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Crypto Accounting Guidance Delivers Mixed Bag of Hope, Questions

May 19, 2022, 8:45 AM

Robinhood Markets Inc. could potentially double its balance sheet when it begins reporting $20 billion of crypto assets held by its platform users on financial statements this summer.

That balance sheet surge for Robinhood and other big crypto players like Coinbase Global Inc. is tied to Securities and Exchange Commission guidance issued in March whichgives companies their first concrete instructions on how to account for the volatile value of cryptocurrencies.

The new staff guidance—which addresses certain digital assets held by platform customers—is drawing some heavy criticism that the SEC excluded the industry and companies from the process, leaving important, unresolved questions about which assets are affected and how to value them.

“It’s a little disconcerting to just get an SAB that just kind of comes out, and who knows if there’ll be another one,” said Kell Canty, CEO of Ledgible, a tax and accounting platform for crypto assets. “There’s only a handful of publicly traded entities that have significant user crypto exposure. So it seems a little premature and scattershot.”

Balance Sheet Impact

Industry backers have been clamoring for at least five years for specific accounting rules that would address the unique economics of investments held in Bitcoin and Ethereum. The narrow guidance—issued as a staff accounting bulletin, known as SAB 121—aims to begin filling that void, providing a stopgap while the US accounting standard-setter crafts a more permanent solution.

Reporting customer assets in the audited financial statements, a key aspect of the new accounting, would tell investors what the company would owe to its customers if those assets were hacked or stolen. Companies would fall within the scope of the guidance if they safeguard users’ cryptocurrencies as a service and if those assets weren’t already on the company’s balance sheet.

Not all trading platforms have consistently disclosed the scale of the risks involved in protecting those holdings.

Paypal Holdings Inc. and Block Inc., the parent of payment processor Square, previously told investors they hold cryptocurrency on behalf of their customers, without specifying how much.

Block told investors in a May 5 SEC filing it will adopt the guidance, which would have increased its balance sheet by $1.1 billion as of March 31. Paypal meanwhile said in an April 28 filing the company still is evaluating what impact the new accounting would have on its corporate reporting.

Robinhood, which detailed its argument to keep the assets off its balance sheet in response to SEC questions last year, and Coinbase previously disclosed the value of those holdings.

Coinbase, the only publicly traded crypto exchange, could add $246 billion worth of its customers’ crypto assets under the guidance, dwarfing the size of its current $21 billion balance sheet. The company said it is reviewing the guidance to determine how it might apply to its financial reporting, according to its quarterly report filed May 10.

In the meantime, the company added new risk disclosures the SEC bulletin calls for and discusses what would happen to all that crypto should the company ever file for bankruptcy.

Robinhood, which said it would apply the new accounting in its second quarter, declined to comment while Coinbase, PayPal, and Block didn’t respond to requests for comment.

Although staff bulletins don’t carry the same weight as a formal regulation, companies generally follow SEC accounting instructions, and auditors will expect their clients to comply with it.

Companies in the IPO pipeline as well as existing public companies—such as banks that might want to get into the crypto transaction business—also would have to comply with the SEC’s de facto requirements. Padding bank balance sheets could trigger capital reserves requirements under federal banking regulations, another potential compliance hurdle for traditional financial institutions.

WATCH: Tax Your Crypto and NFTs? Yes, the IRS Wants Its Cut

Transparency Questioned

Critics of the accounting guidance said it unleashed more thorny accounting questions than it answered and appeared to shut out the industry by issuing direct staff instructions rather than choosing a formal rule-writing process that allows for more public input and debate.

The timing also sparked questions as the bulletin landed just weeks before the Financial Accounting Standards Board agreed to start a project on crypto asset valuations and followed a White House executive order calling on financial regulators to craft workable rules for the emerging crypto marketplace.

“It seems to run a little counter to the more thoughtful, more foundational approach that was mandated by the E.O. that came out,” said Canty, who called the regulator’s approach disappointing.

Addressing how to record and value potential customer-related liabilities was not at the top of the industry’s priority list, he said.

The regulator has fielded a “pretty high volume” of questions related to a wide range of crypto assets, Paul Munter, the commission’s acting chief accountant, told a Baruch College financial reporting conference earlier this month. Addressing platforms’ obligations to its users was one area “where we thought we could be helpful,” Munter said.

Frequent questions from preparers as well as SEC staff tasked with reviewing filings contributed to the decision to provide the relatively narrow guidance, with the aim to better inform investors. In the weeks since the bulletin was published, the market regulator already has handled questions from companies and industry groups, most dealing with the scope of the SEC’s interpretation, a commission official said.

Suzanne Morsfield, global head of accounting solutions for Lukka Inc., an enterprise crypto asset software and data provider, rattled off a string of technical accounting questions the guidance triggered—including whether the user assets meet the definition of a liability and how to treat cryptocurrencies that vary in price on different exchanges.

Those could have been addressed, had the industry been given the opportunity to provide input first through a public comment-and-review process, Morsfield said.

“Why did you start here, and why did you choose this particular path?” she said of her top question for the SEC. “It really seemed like it was a risk that they decided they want some measure of it on the balance sheet, no matter what.”

Risky Business

The SEC also raised eyebrows when it compared assets held by trading platform customers to a type of risky asset a company takes on as part of an acquisition—such as a defective product that could be subject to lawsuits, called an indemnification asset. Under accounting rules for acquisitions, the seller might have to compensate the buyer for any potential future losses related to such assets.

“The SEC is telling us they perceive the risks of the crypto exchanges for holding or safeguarding crypto assets for their customers are very high,” said Vivian Fang, crypto accounting researcher and professor at the University of Minnesota. Some of the hazards the SEC discusses in the bulletin—including technology and regulatory risks—should be borne by the investors, not the exchange, she said.

This month’s collapse of the popular stablecoin Terra, which wiped out as much as $270 billion in market value, underscores the complexity of cryptocurrency investing and the risks involved in the unregulated market.

“This is not a risk-free investment,” Fang said. “We shouldn’t emphasize that Coinbase will catch you as a safety net. That is the wrong impression to give.”

Still, the SEC’s move begins to provide more regulatory clarity to the market and opens the door to treat digital assets more like investments with values that fluctuate over time based on market prices, said Shripad Joshi, senior director and accounting officer at S&P Global Ratings.

Existing guidance, written by an accounting industry task force, compares cryptocurrency to intangible assets such as patents or software and suggested companies should write down the value of cryptocurrencies when their values drop, without the chance to restore the carrying value when prices recover. The SEC’s accounting guidance tells companies to record those user assets based on their fair value, reflecting swings in cryptocurrency prices each quarter.

“Ultimately, I think every investor you ask will tell you there is value in this,” Joshi said. “It’s not like it should be impaired and it’s done.”

To contact the reporter on this story: Amanda Iacone in Washington at aiacone@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergindustry.com; Butch Maier at bmaier@bloombergindustry.com