As CFOs and CEOs are now realizing, there is a new level of complexity to cryptocurrencies and digital assets beyond volatility. In particular, GAAP does not yet provide guidance on accounting for cryptography, leaving many accounting teams in the dark.
Taking Tesla's massive crypto investment as an example , the company invested $1.5 million in Bitcoin in February 2021 . Two weeks later, Tesla's stock rose to $2.5 billion, before falling from $600 million to $700 million soon after, due to expenses. In a sea of red, even though the company has since sold most of its bitcoin holdings, the investment could still be a major challenge for Tesla's accountants.
Fortunately for Tesla and other companies in similar situations, the American Institute of CPAs, along with its Digital Assets Task Force, filled the gap in US GAAP cryptographic guidance, quickly showing that it is the authoritative gospel for cryptocurrency accounting practices and therefore similar.
At this point, the practical support of the AICPA is essential with discussion, overview and examples of various accounting and reporting issues related to investment and ownership of digital assets, although their methods differ between non-investment and investment firms.
Finding the distribution of wealth
While it makes practical sense to classify crypto-assets as cash, cash or foreign currency, if the asset is accepted as legal tender and backed by a government, it can be cash.
In addition, cash equivalents must be short-term investments that are readily convertible to cash or have a lower value. And wealth cannot be a foreign currency if it does not represent money.
Unfortunately, you can't treat them like regular investments or financial instruments. In this case, the digital asset does not have a contract or other type of financial instrument that has the right or obligation to pay or receive cash.
While crypto traders looking to sell assets may consider them a form of inventory, digital assets generally do not meet the definition of inventory as crypto-based assets have no physical substance.
Sign up for Crypto as an intangible asset
Most companies classify digital assets as some sort of intangible asset, at least when they purchase and own the asset. While the best CFOs and CEOs are still not perfect by today's standards, the best CFOs and CEOs are intangible assets like crypto that have no physical substance and promise longevity.
Therefore, companies initially record acquisitions or investments in digital assets at cost and therefore conduct annual trigger-based impairment tests . Needless to say, this opens up entirely new possibilities for financial accounting.
The constant volatility of these digital assets – and the fact that the indefinite-lived intangible asset impairment model reduces but does not offset – accounting results can be difficult to understand and predict.
As we've seen recently, even date volatility requires trigger-based damage tests and vulnerability losses for digital assets. And unlike some financial instruments, the intangible asset impairment system is not a temporary impairment model.
Practical Considerations for Crypto Assets
Of course, with this sense of control, the storage and accounting of crypto-assets is not only about balance sheets, but also about internal controls and processes. To that end, there are some best practices that a company should follow to create an effective regulatory environment and process for crypto holdings.
1. Manage keys and digital wallets. Blockchain transactions are either set in stone or very difficult to undo. So when you send a transaction to a specific wallet address, you cannot change the blockchain record unless the counterparty actively participates.
In other words, incorrect or improper transfer of digital assets can lead to the permanent loss of digital assets. This makes transaction initiation and authorization controls necessary to control the loss or theft of private keys, essentially locking down your crypto wallet.
2. Third Party Reviews. Organizations should consider and understand all the risks associated with using third-party custodians to store digital assets. Note that if a custodian maintains its own ledger offline, it may commingle different client assets at the same address. This can make it difficult to verify certain assets and even defeat the purpose of using blockchain in the first place.
To avoid this waste, companies should start collecting and evaluating service organization control (SOC) reports. The focus can then shift to developing, implementing, and maintaining security controls related to the information shared. The assets of the company belong to the parent company.
For example, CFOs must understand how third-party controls relate to the creation and ongoing security of digital keys used in transactions. A custodian should have client onboarding and due diligence procedures in place to avoid future legal or compliance issues.
Clearly, while crypto and other digital assets represent an additional asset class for diversified portfolios, there are significant risks associated with crypto investments. In addition to volatility, the company must consider the lack of accounting policies and necessary controls before entering the crypto pool.