Valuing Cryptocurrency and Digital Assets
by Kenneth A. Heaslip, CPA, CGMA, MBA, MS, Cullari Carrico LLC –
June 8, 2023
As more companies invest in digital assets, they are looking to CPAs to help them with the accounting treatment — and CPAs are looking for guidance on how to audit such investments. To date, there has been little authoritative guidance on the issue.
While the profession awaits formal accounting guidance from the Financial Accounting Standards Board (FASB), the American Institute of CPAs (AICPA) established the Digital Assets Working Group. The Group has issued nonauthoritative guidance for accountants and auditors: a 2020 comprehensive practice aid and subsequent periodic updates. The most recent aid — which can be accessed by AICPA members for free at aicpa.org — was issued Feb. 28, 2023, and is 81 pages long.
On March 23, 2023, the FASB issued a much-anticipated exposure draft proposing standards for the treatment of crypto assets. Comments are due by June 6, 2023, and it is hoped the final standard will be issued by year end.
Accounting Treatment
When the AICPA assessed the accounting treatment, they addressed several questions:
- What type of asset is a digital asset?
- Should it be carried at cost or fair value?
- How should impairments be determined?
While most people consider cryptocurrency to be an investment, there are significant differences between financial instruments and digital assets. The primary difference is that financial instruments are backed by a government or business entity. The entity has revenues, income and net assets that support the instrument’s value. Digital assets do not provide the asset holder with any enforceable rights to, or claims on, underlying goods, services or other assets. For that reason, digital assets are classified as intangibles.
Under Generally Accepted Accounting Principles (GAAP), intangibles are valued at cost, those with a useful life are amortized over its life and they are tested annually for impairment. This has led the AICPA to conclude that digital assets would be treated the same; since there is an indefinite life, they should not be amortized. When impairments are recognized, the asset should be written down and recovery of impairments will not be allowed.
When the FASB took on the digital asset project, it quickly realized that not all digital assets are the same. They decided to limit the project to fungible assets, not address nonfungible ones, and to rename the topic as crypto assets. Fungible is defined as an item that is readily interchangeable with an identical item at a transparent rate. Under this definition, nonfungible assets such as nonfungible tokens (NFTs) are not within the scope of the exposure draft. For NFTs, accountants should continue to use AICPA guidance. The FASB’s proposal follows the AICPA conclusion that crypto assets should be recorded as indefinite-lived intangible assets. However, unlike other intangibles, they will be presented at fair value, limiting the need for impairments.
The FASB proposes that any changes in fair value of crypto assets be recognized in net income. Transaction costs to acquire them would be treated as an expense when incurred unless applicable industry-specific guidance requires capitalization of such costs. Crypto assets must be presented separately from other intangible assets on the balance sheet, and changes in fair value are to be shown separate from other intangibles on the income statement.
The FASB recognizes that there will not be many changes to the statement of cash flows, but if crypto assets are received as noncash consideration in the ordinary course of business and converted immediately into cash, the transaction should be recorded as cash flow from operating activities.
The exposure draft provides for disclosures of the nature of the crypto asset, the presentation of fair value and cost either in the aggregate or individually, depending on the materiality. Any restrictions should be disclosed, and rollforward information will be required. The disclosures should disclose the line item in the income statement where gains and losses are presented. Finally, the disclosures should include the difference between sale price and the cost basis as well as a description of the activities that resulted in the disposition and the method for determining cost basis.
The new standard will apply to all entities, and the implementation date has not been determined. Cumulative-effect adjustments to retained earnings will be necessary as of the beginning of the annual reporting period of adoption.
Auditing Issues
Auditing has unique challenges. The nature of digital assets makes it difficult for an auditor to confirm their existence, value the less-traded assets and determine internal controls. The demise of FTX Trading Ltd. is a perfect example of the risks associated with audits. In that case, entities deposited their cryptocurrencies with FTX for secured holding. FTX regularly reported portfolio status to their depositors. The controls and reporting turned out to be poor and false. FTX comingled depositor assets with that of their own, improperly withdrew the deposits and lost millions of dollars in depositor assets. To date, it has not been determined who took the assets and where they are now. Any confirmations offered by FTX are unreliable.
For entities that choose to hold the assets in their own wallets, it is not practical to obtain third-party verification of the assets due to the secrecy of the blockchain method of storing the assets.
The AICPA states that audit risks should be addressed in client acceptance and continuance, risk assessment and processes and controls, laws and regulations and related parties. Their guide is a comprehensive approach for auditors. It consists of the following:
- Overview
- Auditor skill sets and competencies
- Management skill sets and competencies
- Management integrity and overall business strategy
- Processes and controls, including information technology
The AICPA document is titled as an aid for auditors, but it also has implications for nonattest services offered by practitioners. Practitioners should evaluate self-review, management participation and advocacy threats before accepting a client.
Auditors need to stay apprised of regulatory, industry, technological or financial reporting developments. In particular, they should identify relevant professional standards that apply to the engagement. The firm should maintain a competent staff at all levels. Risks should be adjusted as new issues are identified, and training should be continuous.
Firms should develop specific procedures that will address the many challenges in digital assets. The procedures should encompass all areas such as identifying policies and procedures, building awareness among firm personnel, communication, training and quality control.
The AICPA practice aid is an excellent tool for any entity with digital assets and firms that service those entities. It is thorough and offers a framework for firm quality control procedures. The document is an important non-authoritative tool. The FASB’s proposed changes will be welcomed by many stakeholders, but until the ASU is issued, the provisions in the draft are not GAAP and should not be implemented.
 | Kenneth A. HeaslipKenneth Heaslip, CPA, MBA, MS, CGMA, is a director at Cullari Carrico, LLC, managing member of Kenn Heaslip Seminars LLC and a lecturer at Queens College. He is a member of the NJCPA and can be reached at kheaslip@comacast.net. Learn more from Kenneth A. Heaslip: |
This article appeared in the Summer 2023 issue of New Jersey CPA magazine. Read the full issue.