Cryptographic accounting and decryption of digital assets

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As CFOs and CAOs are now discovering, there is a whole new level of complexity with cryptocurrencies and digital assets beyond volatility. Specifically, GAAP does not yet provide guidance on crypto accounting, leaving many accounting teams in the dark.

Using Tesla’s massive investment in crypto as an example, the company invested $1.5 billion in Bitcoin in February 2021. Just two weeks later, Tesla’s stake had grown to $2.5 billion. , only to drop to $600 million to $700 million soon after, burying the cost base. in a sea of ​​red. Although the company has disposed of most of its Bitcoin holdings at this point, the investment could still present a significant challenge for Tesla accountants.

Luckily for companies like Tesla and the many others in a similar situation, the AICPA filled the crypto guidance void in US GAAP with its Digital Assets Task Force, releasing what quickly became the unofficial gospel on accounting for cryptocurrencies and the like.

At this point, the practice aid of the AICPA is practically indispensable with its discussion, evaluation and examples of different accounting and reporting issues on investing and holding digital assets, even separating its knowledge between non-investment and investment companies.

Search for an asset classification

From a practical perspective, although classifying crypto assets as cash, cash equivalents, or some type of foreign currency may make some sense, an asset can only be money if it is accepted as legal tender and backed by a government.

Similarly, cash equivalents should represent investments that are readily convertible to cash or approaching maturity, resulting in negligible risk to value. And an asset cannot be foreign currency if it does not represent cash.

Unfortunately, you also cannot count them as a regular investment or a financial instrument. In these cases, the digital assets do not represent a contract with a right or obligation to deliver or receive money or another type of financial instrument.

Additionally, while crypto miners willing to sell the assets may consider them a type of inventory, digital assets generally do not meet the definition of inventory because crypto-based assets lack physical substance. .

Accounting for crypto as an intangible asset

Most companies classify digital assets as a type of intangible asset, at least when they buy and own the asset themselves. While still not a perfect fit, they are the best CFOs and GMs by today’s standards because, like crypto, intangibles lack physical substance and have no prescribed lifespan.

Therefore, companies initially record purchases or investments of digital assets at their acquisition cost and, therefore, subject them to annual and trigger-based impairment tests. Needless to say, this opens up a whole new box of financial accounting worms.

Given the constant volatility of these digital assets and the fact that the indefinite-lived intangible asset impairment model allows for impairment in value but not impairment, accounting results may be difficult for some to understand and anticipate. .

As we have seen recently, even a single day of volatility could warrant trigger-based impairment testing and possible impairments for a digital asset. And unlike some financial instruments, the intangible asset impairment framework is not a sustainable impairment model.

Operational Considerations for Crypto Assets

Of course, with such an unregulated feel, holding and accounting for crypto assets is not just about the balance sheet, but also about internal controls and processes. At this point, there are certain best practices that a business should keep in mind to ensure an effective control environment and processes around crypto assets.

Controls over digital keys and wallets

Blockchain transactions are either set in stone or extremely difficult to reverse. Therefore, once you send a transaction to a specific wallet address, you cannot adjust the blockchain input unless the counterparty is actively involved.

In other words, erroneous or inappropriate digital asset transfers could very well lead to permanent loss of digital assets. This makes controls over the initiation and authorization of transactions imperative, extending to controls protecting against lost or stolen private keys that essentially prevent you from accessing a crypto wallet.

Third party assessment

Businesses should consider and understand any risk associated with using a third-party custodian to store digital assets. Keep in mind that a custodian may consolidate assets from different clients at the same addresses while maintaining its own off-chain ledger. This can make it difficult to verify specific assets, or even defeat the whole purpose of using blockchain in the first place.

To avoid such pitfalls, organizations should start by obtaining and reviewing Service Organization Controls (SOC) reports. From there, the focus can shift to designing, implementing, and maintaining controls over information received from an exchange, as well as controls for the protection by a custodian of a company’s assets. .

For example, finance managers need to understand how third-party controls relate to the generation and ongoing security of digital keys used in transactions. Likewise, a custodian should have enough customer onboarding and due diligence procedures in place to avoid any potential legal or non-compliance issues down the road.

Although crypto and other digital assets represent an additional asset class for balance sheet diversification, an investment in crypto obviously poses significant potential risks. Aside from volatility, a company must also consider the lack of accounting guidelines and necessary controls before jumping into the crypto pool.

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