The SEC published Staff Accounting Bulletin (SAB) No. 121 to provide the staff’s views about the accounting for obligations to safeguard crypto assets that a firm holds for platform users.
In the staff’s view, the actions undertaken by the platforms to protect users’ assets represent a liability. At the same time, however, the platforms can recognize the assets when recognizing the safeguarding liability using fair value measurements.
The staff prepared the interpretive guidance as there has been an increase in the number of platforms where users can carry out crypto-asset transactions. The platform companies safeguard their users’ crypto assets and may also maintain the cryptographic key information for access to the assets.
“The obligations associated with these arrangements involve unique risks and uncertainties not present in arrangements to safeguard assets that are not crypto-assets, including technological, legal, and regulatory risks and uncertainties,” stated SAB No. 121, published on March 31, 2022.
“These risks can have a significant impact on the entity’s operations and financial condition,” the staff guidance explains. “The staff believes that the recognition, measurement, and disclosure guidance in this SAB will 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.”
The staff added Section FF to Topic 5, Miscellaneous Accounting, of the SAB series, and the staff interpretive guidance is applicable to entities that are regulated by the SEC.
Section FF describes a business situation in which Company A that operates a platform and safeguards users’ crypto-assets. Company A also has internal record-keeping of the amount of the assets held for each platform user. The company secures and protects the assets from loss or theft, and any failure to do so will expose the company to significant risks, including risk of losing money.
Users can request Company A to transact in the crypto-asset on their behalf—such as sell and get cash proceeds—or to transfer the asset to a digital wallet for which Company A does not maintain the cryptographic key information.
SAB No. 121 answers three questions related to this particular business situation, including one about why the staff believes Company A should account for its obligations to protect the crypto assets as liabilities on its balance sheet.
Staff’s Rationale
The staff notes that the ability of the users to obtain future benefits from crypto-assets in digital wallets where Company A holds the cryptographic key information depends on the actions of Company A to safeguard the assets. The actions include securing and protecting the assets and the crypto key from loss, theft, or other misuse.
“As Entity A’s loss exposure is based on the significant risks associated with safeguarding the crypto-assets held for its platform users, the staff believes it would be appropriate to measure this safeguarding liability at initial recognition and each reporting date at the fair value of the crypto-assets that Entity A is responsible for holding for its platform users,” SAB No. 121 states. “The staff also believes it would be appropriate for Entity A to recognize an asset at the same time that it recognizes the safeguarding liability, measured at initial recognition and each reporting date at the fair value of the crypto-assets held for its platform users.”
SAB No. 121 said that Entity A should include clear information in the notes to the financial statements about the nature and amount of crypto-assets it is responsible for holding for its users, with separate disclosure for each significant crypto-assets. Entity A should also disclose the vulnerabilities arising from any concentration of such activities.
Moreover, Entity A should include disclosures about fair value measurements.
“In providing these disclosures, Entity A should consider disclosure about who (e.g., the company, its agent, or another third party) holds the cryptographic key information, maintains the internal recordkeeping of those assets, and is obligated to secure the assets and protect them from loss or theft,” stated the staff interpretive guidance.
SAB No. 121 says that disclosures related to the risks and uncertainties of holding users’ crypto assets may be required outside the financial statements.
Entity A, for example, may need to disclose the types of loss or additional obligations that could occur, including loss of customers and reputation, litigation, and enforcement action.
“A discussion of the analysis of the legal ownership of the crypto-assets held for platform users, including whether they would be available to satisfy general creditor claims in the event of a bankruptcy should be considered,” SAB No. 121 states.
Entity A should start applying this guidance to financial statements covering the first interim or annual period ending after June 15, 2022, with retrospective application as of the beginning of the fiscal year to which the interim or annual period relates.
“Entities should include clear disclosure of the effects of the initial application of this guidance,” SAB No. 121 states.
This article originally appeared in the April 5, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.
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