In the past five years, cryptocurrency has gone from a rare and seldom-used form of currency to a headline-grabbing monetary instrument that has the potential to change the way business is conducted. Misunderstood and often misvalued, cryptocurrency has been the cause of major and minor financial frauds and the collapse of financial institutions trading, or even just holding, cryptocurrency.
Most recently, several prominent banks have announced they are closing shop after experiencing losses directly or indirectly related to the cryptocurrency industry. Silvergate Bank bet heavily on the cryptocurrency industry, eventually becoming known as the “Crypto Bank” and dependent largely on its digital asset deposits. When FTX, the crypto exchange and an important client of the bank, collapsed last November due, in part, to a massive misvaluation of crypto assets, Silvergate found itself facing a bank run. To make matters worse, because of rising interest rates, the bank was forced to liquidate, at a loss, securities held as reserves to fulfill the influx of withdrawals.
When failures like this occur, auditors and accountants are often looked to for answers and for their “deep pockets.” This begs the question, what standards should accountants and auditors employ in valuing cryptocurrencies?
Until recently, some accountants may have been inclined to treat cryptocurrency as a cash equivalent; however, under GAAP, cash equivalents are defined as “short-term, highly liquid investments that are readily convertible to known amounts of cash and that are so near their maturity that they present insignificant risk of changes in value because of changes in interest rates.” Cryptocurrency, however, can be subject to major price volatility that is inconsistent with cash or a cash-equivalent treatment.
Cryptocurrency should also not be considered a financial asset (for fair value through profit or loss) for accounting purposes. A financial asset is defined as cash, evidence of an ownership interest in an entity, or a contractual right to receive cash or another financial instrument from another entity. Digital assets are not cash or debt securities and do not provide an ownership interest in an entity. Further, digital assets do not represent any contractual right to cash or some other financial instrument.
A final alternative is to treat cryptocurrency as an intangible asset. Intangible assets are defined as “assets (not including financial assets) that lack physical substance.”
These types of assets must be tested for impairment, which requires entities to write off as an impairment loss any loss in value of the cryptocurrency at the end of the reporting period. However, if the value of the cryptocurrency increases again, the entity cannot mark up the value. This can cause a huge discrepancy in the representation of cryptocurrency value. In some circumstances it may be acceptable to account for intangibles as inventory. If an entity mines and holds cryptocurrencies for sale in the ordinary course of its primary business, it may, in theory, be appropriate to treat them as inventory.
To date, there are still no final U.S. GAAP rules on cryptocurrency; however, the Financial Accounting Standards Board has recently issued a proposal for the valuation of cryptocurrency. The proposal would require holders of digital assets that fall within the scope of the guidance to measure them at fair value at each reporting period, with changes to fair value reflected in net income.
Specifically, those crypto assets would be presented separately from other intangible assets on the balance sheet, and gains and losses would be recorded as net income each period, separately from changes to carried amounts of other intangible assets. The scope of the proposal includes digital assets that:
- Meet the definition of “intangible assets;”
- Do not provide the asset holder with enforceable rights to, or claims on, underlying goods, services or other assets;
- Reside or are created on a distributed ledger based on blockchain technology;
- Are secured through cryptography;
- Are fungible; and,
- Are not created or issued by the reporting entity or its related parties.
This proposal was issued on March 23, 2023, and comments on the proposal are due on June 6, 2023.
Although FASB is currently working hard on standards for the accounting of cryptocurrency, without any final U.S. GAAP rules on cryptocurrency, accountants should be mindful of ensuring proper disclosure of the valuation principles being employed and ensuring the financial statements are not misleading.
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