What are the implications of the new US crypto-asset accounting standard

As crypto assets grow and gain popularity, more and more companies are beginning to hold or use them to seek investment returns, improve payment efficiency, or expand their business models. The U.S. is one of the largest crypto asset markets in the world and one of the first countries to get involved in the crypto asset space. The holding and use of crypto assets by U.S. listed companies varies. In addition to purchasing and holding mainstream cryptocurrencies such as Bitcoin for investment (e.g., MicroStrategy, Tesla); the use of cryptocurrencies as a means of payment for goods or services (e.g., Square) or the use of platforms such as Ether to develop blockchain-based applications (e.g., Thermo Fisher Scientific) have also become the direction of business expansion for major companies.

However, the accounting treatment and disclosure of crypto assets by U.S. public companies is characterized by significant differences and uncertainty. Due to the lack of U.S. Generally Accepted Accounting Principles (US GAAP) specific guidance for crypto-assets, different companies use different accounting models to account for and report crypto-assets, which does not meet the requirement of comparability of accounting information. To address this issue, the U.S. Accounting Standards Board (FASB) adopted a proposed Accounting Standards Update (hereinafter referred to as ASU 2023) in September of this year that would require cryptoassets that meet certain conditions to be measured at fair value and disclosed separately.

The purpose of this paper is to analyze and compare the accounting accounts for crypto assets and the basis and impact of their selection by U.S. public companies before and after the issuance of ASU 2023, which will be explored in the following three aspects:

(1) Accounts and methods of accounting used by U.S. companies for crypto assets prior to the ASU update;

(2) Drawbacks of the accounting rules before the ASU update;

(3) Accounting rules for crypto assets and the impact of the ASU update.

1 Crypto Asset Accounting Accounts Currently Used by U.S. Companies

1.1 Accounting Standards and Regulatory Requirements Required of U.S. Public Companies

U.S. Generally Accepted Accounting Principles (US GAAP) is an authoritative set of non-government accounting standards issued and maintained by the Financial Accounting Standards Board (FASB), and is the accounting standard that must be adhered to by publicly traded companies in the U.S. US GAAP includes the following:

Accounting Standards Codification (ASC): the only official source for US GAAP, covering accounting rules and guidance for a wide variety of industries and topics.

Accounting Standards Update (ASU): used to communicate changes to the ASC, including changes to informal/non-mandatory elements issued by the U.S. Securities and Exchange Commission (SEC.) The ASU is not an authoritative standard, but rather explains how, why, and when the FASB changed US GAAP.

Concepts Statements (Concepts Statements): its guides the selection of economic phenomena that should be recognized and measured, and their presentation in the financial statements or related means of communicating information, by formulating the objectives of financial reporting, the qualitative characteristics of useful financial information, and other concepts.

In addition to complying with US GAAP, US public companies must also comply with the rules or "listing standards" of the US Securities and Exchange Commission (SEC), including rules on corporate governance and audit committees.

1.2 Accounting for crypto-assets under current accounting standards

Prior to GAAP's release of the 2023 Crypto Assets Accounting Standards Update, there was no uniformity in accounting for crypto assets.In 2020, the American Institute of Certified Public Accountants (AICPA) formed a Digital Assets Working Group and issued an unofficial guide titled, "Accounting for and Auditing of Digital Assets," (the "Guide"), which instructs accountants on accounting for digital assets. The Guide states that crypto assets, in general, should be accounted for as indefinite-lived intangible assets. Indefinite-lived intangible assets are intangible assets that do not have laws, regulations, contracts, or other factors that limit their useful life (trademarks, copyrights, or licenses, etc., fall into this category). Such assets are not subject to amortization, but are required to be tested for impairment at least annually to determine whether their carrying value exceeds their fair value. If an impairment occurs, an impairment loss is required; however, if there is an increase in value, the impairment loss that has been recorded cannot be recovered.

The Guide also provides for the accounting treatment of crypto-assets in the following three scenarios.

A crypto-asset is accounted for as a financial asset in situations where the crypto-asset provides a contractual right (including the right to redeem the stablecoin for cash from the issuer) to receive cash or another financial instrument such as a stablecoin.

Certain broker-dealers may hold digital assets for sale in the ordinary course of business, at which point the cryptoassets may be accounted for as inventory at fair value with changes in fair value recognized in profit or loss.

A company that qualifies as an investment company should determine whether the crypto assets it acquires represent debt securities, equity securities, or other investments, and should measure its investment at fair value.

Depending on the purpose of holding crypto assets, this paper will study the following three typical enterprises holding large amounts of crypto assets: crypto asset long-term investment companies, mining companies and crypto asset trading platforms, and explore how they account for crypto assets respectively.

1.2.1 Accounting for companies with long-term investments in encrypted assets

Companies that invest in crypto assets for the long term do not hold crypto assets for speculative purposes, but are bullish on the long-term value of crypto assets. Therefore, they generally classify crypto assets as indefinite-lived intangible assets, which are measured at original cost. If the cryptocurrency is impaired during the holding period, an impairment provision is made. Companies that treat crypto assets in this manner include Tesla, Square, MicroStrategy, and others. Due to the volatility of the market price of crypto assets such as Bitcoin, these assets require an impairment provision when the price declines; however, an increase in price does not increase the carrying value of the asset. As a result, the carrying value of crypto assets measured as indefinite-lived intangible assets is often the lowest market price, which may affect the assessment of a company's profitability and may result in the carrying value of cryptocurrencies being far from their actual value.

Tesla, for example, lists digital and intangible assets in the "non-current assets" section of its balance sheet in its 2022 annual report, presumably in light of the purpose for which it holds its digital assets (predominantly in Bitcoin): it believes in the potential of digital assets to serve as a long-term cash substitute, rather than as a short-term financial instrument. financial instruments. Meanwhile, in Tesla's statement of cash flows, cash inflows and outflows related to the purchase and sale of bitcoin are presented in cash flows from investing activities (accounted for as purchases of digital assets & proceeds from sales of digital assets).

1.2.2 Accounting for mining companies

After acquiring crypto assets, mining companies sell them to the market in exchange for a profit. Since mining companies hold/acquire the same types of crypto assets (predominantly Bitcoin) as companies that invest in crypto assets for the long term; they account for the value of their crypto assets in the same way: by accounting for the crypto assets as indefinite-lived intangible assets. However, unlike Tesla, most mining companies (e.g., Bit Digital, CleanSpark, and Riot Blockchain, among others) list their crypto assets as current assets, which is in direct conflict with the nature of intangibles, but better reflects the economic substance of the fact that such companies do not hold cryptocurrencies for the long term but rather turn them into profits.

The process by which mining companies convert crypto assets into profits is generally measured in two ways if it is to be shown in the statement of cash flows. One is to treat it as "cash generated from investing activities" and the other is to treat it as "cash generated from operating activities". Among them, the former is adopted by most mining companies, while the second method is adopted by fewer companies, such as Coin Citadel. Some analysts point out that treating the conversion of crypto-assets into profits as an investing activity can affect a company's cash from operations ratio and mislead investors' decision-making, as crypto-assets are actually derived from the company's main business, not from investments.

1.2.3 Accounting for crypto-asset trading platforms

A typical example of a crypto-asset trading platform is Coinbase, whose main business is to provide a crypto-asset trading platform for the general public, from which it collects fees to make a profit. Similar to a mining company, the fees collected by Coinbase are subject to a "conversion to profit" process. According to Coinbase's prospectus, Coinbase's revenue from each crypto-asset transaction will be based on the fair value of the crypto-asset. Coinbase will convert these revenues into U.S. dollars once they reach a certain amount to minimize the financial risk associated with changes in fair value.

In addition to this, Coinbase also holds a certain amount of crypto assets for a long period of time, just like Tesla, and accounts for this portion of its assets in the same way as Tesla.

1.3 Conflicts between existing rules and International Financial Reporting Standards (IFRS) and their lagging behind

Taking an overview of the accounting treatment of crypto assets by U.S. companies prior to the issuance of ASU 2023, it is easy to see that this treatment is in some conflict with International Financial Reporting Standards (IFRS). The most obvious conflict lies in the way intangible assets are measured. U.S. companies, represented by Tesla, value cryptocurrencies according to the cost method, with no upward adjustment after the asset is impaired. However, IAS 38 - Intangible Assets states that intangible assets can be measured for value based on a cost model or a revaluation model, if applicable. Since most companies hold cryptocurrencies that are actively traded, IFRS-compliant companies typically measure the value of cryptocurrencies using the fair value approach, which allows for the reversal of impairment losses. However, for U.S. companies that measure cryptocurrencies under the cost method, profitability is understated if a loss is incurred before the crypto asset is sold.

Second, the current rules do not adequately address the balance sheet presentation of crypto-assets. Indeed, treating crypto assets as intangible may not better reflect the liquidity of a company's wealth, as in the case of Tesla, which lists its "digital assets" as non-current, but whose holdings of bitcoin are inherently liquid and easily realizable in the marketplace. Bitmain, on the other hand, lists its holdings as liquid in its prospectus, even though, like Tesla, it states that it "intends to hold Bitcoin for the long term". Therefore, further accounting standards are needed to determine whether crypto assets should be classified as current or non-current.

Finally, current accounting standards prevent mining companies from properly assessing their profitability. When revenues generated by a mining company's primary business (bitcoins) are converted to United States dollars, they are measured as "cash generated from investing activities" rather than "cash generated from operating activities", and this cash flow categorization distorts the ability of a mining company's primary business to generate cash flows.

2 The release of ASUs in 2023 and their impact

2.1 Key elements of ASU 2023

The FASB issued a proposed Accounting Standards Update (ASU) on March 23, 2023, entitled Intangibles - Goodwill and Other - Cryptographic Assets (Subtopic 350-60): Cryptographic Accounting and Disclosures for Assets. This new rule, which was adopted in September of this year, requires that cryptoassets be measured at fair value and changes in fair value be recognized in comprehensive income in each reporting period if they meet the following criteria

Cryptographic assets meet the U.S. Generally Accepted Accounting Principles (US GAAP) definition of intangible assets;

The holder has no enforceable rights or claims to the underlying goods, services or other assets;

Crypto assets reside on a distributed ledger based on blockchain technology;

Encrypted assets are protected by encryption technology;

Crypto assets are fungible, i.e., interchangeable with similar assets;

Cryptographic assets are not created or issued by the reporting entity or its affiliates.

This new rule also requires crypto assets to be presented separately on the balance sheet with detailed disclosures in the notes about crypto assets and activities, such as specific assets held, restricted assets, fair value hierarchy, and related party transactions.

The purpose of this new rule is to address the current lack of GAAP guidance for crypto assets and the inconsistent and non-comparable information resulting from the use of different accounting models by different entities.The FASB believes that measuring crypto assets at fair value better reflects their economic substance and market volatility, and improves the relevance and credibility of financial reporting.

This new rule, which is expected to be officially released by the end of 2023 and will take effect in 2025, applies to all public and private companies that hold or invest in crypto assets. However, companies may choose to adopt these rules earlier.

2.2 Impact of ASUs in 2023: a critical step forward

Previously, TaxDAO has written an article, "Detailed Explanation of the New Changes in U.S. Cryptocurrency Accounting Rules," which analyzes the accounting impacts, tax impacts and accounting practice impacts brought by ASU 2023. Based on this, this article will focus on the impact of the 2023 ASU on the industry's accounting treatment.

As mentioned earlier, valuing crypto assets according to the cost method would lead to inaccurate valuations. The newly revised accounting standard is directly aligned with the IAS practice this time by applying the fair value approach to the valuation of crypto assets in order to accurately reflect the value of the company. However, the fair value method requires more frequent changes in the value of crypto assets and corresponding gains and losses on changes in fair value than the annual impairment accounting of the cost method, which adds a burden to the company's accounting. For companies such as MicroStrategy and Tesla that have invested in crypto assets for a long time, the new accounting method will improve their book profits.

Although 2023ASU does not solve all the problems of the current rules, such as not explicitly mentioning the liquidity treatment of crypto assets, not covering crypto assets such as NFTs, wrapped tokens, etc., it is a key step in the accounting regulation of crypto assets. A journey of a thousand miles begins with a single step, and the 2023 ASU, which starts from the commonality of cryptocurrencies, is undoubtedly a good start; only when a consensus is reached and a mature solution is formed in the general area, the regulation of the niche area will have a source of living water, and it will be able to move steadily and far.

In addition to addressing the issue of accounting standards for crypto-assets in the U.S. domestic market, ASU 2023 also has important implications for the harmonization of international accounting standards. Currently, the two main sets of accounting standards commonly used or referenced internationally are the United States Generally Accepted Accounting Principles (US GAAP) and the International Financial Reporting Standards (IFRS), and there are a number of discrepancies and conflicts between them, which lead to different accounting treatments for the same economic phenomenon in different countries or regions, affecting the quality and comparability of accounting information.The issuance of the 2023 ASU brings the U.S. crypto asset accounting standards closer to IFRS, particularly in the areas of fair value measurement and reversal of impairment losses. This helps to narrow the gap between the two sets of accounting standards and improve the harmonization of international accounting standards. At the same time, it also provides a reference and a model for other countries or regions to formulate or improve the accounting standards for crypto assets, which promotes the development and standardization of the global crypto industry.

References:

[1] International Accounting Standards Board. (2020). IFRS 13 Fair Value Measurement.

[2] International Accounting Standards Board. (2020). IAS 38 Intangible Assets.

[3] KPMG. (2021). Accounting for crypto-assets: A new era of opportunity and challenge.

[4] PwC. (2021). Cryptoassets: Accounting for cryptocurrencies under IFRS.

[5] TaxDAO.(2023). Detailed explanation of the new changes to the accounting rules for cryptocurrencies in the United States.

[6] Li, Hanjun. (2022). Accounting Treatment and Valuation Logic of Cryptocurrency Assets under the [7] International Accounting Standards Framework-Based on the Perspective of Holders and Issuers.

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