier to think about it like a license of an intangible asset, because the accounting model kind of falls into place.” He then suggested looking to the leasing literature and related interpretive guidance to resolve questions that arise.
Paul then turned the conversation to the safeguarding of crypto assets and the guidance under SAB 121. “When you’re acting as a custodian or a sub-custodian,” she said, “you’re going to end up having an obligation to return the crypto and, in this situation you can end up with the liability on multiple entities’ books.”
She then delved into further detail about the valuation of such assets and the consideration of control in custodial relationships. “Before you think whether your custodial services results in following SAB 121,” she said, “the first step is to say, ‘Do I control that underlying asset?’ If you think about your responsibilities, and you have the ability, let’s say, to buy sell re-hypothecate the crypto asset that you are custoding, then you actually have control of the crypto, and you would put the crypto on your books, with a right to return that crypto.”
Paul noted that those assets may be measured differently, “because that crypto may be an intangible, so it’s not really not sure that’s fair value from an asset side, and the liability may or may not have an embedded derivative that gets measured at fair value, so you may not be at fair value on the liability side, either. If you pass through that, though, and you say, ‘I don’t have control of the crypto that I am safeguarding,’ then you go into SAB 121 if it’s applicable for you … then you are going to put that asset and liability in your books at fair value of the underlying crypto, mark to market each period, and ask, ‘Am I in the custodial services business and does it apply to me?’”
Companies must “think about that from your customers’ perspective,” Paul said. “You can’t really say, “Well, I’ve subcustodianed that out and, therefore, this is not my obligation.’” What does your customer think? Do they think you own sort of the relationship with them? Are they going to go to you for any recourse or complaints or issues? Are they going to say that when I have a problem, the first phone call is you? And are you keeping all the records, are you providing the information through a transactional statement to the customer… If you’re answering ‘Yes,’ to all those questions, then you probably have that safeguarding obligation—even if you’ve then turned around and asked a subcustodian to actually perform the safeguarding. They also will have that obligation, but you, in your role, also have an obligation.”
Paul concluded the discussion by asking Manders for her thoughts about where FASB’s future standards setting in this area might be headed. “The project is currently on our research agenda. The board is going to consider the responses that we got back from our invitation to comment that broadly supported taking on a project to explore the accounting for certain digital assets at fair value,” Manders noted. “Nearly all respondents across all stakeholder types agreed that a project that either would permit or require companies to account for certain digital assets at fair value should be a top priority for the board going forward. In terms of investor discussions, there’ve been a lot of discussions about the decision usefulness of that information.”
“As we look at pervasiveness, since that’s one of the key standard setting questions, there were many respondents, including users, who noted that because of the continued growth and change in this digital asset space, that you should look at the trajectory of pervasiveness of digital assets, along with the current state,” she continued. “The staff plans to provide the board with a summary of the research performed to date. … And at that meeting, we plan to ask the board to consider the agenda criteria and whether to add a project to its technical agenda.”
Manders noted that the board will consider whether there is an identifiable and sufficiently pervasive need to improve GAAP, whether there are technically feasible solutions, and whether the perceived benefits are likely to justify the expected costs of a new standard. “If the board does not add a project at that meeting,” she said, “we hope to get some direction on any additional research that’s needed. And if the board adds a project, our work has just started. Certainly, we encourage the engagement from stakeholders and others, whether you agree or disagree, as we go forward on that process.”