Published:
Feb 2, 2024
Updated:
February 13, 2024
Crypto Assets and Fair Value Measurement
Discover the impact of the Financial Accounting Standards Board's ASU 2023-08 on crypto asset accounting and disclosure. Learn how this update addresses fair value measurement, transparency, and international reporting consistency, shaping a more accurate depiction of crypto asset economics and financial reporting practices.
Introduction
In December 2023, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU), ASU 2023-08, addressing the accounting for and disclosure of crypto assets. Before the inception of ASU 2023-08, it was standard practice for companies and auditors to use ASC 350 as a guide for measuring crypto assets as indefinite-lived intangible assets on financial statements. Under the indefinite-lived intangible asset classification, companies held crypto assets on the balance sheet at historical cost and regularly evaluated those assets for impairment using the fair value framework in ASC 820. In accordance with ASC 350, whenever the price of a crypto asset dropped below its carrying amount, the company was required to recognize an impairment expense and reduce the asset’s value.
Holding crypto assets as indefinite-lived intangible assets only allowed for the crypto assets to be written down on the balance sheet; thus, any appreciation in the value of a crypto asset, whether occurring before or after impairment, remained unaccounted for on the balance sheet until the asset was sold. Consequently, this approach often resulted in the undervaluation of crypto assets on the financial statements as practically all companies would recognize the impaired asset at lower than cost and lower than market value. Thus, industry experts argued that this measurement method failed to accurately depict the economic reality of crypto assets, as it neglected to reflect fair values.
In response to these concerns, the FASB addressed the lack of accounting standards on crypto assets by issuing ASU 2023-08. These improvements will better reflect the underlying economics of crypto assets and give investors more decision-useful information.
Methodology
ASU 2023-08 specifies that qualifying crypto assets must be measured and disclosed at fair value, subject to the requirements explained below. Fair value is defined in ASU 2023-08 as “[t]he price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This methodology allows both increases and decreases in the value of a crypto asset to be reflected in net income. The transaction costs of acquiring a crypto asset, such as commissions and other related transaction fees, are expensed as incurred unless an entity capitalizes those costs in accordance with industry-specific guidance. Companies must use the appropriate principles outlined in ASC 820 to determine fair value.
Scope
The amendments in ASU 2023-08 apply to assets that meet all the following criteria:
1. Meet the definition of intangible assets as defined in the Codification.
The US GAAP (Generally Accepted Accounting Principles) Codification states that intangible assets are “assets (not including financial assets) that lack physical substance. (The term intangible asset refers to intangible assets other than goodwill).” Crypto assets that do not meet the definition of intangible assets as defined in the Codification include the following:
- Cash: A crypto asset may qualify as cash if it is accepted as legal tender and issued by a government. In 2021, El Salvador embraced the cryptocurrency Bitcoin as a legal tender, thereby classifying Bitcoin as cash in El Salvador.
- Cash equivalents: A crypto asset may be a cash equivalent if it is short-term, highly liquid, and redeemable with the issuer. While cryptocurrencies like Bitcoin and Ethereum have gained recognition as forms of payment, they do not fit the definition of cash equivalents because their values can be highly volatile.
- Financial instruments: Financial instruments include contracts that impose an obligation on one party and convey a right to another party to deliver/receive cash or another financial instrument. If a crypto asset provides a contractual right to receive cash or another financial instrument, it would be classified as a financial asset.
2. Does not provide the asset holder with enforceable rights to or claims on underlying goods, services, or other assets.
Wrapped tokens, also known as tokenized or synthetic assets, may expose holders to underlying goods, services, or assets. These tokens are typically generated by collateralizing or “wrapping” an existing asset and representing it on a blockchain as a token. Consequently, wrapped tokens contain a contract that has an underlying asset. Since wrapped tokens grant the asset holder rights to underlying assets, services, or goods, they fall outside the scope of ASU 2023-08. As a result, an entity may need to use the traditional intangible asset model to account for wrapped tokens.
3. Are created or reside on a distributed ledger based on blockchain or similar technology.
4. Are secured through cryptography.
5. Are fungible.
Fungibility refers to the capacity of individual units of a specific asset to be interchangeable and indistinguishable. In contrast, non-fungible assets are unique and lack interchangeability, with each unit possessing distinct properties or attributes. Non-fungible tokens (NFTs) are classified as non-fungible because they typically represent ownership or proof of authenticity of a unique item or piece of content, such as artwork, music, tweets, or memes. Since these items are not interchangeable, NFTs are excluded from the scope of ASU 2023-08.
6. Are not created or issued by the reporting entity or its related parties.
ASU 2023-08 does not extend to crypto assets that the reporting entity (or its related party) has issued or created, even if those entities have acquired the crypto assets from an unrelated third party. Such crypto assets must adhere to the traditional intangible asset model for accounting. However, Paragraph 17 of the Basis for Conclusions of ASU 2023-08 states that a reporting entity engaged solely in the mining or validation process - which subsequently receives newly created crypto assets as compensation for services - is not regarded as the creator of the received crypto assets. Therefore, such assets can be accounted for within the scope of ASU 2023-08.
Crypto assets are often mined with the intent to sell them and, therefore, may meet inventory characteristics. Thus, broker-dealers subject to ASC 940, Financial Services – Brokers and Dealers, might consider their crypto asset holdings as inventory and account for them as such.
Disclosures
ASU 2023-08 outlines specific disclosure requirements for crypto assets in financial statements. Entities must disclose details for significant crypto asset holdings during annual and interim reporting periods, including name, cost basis, fair value, and number of units. Entities must also disclose aggregate cost basis and fair value for non-individually significant assets.
For annual reporting, entities must disclose the method used to determine the cost basis of disposed crypto assets and the income statement line item for gains and losses. An annual reconciliation of aggregate crypto asset holdings, covering additions, dispositions, cumulative realized gains/losses, and gains/losses in net income, is required. Net gains or losses should be presented in the appropriate reconciliation line.
Entities with crypto assets under contractual sale restrictions must disclose fair value, nature, remaining duration of restrictions, and circumstances for the potential lapse of the restrictions as of the balance sheet date. These comprehensive disclosures aim to enhance transparency and understanding of financial reporting related to crypto assets.
Adoption Timeline
While early adoption is permissible, ASU 2023-08 takes effect for fiscal years beginning after December 15, 2024, including interim periods within those fiscal years. Upon adoption, entities are required to record a cumulative effect adjustment to retained earnings as of the beginning of the annual adoption period. Retrospective restatement for prior periods is not required or permitted. This adjustment may lead to a significant increase in retained earnings for many companies with undervalued crypto assets on their balance sheets.
A tax warning has been issued by Deloitte that emphasizes a potential consequence of the increase in retained earnings under certain circumstances. Specifically, such an increase in retained earnings may be classified as adjusted financial statement income (AFSI), subjecting it to the 15% corporate alternative minimum tax (CAMT). The impact of CAMT requires the company to calculate its tax liability under both the regular corporate income tax system and the CAMT system, subsequently obligating the payment of the higher of the two tax liabilities. This cautionary note emphasizes the importance for entities to assess the tax consequences linked to the adjustments made during the adoption of ASU 2023-08.
IFRS vs US GAAP
International Financial Reporting Standards (IFRS) do not prescribe a specific methodology for measuring and disclosing crypto assets. Given the unique nature of cryptocurrencies, the most common approach is to classify them as intangible assets under IAS 38, except when they are within the scope of another standard (i.e., IAS 2, IAS 32). This classification is based on the fact that crypto assets meet the definition of an intangible asset as identifiable non-monetary assets with no physical substance. According to this treatment, crypto assets are initially measured at cost and subsequently measured using one of two options discussed below: cost model or revaluation model.
Under the cost model, companies measure their crypto holdings at cost less impairment losses and amortization, similar to US GAAP requirements before the inception of ASU 2023-08. Any impairment triggers expense recognition and a corresponding write-down of the crypto asset’s value on the balance sheet. Conversely, the revaluation method allows companies to recognize crypto holdings at fair value only if an active market exists. This approach requires companies to track the original cost and record any movement below cost in net income, whereas companies must record any movement in value above cost in other comprehensive income.
Before the introduction of ASU 2023-08, the cost approach was popular among companies needing to comply with both IFRS and US GAAP reporting requirements. Employing the cost approach for IFRS enabled these companies to adhere to both sets of standards without altering accounting methodology; however, the prevailing and preferred methodology among companies adhering to only IFRS was revaluation, where crypto assets are recognized and measured at fair value. As the IFRS revaluation model aligns with fair value measurement in ASU 2023-08, companies subject to both IFRS and US GAAP reporting requirements will likely opt for revaluation under IFRS for consolidated and statutory reporting consistency.
Conclusion
ASU 2023-08 represents a significant stride towards a more accurate and transparent depiction of the financial landscape of companies holding crypto assets. The transition to fair value measurement enhances immediacy in capturing market fluctuations and provides stakeholders insight into the underlying economics of crypto assets. Additionally, aligning with IFRS guidance on measuring crypto assets establishes a more consistent approach across international reporting frameworks.
ASU 2023-08 significantly amplifies the importance of the methodology employed in calculating fair values and the inputs applied in those measurements. As a result, there will be heightened discussion surrounding how crypto assets align with ASC 820 fair value measurement. This shift responds to the evolving nature of the crypto asset market and underscores the need for entities to refine their approaches to ensure accurate and comprehensive financial reporting. Overall, ASU 2023-08 resolves the complexity from a lack of defined standards and sets the stage for a more robust and informed understanding of the financial implications associated with crypto assets.
Resources Consulted:
https://www.journalofaccountancy.com/news/2023/dec/fasb-issues-new-cryptoassets-standard.html
Footnotes
Feb 2, 2024