The second part in the series addresses accounting, tax, and SEC reporting considerations.
As companies consider investing in bitcoin or other cryptocurrencies, their finance and reporting organizations will need to have a clear understanding of the accounting and tax treatments these new assets require.
Prevailing accounting principles were, of course, largely established at a time when digital assets were not yet even contemplated. U.S. Generally Accepted Accounting Principles (GAAP) do not offer specific guidance for the treatment of digital assets, and, to date, the Financial Accounting Standards Board (FASB) has decided not to add a project on accounting for cryptocurrencies. For those reasons, a company’s accounting function must draw on existing U.S. GAAP to facilitate accounting for digital assets.
First, the accounting will be determined by what the company is accounting for. What is it investing in? If a company is not subject to specialized industry guidance, practice has settled on accounting for certain digital assets, like bitcoin, as an “indefinite-lived intangible asset.” That is, it does not meet the accounting definition of cash or a cash equivalent, financial instrument, or inventory.
Here’s the accounting challenge with digital assets being reflected as intangible assets: According to U.S. GAAP, acquired digital assets (intangibles) should be accounted for at cost, subject to subsequent impairment, as appropriate. That means that when the asset is impaired, the company must write down the value on its books. The converse is not true. The value of the asset cannot be written up if the price goes up or if a previously written-down asset subsequently recovers. As a consequence, for accounting purposes, it is virtually impossible to book any ROI on digital assets held as investments.
The accounting rules may present certain constraints: The accounting may not reflect the economics of how a company may value its digital assets.
Absent the ability to mark up the value of its digital asset holdings, if the company believes fair value to be more reflective of the economics of its investment, it has the flexibility to provide disclosures that it believes are meaningful to its investors. For example, the company can provide investors with information about the value of one digital asset (say, a bitcoin), by flagging the price of one bitcoin at a given time on a given exchange. Then again, unlike equities, bitcoins are typically traded on multiple exchanges, and around the clock, seven days a week. Hence, any snapshot of the price can only provide rough guidance. But with the knowledge of the number of coins or other digital assets held, investors can arrive at an approximate determination of the valuation of the company’s digital asset holdings. Note that companies should be mindful of non-GAAP measures when preparing these disclosures.
SEC Reporting and Disclosure Requirements
Absent standard-setting on specific accounting for digital assets, the accounting function draws on various rules and frameworks under the rubric of existing U.S. GAAP. Similarly, the required disclosures need to be drawn from those relevant sections within U.S. GAAP to align with the accounting, resulting in a patchwork of disclosures. For example, the disclosure requirements within ASC 350, Intangibles–Goodwill and Other apply to the digital assets held as an investment. And additional disclosures under ASC 820, Fair Value Measurement would be required for the nonrecurring fair value measurement used to determine impairment of those digital assets. To the extent the company sells digital assets or uses them in its business transactions, additional disclosures would be required.
These disclosures, drawn from various areas of U.S. GAAP, should articulate the accounting to an investor and explain why the digital assets, and related transactions, are presented the way they are in the financial statements. A reader should be able to understand the company’s investment in digital assets. That includes where it is presented on the financial statements and the overall investment strategy. This may require the reporting function to provide additional information and disclosures beyond what’s required to paint the full picture of its investment in digital assets and bridge the gap between what is presented in the financial statements as a result of the accounting and what the company believes is useful information for the reader.
When considering the presentation in the financial statement, there are plenty of potential pitfalls and mere logic does not suffice. For example, one may be tempted to conclude that write-downs on a digital asset are akin to a loss on an investment and hence should be classified as nonoperating income. But because of their treatment as intangible assets, that presentation may not be appropriate or allowed.
Tax Treatment and Challenges: Investment Perspective
The rules governing tax treatment of digital assets do not depend on U.S. GAAP accounting rules and frameworks. One key difference: In accounting, digital assets can only be marked down when impaired (impairment accounting) and not marked up when their value increases; but in tax, such a move only results from an election that may be available to certain dealers or traders whereby the assets are marked up or down to fair value. For tax purposes, gain or loss is normally recognized only when a digital asset is sold or exchanged.
In the U.S., there are two tax accounting methods or treatments that can help account for gains and losses: specific identification (ID) and first in, first out (FIFO).
The specific ID method can be used to determine the cost basis of each digital asset the company is selling or exchanging. That means that every time the company disposes of such an asset, it is specifically identifying the exact units it is selling or exchanging. So how does one specifically identify a digital asset like bitcoin, given that it is deemed to be a fungible asset? By segregating tranches into distinct addresses or wallets. It’s common for investors to develop wallet structures to house different tranches of their digital assets with different cost bases and holding periods. Hence, when it comes time to sell, a given wallet or tranche is readily distinguishable from another, and the relevant information is at hand—date and time each unit was acquired or wallet created; cost basis and fair market value of each unit at the time it was acquired or wallet created; and, finally, the fair market value of each unit when it was sold or exchanged.
Absent the use of the specific ID method and wallet structures, there are very limited ways to distinguish among the different assets. Hence, taxpayers are likely bound to use a FIFO approach. In other words, absent the specific ID information (time, date, cost basis at time of purchase) and an adequately segregated and identified asset, each time a company disposes of a digital asset, the presumption is that the company is disposing of its oldest asset or coin(s). Although complex and sometimes messy, tracking the cost basis versus the current market price is important for both tax and accounting, and even more challenging if the methods used for tax and accounting are not the same.
From a tax standpoint, digital assets held for investment purposes are normally deemed a capital asset. Capital losses can only be used to offset capital gains. So while a company may mark down for an impairment for accounting purposes, tax does not follow that methodology (except in certain limited circumstances relating to an election to mark to market as a dealer or trader in digital assets). Rather, it’s a matter of layering in a deferred tax asset (DTA), which may require a valuation allowance if there are no other sources of capital gains.
So how does this play out in a set of financial statements? Members of a company’s tax function must live and abide by the rules and framework of U.S. GAAP first, and then layer on the tax treatment in terms of deferred taxes.
Tax Treatment and Challenges: Business Transactions Perspective
In addition to considering the investment angle, it’s important to consider the use of digital assets in business transactions, such as fund transfers, paying vendors, and as an accepted form of payment from customers. When used for such transactions, digital assets should be segregated into separate addresses or wallets to maintain a clear distinction between digital assets used in the operation of the business (ordinary assets) and digital assets held for investment (capital assets). Naturally, if digital assets are being used in place of fiat, such actions will generate a gain/loss recognition event for tax purposes under the umbrella of a barter transaction. That’s the case every time digital assets are used in a business transaction. This has a related impact on accounting as well, and the process can become very complex on both fronts.
Accounting for Digital Assets Used for Business Transactions
When companies use digital assets that are accounted for as intangibles for business transactions, such as paying vendors, these transactions will require a different accounting treatment, which is more complex. That is a consequence of the intangible asset now being used as a tangible one—i.e., a financial versus nonfinancial asset. The resulting financial reporting oftentimes doesn’t align or “make sense.” Many have expressed concerns that the financial reporting may be misleading, rather than useful, to investors. That said, more and more mainstream financial services and fintech companies are now offering customers the possibility of holding or exchanging bitcoin.
Outside of the U.S., the treatment of digital assets varies substantially. Accounting under International Financial Reporting Standards (IFRS) may similarly view digital assets, like bitcoin, as intangible assets. However, the intangible asset guidance under IFRS differs from U.S. GAAP. When a company uses digital assets like bitcoin to transfer funds across borders—say, to a foreign subsidiary in Europe—it encounters complexities in other jurisdictions.
The transfer process may involve a number of steps: converting fiat to a cryptocurrency, transferring the cryptocurrency, then reconverting the cryptocurrency to fiat. The benefit, of course, is that such a process avoids bank transfer fees. Yet the act of transferring funds may well have triggered an unrealized gain or loss. And since the subsidiary may not be subject to the same tax and accounting rules as the U.S. parent company, there may be implications in the following areas:
- Gain recognition rules
- Cost basis tracking methods
- Indirect taxes, such as VAT
- Withholding taxes that may apply upon transfer.
The tax and accounting rules are complex but workable. The rules are jurisidiction-specific and may evolve, which requires ongoing monitoring, education and most importantly, understanding the detailed interdependencies of the tax and accounting implications.
Editor’s note: This is the second article in a three-part series. Next up: Part 3 will explore the unique risks involved, as well as custody decisions and organizational challenges.
—by Tim Davis, Global Center of Excellence for Blockchain Assurance leader, Risk & Financial Advisory; Amy Park, blockchain and digital assets specialist, US Audit & Assurance; Ella Bergmann, senior manager, Audit & Assurance; Carina Ruiz Singh, partner, Risk & Financial Advisory; Seth Connors, senior manager, Risk & Financial Advisory, all with Deloitte & Touche LLP; and Rob Massey, Global & US Tax leader, Blockchain and Digital Assets, Deloitte Tax LLP.