As cryptocurrencies become more popular and easier to access, many nonprofit organizations are facing the decision to either accept the virtual currency or miss out on substantial donations. Other organizations are weighing the benefit of purchasing cryptocurrency as an investment strategy against the risks associated with its market volatility.
When a nonprofit decides to move forward with the purchase or receipt of crypto assets, one of the immediate considerations will be how those transactions will impact the organization’s financial statement. With no formal accounting standard on crypto assets, the accounting considerations are often just as new and unique to the accounting profession as they are to the recipient organization.
Nonprofits should consider the following as they craft a policy on accepting crypto assets and determine if they should liquidate the assets immediately upon receipt or if the impact would be greater to hold them long-term, similar to an investment.
What is a crypto asset?
A crypto asset is a digital asset that uses cryptography to record, secure and verify transactions on a digital ledger called the block chain, as well as to control the creation of new units of currency. In today’s market, there are several forms of crypto assets, with Bitcoin and Ethereum being the most widely recognized and well-known. Recently, other forms of crypto assets are becoming popular such as non-fungible tokens (“NFT”) to buy and sell artwork and provide proof of ownership.
How are crypto assets accounted for?
Because crypto assets lack physical substance and are not financial assets, they are treated as intangible assets and are recorded at acquisition cost. They are accounted for as indefinite-lived intangible assets and are subject to impairment testing on an annual basis, or more frequently if changes in circumstances indicate it is more likely than not that the asset is impaired.
If impairment exists and it is concluded that the carrying amount of the crypto asset exceeds its fair value, the nonprofit should recognize an impairment loss for the amount equal to that excess. Once the impairment loss is recognized, the adjusted carrying value then becomes the new basis of accounting of the crypto asset.
Once impaired, the organization cannot recover the impaired value until the asset is sold and gain is realized as the difference between the sales price and the impaired value.
Why are crypto assets not treated like other classes of assets?
On the surface, it may appear that cryptocurrency could fall into other asset categories, but upon closer examination, they will most likely not meet any of the following definitions:
- Cash and cash equivalents (i.e. currency) – Crypto assets will not meet the definition of cash or cash equivalents as they are not considered legal tender and are not backed by sovereign governments. In addition, crypto assets typically do not have a maturity date and have traditionally experienced significant price volatility.
- Financial instrument (i.e. investment) – Under Generally Accepted Accounting Principles (GAAP), a financial instrument conveys to the holder of the financial instrument the contractual right to either received cash or another financial instrument from the issuer, or to exchange a financial instrument with the issuer on potentially favorable terms. Crypto assets generally do not meet these conditions. (There are investment vehicles that enable an investor to trade crypto futures and options, that can be considered financial instruments, as they convey the rights listed above.)
- Inventory or commodity – Although crypto assets may be held for sale in the ordinary course of business, they are not tangible assets and therefore do not meet the definition of inventory.
As a result, since crypto assets do not meet the definition of these asset classes and are intangible, they default to being considered an intangible asset with an indefinite life and are therefore subject to impairment review at the end of a reporting period.
Issues with recognizing crypto assets as intangible assets. While “intangible assets” is, by definition, the category best-suited to crypto assets, the treatment has its share of challenges.
- Volatility and impairment – While the better-known crypto assets have tended to increase in value over the past years, there have been major price swings. This leads to questions such as, when is the crypto asset impaired (during the volatility or only at the end of the reporting period)? And is there any subsequent event consideration as the financial statements are getting ready to be issued?
- Auditing considerations – Most crypto assets are used as mediums of exchange, and therefore there are actively traded markets; however, there is no market close. At what point in time on any given day would the crypto asset be valued?
In addition, as these are digital assets that exist in a digital wallet, which can be kept both on a digital exchange (“hot wallet”) or offline (“cold wallet”), are auditors properly trained to audit these assets, as well as the blockchain on which it resides?There are questions such as existence, completeness and even rights and obligations that need to be considered and responded to.
GAAP departure. Rule 203 [sec. 203 par. .01] recognizes that, upon occasion, there may be unusual circumstances when the literal application of GAAP would have the effect of rendering financial statements misleading. In such cases, the proper accounting treatment is that which will render the financial statements not misleading.
In these situations, a modified opinion would be rendered; however, the financial statement preparer would need to evaluate management’s rationale for the GAAP departure.
- If the preparer agrees with management’s assertion that following GAAP would make the financial statement appear misleading, then one would be able to justify a qualified opinion as it would not be considered to be pervasive.
- If the preparer believes that management is making the argument to make their results look better, and the situation is pervasive enough to call management’s integrity into question, an adverse opinion may be warranted.
For a more in-depth description of the different types of opinions, see AU-C Section 705.
Crypto assets have become more readily available and accepted by vendors, and several major governments, such as the US and China, are in the process of examining and creating a digital currency. As such, cryptocurrency donations will become increasingly more common. Until formal guidance is issued, the exchange of cryptocurrency will be laden with uncertainty and compliance risk. Nonprofits should work closely with their CPAs and other advisors to proactively evaluate the technology, compliance procedures and strategies that are needed to position their organizations on the receiving end of this profitable trend.