Crypto, AI, and accounting news
Switching gears: a quick dive into hot topics - from Coinbase's crypto accounting to SEC comments on beneficial ownership
I want to deviate from my standard concept of writing a longer, in-depth, data-driven piece about a particular company or trend and highlight several topics and discussions that drew my attention in the past several weeks. More specifically –
A recap of my interview with MarketWatch about Coinbase’s accounting for crypto assets.
A discussion about why depreciation expenses of large cloud providers could be understated.
SEC enforcement of beneficial ownership rules and a potential uptick in SEC comments on 13D and 13G filings.
Coinbase and Block: non-GAAP accounting for crypto assets
Last week, I had an opportunity to discuss two of my favorite topics – non-GAAP reporting and SEC comment letters with MarketWatch. This time, in the context of the transition to a new FASB accounting standard for crypto assets, ASU 2023-08, which requires companies to recognize certain digital assets at fair value on the balance sheet.
The transition to the fair value model received broad support from the stakeholders – including preparers, investors, and audit firms, with 82 out of 83 respondents agreeing that the fair value model "would provide investors with more decision-useful information”. (For additional discussion, see my December 2023 piece.)
So, if the information is useful to investors, why did two major crypto holders - Block (Ticker: SQ) and Coinbase (Ticker: COIN) - remove the re-measurement adjustments in the non-GAAP presentations? The short answer is that the new standard increases earnings volatility because quarterly changes in fair value must be recorded as a gain or loss on the income statement. Before ASU 2023-08, companies used the cost-less-impairment model, reporting crypto assets at the lowest price since the acquisition day.
As I explained to MarketWatch, smoothing earnings by stripping out the impact of new accounting guidance may potentially violate Regulation G because it changes the timing of the recognition of gains and losses, creating a tailored accounting method prohibited by Question 100.04 of SEC’s C&DIs. Additionally, Question 100.01 of C&DIs prohibits removing normal, recurring operating expenses.
Coinbase noted in its non-GAAP section that the Company is stripping impact only for “…gains and losses on crypto assets held for investment, as they do not represent normal, recurring, operating expenses”. On the other hand, Block Inc does not explain why the bitcoin re-measurement adjustment used to arrive at Adjusted Net Income is allowed. Moreover, Block’s definition of Adjusted Net Income does not list the Bitcoin re-measurement adjustment while still listing “bitcoin impairment losses” – an adjustment that is no longer applicable under the fair value model.
AI boom, Nvidia valuation, and lifespans of GPUs
I was reading a piece by Kroker Equity Research that discussed the risks and catalysts of Nvidia’s (Ticker: NVDA) growth model. Oguz Erkan of Capitalist Letters in one of the comments noted that, under an optimistic scenario, the data centers would grow exponentially, and GPUs in those data centers would need to be replaced every four years:
I do not have a take on Nvidia's trillion-dollar valuation question, but this note drew my attention. What is the lifespan of a graphical processing unit (GPU) in the data centers, and how does it compare to the lifespan of a traditional central processing unit (CPU)? This question is important not only for Nvidia but also for understanding CAPEX and the related cash flow of the companies trying to capitalize on the AI tsunami.
A four-year lifespan of a GPU implies a comparable four-year useful life of servers in the data centers. However, in the past several years, large consumers of computational power—including Amazon (Ticker: AMZN), Alphabet (Ticker: GOOGL), Meta (META), and Microsoft (Ticker: MSFT)—have extended the useful life of their servers from four to five or even six years.
The table below describes the impact of changes in the depreciable life of servers for several large cloud providers.
Table 1 – Changes in Depreciable Life for the Years 2022-2024
From an accounting perspective, a change in the useful life of equipment is treated as a change in accounting estimate, and the impact is recorded prospectively. For large companies, holding servers two years longer can give a material boost to the bottom line – for instance, for Alphabet, increasing the useful life of servers from four to six years decreased depreciation expenses by $3.9 billion and increased EPS by $0.24 for the year ending December 31, 2023.
Mark Maurer, citing experts, reported for the WSJ that companies choose to replace servers less frequently because of the slowdown in the technological advancements in releasing new central processing units:
“What’s more, the pace of development in central processing units, which go into servers and personal computers, has slowed in recent years, limiting the improvements companies can make when installing new servers, Mr. Galabov said.”
However, the pace of the technological innovation is increasing for GPUs—at least for now. Nvidia CEO Jensen Huang noted on the Company's Q1 2025 conference call that the Company will release new chips yearly, compared to the previous biannual releases.
If, as the WSJ reported, technological improvements are a key factor in deciding when to replace servers, the lifespan of the GPUs is likely to be shorter than that of the CPUs.
Accounting is, for the most part, reactionary. Changing depreciation policy and recording a multibillion change in accounting estimate requires sufficient historical data and volumes of supporting documentation. Currently, the majority of servers in the data centers of large cloud providers are still likely to rely on traditional CPUs. However, if the mix of the processing units in the data centers shifts toward more GPUs, spreading the cost of servers over six years may lead to understated depreciation expenses and overstated EPS.
SEC enforcement of beneficial ownership – a trend to monitor
SEC comment letters questioning the timing of beneficial ownership reported on 13D and 13G filings are uncommon. Over the years, I've seen only one case of SEC scrutiny over an untimely 13D report – namely, SEC comments to Elon Musk after Musk failed to disclose a stake in Twitter within ten business days after the acquisition. SEC also questioned why Musk opted to Form 13G, which should be used by passive investors, instead of reporting his holdings on Form 13D. Musk didn't respond to the SEC but amended the filing.
On April 5, 2024, the SEC issued comments to Kimmeridge Energy Management Company LLC, inquiring why Kimmeridge did not file a 13D within ten business days after delivery of an acquisition term sheet to SilverBow Resources Inc. in July 2022:
“We note the Schedule 13D filing made by Kimmeridge on September 23, 2022. Please advise us as to why such filing was made one month after August 23, 2022, the date on which Kimmeridge appears to have delivered a term sheet to SilverBow regarding a business combination between SilverBow and an affiliate of Kimmeridge, rather than within 10 days of such date, as then required by Section 13(d) of the Exchange Act and Rule 13d-1 thereunder.”
Kimmeridge responded that the shares of SilverBow were acquired as a passive investment, and the term sheet was part of a preliminary discussion that was not meant to lead to the change in control.
“Kimmeridge is an investor focused on the oil and gas industry and initially acquired its position in the Company in March and early April of 2022 in the ordinary course of its business because it believed the Company’s stock was undervalued and represented an attractive investment opportunity as the Company has historically under-performed its peers. Kimmeridge subsequently sold its entire equity position in mid-April 2022 due to the stock price rising above attractive levels to continue purchases. Following a decrease in the share price, Kimmeridge began re-establishing an equity ownership position in the Company in mid-May 2022, and acquired an aggregate of 3,281,356 shares by mid-July 2022, at which point it ceased any trades in the Company. As such, Kimmeridge filed an initial Schedule 13G under Rule 13d-1(b)(2) - within 10 days of the end of July 2022, the month that its beneficial ownership exceeded 10% as of month end.”
And also:
“The transactions set forth in the August 23, 2022 Term Sheet did not contemplate or include terms which would result in a change of control of the Company, the terms related to the potential purchase by the Company of the membership interests in KTG were it to acquire the Laredo Assets. We also find it notable that the Company and its counsel, Gibson Dunn & Crutcher LLP, were in contact with Kimmeridge and its counsel, Kirkland & Ellis LLP, with respect to the August 2022 Term Sheet and never raised at that time that it was of the opinion that Kimmeridge’s actions, discussions or interactions with the Company were non-passive in any way. Instead, it is only now, more than a year and a half later, in connection with the current proxy contest that the Company has chosen to characterize the initial conversations between Kimmeridge and the Company in 2022 as non-passive conversations in which Kimmeridge was ultimately looking to gain control of the Company.”
Notably, on March 13, 2024, Kimmeridge made an offer to purchase 32.4 million of SilverBow's shares at a price of $34 per share and inject $500 million in capital in exchange for an additional 14.7 million shares. SilverBow Resources rejected Kimmeridge's offer and was acquired by Crescent Energy (Ticker: CRGY) in May 2024.
While SEC’s comments to Kimmeridge may look like a one-off, Corp Fin’s Director Erick Gerding highlighted compliance with the beneficial ownership rules as one of the priorities for the 2024 disclosure review program:
“Beneficial Ownership Reporting
On October 10, 2023, the Commission adopted amendments to modernize the rules governing beneficial ownership reporting.[21] The Division staff is closely monitoring the implementation of these new rules.
The Division staff will review selected beneficial ownership reports to assess compliance with the new, shortened filing deadlines and issue comments as necessary to improve required disclosures.”
Say it differently – we will likely see more SEC comments on 13D and 13G filings.
For questions and data inquiries, please contact olga@deepquarry.com