The guidance in SAB 121 is specific to companies that safeguard, or custody, crypto assets for their platform users.
SEC Staff Accounting Bulletin (SAB) 121 was released on March 31, 2022.
The bulletin’s purpose was summarized as a way to “[express] the views of the staff regarding the accounting for obligations to safeguard crypto assets an entity holds for platform users.”
Commissioner Hester M. Peirce quickly published a dissent upon its release. Peirce questioned the timing and process of the bulletin, sought to acknowledge the SEC’s role in creating some of the regulatory risks highlighted in SAB 121, and wondered if a bulletin was in fact an appropriate approach to publicly communicate this accounting change.
Below, we’ll discuss the contents of SAB 121 and potential issues it could cause.
What guidance does SAB 121 contain?
In SAB 121, the SEC clarifies their standing that companies who are responsible for safeguarding customer assets must do the following:
- Report the obligation associated with these custody arrangements as liabilities on their balance sheet
- Recognize a corresponding asset “similar in nature to an indemnification asset” as outlined in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 805
- Measure the liability and asset, upon initial recognition and at each reporting date thereafter, at the fair value of the assets being custodied
- Disclose risks related to these custody arrangements to their investors
Importantly, the bulletin requires companies who file with the SEC to comply with this updated guidance by June 2022. More specifically, companies must adopt this guidance for financial statements covering the first interim or annual period ending after June 15, 2022; this includes retrospective application from the beginning of the fiscal year if the date above reflects an interim period.
The SEC felt this guidance was necessary given the increase in the number of companies that are both offering customers the ability to transact in crypto assets and then providing customers services to safeguard those assets. Given the technological, legal, and regulatory risks these arrangements introduce, the SEC believes the guidance provided in SAB 121 will enhance information investors receive as they make capital allocation decisions.
It’s important to emphasize that this guidance is specific to companies that safeguard, or custody, crypto assets for their platform users, and is only likely to apply to digital assets held on behalf of customers—not the company’s corporate holdings of digital assets.
Such companies would include cryptocurrency exchanges and other custody providers as well as any traditional bank or firm holding digital assets on behalf of their clients.
How does SAB 121 differ from current guidance?
Typically, an entity would only report digital assets that it has control over on its balance sheet. The American Institute of Certified Public Accountants’ (AICPA) Digital Assets Practice Aid provides important non-authoritative guidance that many companies have relied upon.
In Question 10, the AICPA states the following in regards to which entity should recognize the digital assets on their balance sheet when a depositor uses a custodian service:
“The digital asset should be recognized on the financial statements of the entity that has control over the digital asset. Determining which entity—the depositor or the custodian—has control of the digital asset should be based on the specific facts and circumstances of the agreement between the depositor and custodian and applicable laws and regulations.”
A company would then be responsible to record the digital assets for which it has demonstrated control on its financial statements. They would be accounted for as intangible assets and follow the prescribed approach outlined in the practice aid which includes analyzing the assets on a regular basis for impairment.
The SEC’s guidance in SAB 121 could reflect a departure from this treatment by requiring companies who custody assets for their users to report a safeguarding liability and asset regardless of whether or not they control those assets.
What accounting issues could arise as the result of SAB 121?
SAB 121 makes the SEC’s position clear; companies who are responsible for safeguarding customer assets must report the asset, and the related obligation to return the asset, on their financial statements.
However, it raises additional questions in practice. The examples below highlight some of these questions:
- One issue is the potential double reporting of assets where, for instance, a single bitcoin (BTC) could be reported on multiple companies’ balance sheets when an exchange holds that BTC for one of its customers, but also safeguards that BTC with another third-party custodian. In this scenario, which is all-but standard in the industry, both the exchange and the third-party custodian could be required to report that BTC on their financial statements.
- Another question is the process and appropriate inputs for valuing certain digital assets, such as unique NFTs, or other long-tailed, thinly-traded assets.
- Companies within the scope of this guidance could be required to utilize multiple accounting models for the digital assets they hold. For example, they would utilize this guidance and report customer holdings, both the asset and liability side, at fair value, while corporate holdings could still fall under the current intangible asset model.
Accounting firms, practitioners, and other entities impacted by this new guidance continue to seek clarification from the SEC on these issues.
Final thoughts
While this bulletin from the SEC is making some accounting teams nervous, other stakeholders are encouraged simply to see the SEC issue guidance specific to digital assets accounting—despite the questions it raises.
While there is much conversation happening around SAB 121, industry participants are hopeful to see continued momentum on the appropriate accounting treatment for digital assets in the months ahead from other standard-setting bodies including the FASB.
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