The Rise and Impacts of Digital Asset Use: Through the Eyes of the Accountant
June 9, 2023
Authors: Graham Michitsch, Senior Manager, Risk & Accounting Advisory Services | Louis Liu, Manager, Risk & Accounting Advisory Services
Digital assets and the underlying technology have taken the marketplace by storm in recent years and accountants are not immune. Whether implementing for increased efficiency, new product or service offerings, added security measures or supporting new business models, it is quickly becoming vital that the accountants understand the importance, impacts and the associated risks with adopting various digital asset and crypto technologies.
Digital Asset Adoption
Companies are increasingly incorporating digital asset technologies for a variety of reasons, including efficiency gains, increased transparency and added security. Digital assets can be transferred across borders and settle transactions faster than traditional assets, reducing cost and increasing efficiency. Related to increased security, they are underpinned by cryptography and allow the same information to be distributed and captured across multiple and immutable sources of records. The use of the technology can also provide access to new sources of capital and support overall marketplace innovation, such as the emergence of decentralized finance (DeFi) technology.
However, such adoptions have led to unprecedented accounting and financial reporting challenges for those that have already made the transition – such as contract analysis to determine if the crypto payment should be treated as a non-cash consideration under ASC 606, or what constitutes as a taxable event when wrapping and vaulting Bitcoin1. Companies wishing to embrace these new tools need to carefully evaluate the specific requirements and potential downstream ramifications such as how to properly account for the specific transaction and what potential exposures it creates.
Companies are becoming extremely sophisticated and those leveraging DeFi technology can cause unseen, added complexity with accounting, reporting and tax compliance matters. Due to the growing size of blockchains, related bookkeeping complexities and the expectation to produce accurate recordkeeping, there is now an underlying necessity to incorporate crypto specific software solutions and compliance programs to support these initiatives, if not implemented already. Additionally, companies may also need to reevaluate the underlying processes, and supporting tools and workflows that are posed to incorporate the use of digital assets such as month-end close, reporting and compliance to successfully incorporate these added needs.
Evolving Regulatory Landscape
Along with disrupting the operational processes, digital assets also had unpresented and profound impacts on the accounting and reporting guidance. Currently, companies who report crypto assets on their balance sheet are required to follow ASC 350-60 guidance, relating to intangible assets and the cost-less-impairment model. However, based on the feedback from respondents to the 2021 FASB Invitation to Comment related to Accounting for and Disclosure of Crypto Assets, applying that model has its limitations and does not provide users of their financial statements with decision-useful information. For one, the current guidance reflects only decreases, but not increases, in the value of crypto assets until sold, which limits the underlying economics of those assets as well as the Company’s actual financial position.
As a result, in March 2023 FASB issued the Proposed Accounting Standards Update (ASU) related to ASC 350-60 and the accounting for and disclosure of crypto assets that improves the accounting and disclosure of certain crypto assets to better reflect the economics, but also potentially reducing cost and complexity associated with applying the current model. Under the updated guidance, entities would measure certain, but not all, crypto assets at fair value and recognize changes in fair value in net income within their reported financials. There is more to come on the timing and impacts of the new guidance as the effective dates will be decided in future deliberations for a final ASU.
In addition to the reporting and disclosure changes, there are additional custody and risk mitigation measures companies may need to adopt. Specifically, the SEC proposed RIN 3235-AN08 related to Cybersecurity Risk Management for Investment Advisers, Registered Investment Companies and Business Development Companies that requires companies to adopt and implement written cybersecurity policies and procedures to address risks related to digital assets, requiring companies to have mature internal reporting processes. Due to the nature of the proposed implications and considering other regulatory developments in cybersecurity, the SEC reopened the comment period for the Investment Management Cybersecurity Release until May 22, 2023.
The regulations only get better if you are a company that takes custody of digital assets on behalf of customers as the SEC published Staff Accounting Bulletin 121 (SAB 121), which expresses their view on an entity’s obligation to safeguard crypto assets for another party. The objective of SAB 121 is to “enhance the information received by investors and other users of financial statements about these risks, thereby assisting them in making investment and other capital allocation decisions,” but that proposition presents unique technological, legal and regulatory risks and uncertainties, as well as additional reporting and compliance processes that companies will have to navigate.
Most recently, the International Organization of Securities Commissions (IOSCO) issued the first global attempt at regulating crypto and digital assets (excluding DeFi) with their proposed release of 18 policy recommendations. The recommendation and approach intend to cover a variety of topics including conflicts of interest, market manipulation concerns, cross-border regulatory cooperation, custody and treatment of retail customers. There is a public comment period open through the end of July 2023, with the intent to finalize the proposals as early as Q4 2023.
Increased Risks Operating With Digital Assets
Apart from the evolving regulatory landscape and due to major incidents making headlines, there is increasing scrutiny surrounding the disclosure of cybersecurity risks and incidents. If companies fail to implement crypto asset cybersecurity measures, they may become victims of cybersecurity attacks themselves. Vulnerable targets may include companies that are operating with digital assets but have not gone through the process to fully understand the risks, exposures and required mitigation processes to be established.
It is common practice by now for companies to use cold storage to segregate and monitor its digital assets, only use trusted devices and networks, and enforce blockchain-specific security and controls, but without advanced defensive techniques like robust internal and external cybersecurity architecture, companies are still vulnerable to attacks and potential losses. When constructing the proper control environment, companies can also explore certain risk management steps, such as commercially available insurance products for digital commodities to help mitigate unexpected losses on Bitcoin, or other digital commodities held in cold storage or across multiple institutions and custodians.
Additional Accounting, Tax and Compliance Requirements
As mentioned above, the emergence of digital assets has ushered in a new wave of disruptions, created new opportunities and potential uncertainties for accountants. Due to the unique nature of the evolving industry and associated technology, there is currently no AICPA authoritative guidance on how to properly address and account for every crypto and DeFi transaction, which leaves company accountants left to establish their own protocols and applications while complying with all the necessary regulations.
These activities and related accounting and tax questions are complicated, so companies engaged in various arrangements must have department leaders that are well versed in the proper accounting treatment, and tax implications and exposures created by their activities, as well as the related recordkeeping obligations to support U.S. tax return and financial statement reporting. It is clear that the use of the proper accounting, and tax software and partner is imperative to support these activities, produce accurate financial statements, and establish justifications and positions for tax perspectives.
How Cherry Bekaert Can Help?
It is clear that digital assets, such as Bitcoin, are not merely a passing fad, but a significant innovation with potentially serious implications for the future of commerce, economies, investment, global finance and accountants. Cherry Bekaert’s Accounting Advisory, Tax and Cybersecurity professionals are at the forefront of the digital assets and cryptocurrency landscape. Let us help you explore the digital asset adoption readiness process to understand the accounting, financial and operational considerations, including the required compliance, workflows and security measures needed to embark on this journey. Reach out to your Cherry Bekaert advisor or a member of our Accounting Advisory practice.
1The term “Bitcoin” with a capital “B” is used here and throughout to refer to the system of cryptography and technology that produces the currency “bitcoin” with a lowercase “b” and verifies bitcoin transactions.