A Quick Guide to Crypto and Digital Asset Accounting

Cryptocurrency accounting presents an increasing number of challenges to enterprises, companies, institutions, and businesses. While interest in maintaining a balance of digital assets is skyrocketing, among consumers and professionals alike, the lack of clear guidance on how to handle digital assets on your books makes properly understanding crypto accounting an up hill battle.

Companies like Tesla, Square, and MicroStrategy notoriously have large amounts of crypto assets on their books. But that’s only the tip of the iceberg. 

Understanding proper crypto accounting procedures requires properly understanding the challenges that accompany crypto asset data and how this data can fit into US generally accepted accounting principles (GAAP).

The Challenges with crypto data

At their core, fitting crypto data into traditional accounting is like fitting a square peg into a round hole. Without some modification or alteration to the peg or the hole, it just doesn’t work – but what needs to be altered?

Crypto data is highly abnormal, meaning that it assets have non-standard naming conventions, no singular source of pricing data, high volatility in markets, and 24/7 trading, just to name a few.

The challenges around crypto data span two verticals, aggregation and normalization.

First off, in order to be able to properly account for crypto assets, the underlying asset data needs to be aggregated, collected, and compiled. Digital assets are based on the principle of decentralization, meaning that aggregation of data requires novel techniques to traditional assets. While one source may give you transaction data on the surface, it may be lacking pricing data, underlying asset information, or transaction meta data. There are entire business lines that have grown to simply aggregate crypto data for enterprises and institutions.

The second vertical challenging crypto asset data is normalization. After the data is collected, the question shifts to “well, what do we do with it?”

Aggregated crypto data is still highly abnormal, with any number of the abnormal qualities mentioned prior. The data has to go through a normalization process, gently sculpting the square peg of crypto data to be able to fit into the round hole of traditional asset accounting. 

But – crypto accounting would be far easier if there was some guidance and rules to follow. In October 2022, FASB, the Financial Accounting Standards Board, released new guidance addressing digital assets. 

“The Financial Accounting Standards Board (FASB) reached a decision on the measurement of corporate crypto assets, which will mandate the use of fair value of accounting instead of intangible asset accounting.” said Ledgible Sr. Advisor Vivian Fang, “this is a highly anticipated decision that seeks to provide clarity on how public entities in the U.S. should account for their holdings of crypto assets.”

But what does this actually mean for the future of crypto accounting?

Understanding guidance from FASB

As it stands, U.S. GAAP offers no authoritative guidance or rules that specifically address the accounting or disclosure for corporate investments in cryptocurrencies. In fact, on three separate occasions, the FASB rejected requests to set accounting rules for digital assets, citing that they are not pervasive enough to warrant explicit guidance.

In the absence of definitive rules, the Big Four accounting firms and AICPA issued non-authoritative guidance between 2018 and 2019 suggesting that, under the current framework, crypto holdings best fit the definition of intangible assets following ASC 350, Intangibles–Goodwill and Other. However, all parties acknowledged that the accounting treatment recommended by this guidance is not ideal.

With the rise of corporate crypto holdings, the limitation of the prevailing accounting becomes increasingly evident. For example, MicroStrategy Inc. disclosed an impairment loss of $194.1 million on its $1.9 billion of BTC holdings in its 2021 Q1 quarterly report. The company also disclosed sufficient inputs to calculate a total fair value of $5.1 billion for these holdings, or 2.7 times the balance sheet value.  In this case, the use of intangible asset accounting sends mixed signals to financial statement users, as the disclosure of an impairment loss seems to be at odds with significant market appreciation in the same period.

In 2021, the FASB released an agenda consultation that publicly solicited comments on currently debated accounting topics including crypto accounting. The response was enthusiastic, and most commenters recommended that the board considers a fair value accounting approach in treating crypto assets as opposed to a historical accounting approach.

For that reason, this tentative decision made by the board is a very welcomed development by the market, especially given the growing corporate interest in cryptocurrencies and the lack of accounting guidance in the past.

That being said, applying a fair value accounting approach to crypto assets is not as straightforward as one may think. First, unlike stock or bonds which are typically traded on centralized exchanges, most cryptocurrencies are decentralized so it is common to observe discrepancies in their pricing across different exchanges. Take bitcoin as an example: there is simply no standard or global price for bitcoin at any given point of time. As a result, most bitcoin price trackers, such as Google, calculate an average estimate or a recently traded price of bitcoin based on the transaction history of a prominent bitcoin exchange. Thus, in order to improve the comparability in companies’ application of the fair value accounting approach, the board will need to specify the fair value basis for crypto assets more clearly.

Second, not all crypto assets are created equal: while major cryptocurrencies (particularly bitcoin or ether) are mostly liquid and readily convertible to cash, non-fungible and other utility tokens are not always well traded. In fact, during the crypto winters where the market liquidity tends to dry up, some altcoins may not have any trade in a day, making it very difficult to determine their fair value. A recent study by Anderson, Fang, Moon and Shipman (2022) finds that companies with crypto assets, when left unguided before 2018, were more likely to adopt fair value accounting and provide fair value disclosures when the crypto markets were more liquid. This finding suggests that the fair value accounting approach may make sense only when a liquid market exists. Indeed, the Japanese GAAP recommends the use of a fair value accounting approach only for crypto assets traded on active markets but a cost accounting approach for those not actively traded.

While concrete guidance still seems like it’s moving at a turtles pace, how then can professionals account for cryptocurrencies today?

Recording Digital Assets in General Ledger Accounting

We’ve stressed the unique challenges that accounting professionals face when seeking to properly account for digital assets, but at their core, they’re still assets – and thus, basic accounting principles will still apply to them. 

For example, if a business buys digital assets, that asset then needs to be recognized at fair market value. Digital asset accounting professionals will do this by recording a debit for the digital asset purchase to the account. 

If the digital assets were bought through fiat, then the cash account would be credited for the same amount as the fair value purchase of the digital assets. 

When the crypto assets are later sold, the accounting process occurs in reverse. The digital asset is credited to remove it from the balance sheet at the book value, and then the cash account is debited the same amount of the proceeds from the sale, in general.

One challenge often faced here is that the proceeds from the sale could be higher than the book value of the assets in your system. This can be caused by appreciation and/or impairment. In this case, it’s often necessary to create a credit of a capital gain amount, equivalent to the delta between book value and proceeds. 

Generally, as accounting professionals seek to properly record digital assets on their books, they utilize subledger accounting systems specifically designed for crypto asset, like Ledgible, to then connect to their general ledger system. These sub-ledger systems take care of the aggregation and normalization challenges mentioned earlier, automatically.

But this is just one non-prescriptive example, the actual accounting for digital assets can be slightly more complex, like in the scenario of digital assets being used for payments

Accounting for Digital Asset Payments

Paying vendors with digital assets is one of the most common use cases for companies that hold crypto on their books. In this case, the payment is recorded in the exact same manner as it would be if you sold the digital assets. In essence, it counts as a disposal. A capital gain or loss thus then needs to be recognized. Here’s a brief example:

You hold 50 BTC on your books, represented at a fair value of $15,000 per BTC, or $750,000 for the whole lot. However, perhaps the value of BTC since acquisition has gone up to $20,000 per coin, bringing your holdings to a value of $1,000,000. 

Say you make a payment of $1 Million to a vendor, using the bitcoin you hold on your balance sheet. You would record this as a debit of $1 million to the appropriate expense account, then credit your digital asset account the original $750,000 and then credit the $250,000 to a capital gains account. 

From this brief example, you can begin to understand that crypto asset accounting can be a little counterintuitive in actual functionality. 

After getting some brief understanding of crypto accounting principles, the next question might be how crypto accounting is connected to crypto asset taxation.

Connecting Crypto Accounting to Crypto Tax

For traditional assets, we understand that accounting and taxation are industries linked at the hip. However, when it comes to crypto, many of the accounting procedures for digital assets won’t match up 1:1 for tax filing or tax information reporting purposes. 

A  good example of this is presented when we examine unrealized losses. Existing GAAP rules may necessitate journal entries for impairment events, without deductions for unrealized losses on taxes. 

Crypto tax calculation presents its own host of challenges, and having tools in your arsenal that both solve the accounting puzzle as well as solve the crypto tax challenge, like Ledgible does, is essential to maintaining industry standards in digital asset custody, accounting, and taxation.

Making crypto data Ledgible

Ledgible is a SOC 1 & 2 Type 2 audited crypto tax and accounting platform, built for enterprises, institutions, and accounting professionals. Ledgible specializes in making crypto data legible for existing tax and accounting software and workflows, enabling digital assets to fit into the round hole of traditional finance. 

The Ledgible Crypto Platform is a proven crypto asset solution for professionals with leading accounting firms and major crypto companies globally. 

 

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.

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