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It’s Time to Talk About Cryptocurrency and Digital Asset Accounting

by Adam Olsen, CPA* - August 2021 7 min read

If cryptocurrencies and digital assets like bitcoin and NFTs (non-fungible tokens) have you scratching your head, you’re not alone. Sure, some of the confusion might stem from an entirely new vocabulary – blockchain, distributed ledgers, smart contracts, and countless other terms – but not all of it.

As businesses are now discovering, there’s a whole new level of complexity lying just beneath crypto’s binary-coded surface, mainly how to account for them. So join us as we discuss these asset types, how the accounting standards apply to them, and what it all means for your accounting team.

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Digital Assets Aren’t a Passing Fad

We understand things come and go out of society’s spotlight pretty quickly – pet rocks, fidget spinners, dubstep, and 3-D movies, to name a few. However, digital assets and cryptocurrencies don’t fit into that category.

In fact, the financial world has been far more welcoming to these assets than most people realize. To that point, massive firms like JP Morgan, Mastercard, and UBS have already sunk millions into the Ethereum – the world’s second-largest virtual currency – network and infrastructure.

Even more astounding, the European Investment Bank (EIB) recently issued $121M in two-year digital bonds through Etherium’s public blockchain network. And, of course, we don’t even have to mention how often bitcoin and NFTs make headlines these days.

The point is, these digital assets and currencies aren’t a passing fad. They’re here to stay, meaning any company thinking about dipping its toe into the crypto waters needs to understand what it’s getting itself into. And that starts with accounting for these new digital darlings.


The FASB and Digital Assets

This is the point of the discussion where things get especially murky for a CFO or CAO looking for answers on digital asset and cryptocurrency accounting. Because, to put it bluntly, there really isn’t much – or more like any – guidance specific to them.

Let’s look at Tesla as an example. As you might know, the company put $1.5B into bitcoin in February 2021. Just two weeks later, Tesla’s crypto stake had grown to $2.5B, obviously a nice holding on paper. But that’s where the accounting issues begin since, as of May 2021, that very same bitcoin holding was $600M to $700M in the red. So how does that mess shake itself out on the books?

Well, we obviously can’t say exactly what Tesla’s accounting and financial reporting functions will do with all of that. However, we can explain what the going consensus is on accounting for these highly volatile, perpetually mysterious assets.

Start With the Best-Fitting GAAP Framework

The conversation begins by determining exactly how to classify these assets as on the balance sheet. Maybe as cash, cash equivalents, or a possible type of foreign currency, you ask? Nope. For an asset to be cash, it must be accepted as legal tender and backed by a government.

Likewise, cash equivalents must represent investments that are readily convertible to cash or have a near maturity that results in insignificant risk to the value. And an asset can’t be a foreign currency if it doesn’t represent cash.  

Unfortunately, accounting for them as a plain ol’ investment or financial instrument is another swing and a miss. That’s because digital assets don’t represent a contract with a right or obligation to deliver or receive cash or some other type of financial instrument. And while crypto miners who intend on selling the assets might think of them as a type of inventory, digital assets usually don’t meet the definition since cryptography-based assets lack physical substance.

So where does that leave us?  Most companies are classifying digital assets as a type of intangible asset. Granted, this still isn’t a great fit, but it’s the best we have under the current standards since it provides the broadest definition. Specifically, digital assets:

    1. Lack physical substance, and;
    2. Are indefinite-lived as they have no prescribed life.

This means companies initially record digital assets at their acquisition cost and, thus, subject them to annual and trigger-based impairment tests. Needless to say, this opens up an entirely new can of financial accounting worms.

Given the constant volatility of these digital assets – and the fact that the impairment model for indefinite-lived intangible assets permits a write-down in value but no write-up for increases – the accounting outcomes can be hard for some to wrap their head around.

In fact, even a single day's significant decline in the value of a digital asset could warrant a trigger-based impairment test and a possible impairment charge. This is because unlike some financial instruments, the impairment framework for intangible assets is not an other-than-temporary-impairment model.  

All things considered, there’s a fair amount of financial report McGyvering when accounting for things like cryptocurrencies and digital tokens on the balance sheet. And it looks like it’s going to continue like that for the foreseeable future.

Performing Impairment Tests on Digital Assets

Now that we know what we’re up against, it’s just a matter of following applicable guidance in ASC 350. In this case, that means looking at the asset’s fair value and comparing it to its carrying value. If the fair value is less, then you have to write it down and take an impairment charge.

But as we mentioned earlier, you cannot recover any value for previous impairment charges taken under current US GAAP. Instead, you would only recognize any upside as a gain upon the sale of the intangible asset, and that’s just in cases where the sale price exceeds the adjusted carrying value.

Going back to Tesla, unless bitcoin turns around – which is entirely possible – the company could be looking at a substantial impairment loss in its Q2 2021 financial statements and an adjusted cost basis.

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What’s Ahead for Digital Asset Accounting

You’re not wrong for thinking digital asset accounting has a distinct Wild West feel to it right now. Therefore, it’s safe to assume regulators will standardize the applicable guidance at some point, particularly as these assets grow in popularity. Maybe that will entail moving to a fair value model, a carve-out definition of a financial instrument, or even an entirely new asset class. Only time will tell.

Also, as an additional wrinkle, since some companies are accepting digital currencies in exchange for goods and services, that brings the ASC 606 rev rec framework into the fold. In this instance, the crypto would be a non-cash consideration from the customer and accounted for as such.


The Bottom Line: Proceed With Caution

Seems like a bit of a headache, right? That’s because it is. Ultimately, a company must weigh the good versus the bad when looking at digital or crypto assets. Yes, it’s another financial asset class that allows you to further diversify and possibly recognize some serious gains.

However, the accounting can be messy, and the significant volatility only amplifies the mess on the financial statements. Our advice is to proceed with caution and consult the AICPA practice aid on the topic, Accounting for and Auditing of Digital Assets. There, you’ll find additional insights and helpful use cases that might shed a valuable light on your specific accounting issue.

In the meantime, your technical accounting gurus here at Embark are always here to step in whenever you need us, whether for digital assets, cryptocurrencies, or anything else. It’s what we do.


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