New Accounting for Crypto Assets - What About Non-GAAP?
On September 6, 2023, the Financial Accounting Standards Board (FASB) voted to adopt a new rule, changing the accounting and disclosure for crypto assets from the current cost-less-impairment model to a fair value model. The standard is expected to go into effect in 2025, and early adoption is permitted. (Bloomberg and WSJ provided good overviews of the upcoming rule.)
Early this year, FASB requested comments on the proposed standard. The shift to the fair value model was widely supported by preparers, investors, and audit firms, with 82 out of 83 responders affirming that the fair value model “would provide investors with more decision-useful information”. However, the fair value accounting is bound to introduce volatility into quarterly earnings because crypto asset holders would be required to record quarterly gains and losses on the income statement.
In a LinkedIn thread, an interesting discussion developed between Francine McKenna, author of The Dig, who consistently writes about crypto accounting, and Professor Alan Jagolinzer of the University of Cambridge Judge Business School, about a possible way to overcome the expected volatility issue – namely, about the presentation of non-GAAP metrics that remove the changes in fair value of crypto assets:
First, let’s consider how companies currently disclose non-GAAP crypto adjustments. Under the current cost-less-impairment model, digital assets are reported on the balance sheet at the lowest price since the acquisition. Notably, in at least two comment letters threads, the SEC challenged non-GAAP adjustments that removed bitcoin impairments.
· On September 22, 2022, the SEC issued a comment letter to Bit Digital, Inc (BTBT) questioning whether, given the recurring nature of impairments of digital assets, adjusting for the impairments would substitute individually tailored metrics and violate Question 100.04 of Regulation G.
· On October 7, 2021, the SEC issued a comment letter to MicroStrategy (MSTR) asking the company to clarify why adjusting for bitcoin impairments is useful to investors. On December 3, 2021, the SEC issued a follow-up letter objecting to the adjustment (we discussed SEC comment letters to MicroStrategy in our blog with Calcbench).
Bit Digital, Inc. and MicroStrategy agreed to remove bitcoin impairments from future non-GAAP presentations.
Under the proposed new standard, companies would be required to record changes in fair value of digital assets on the income statement instead of testing the assets for impairment. To the best of our knowledge, there is no crypto-specific non-GAAP guidance that would apply to the changes in the fair value of crypto assets. However, earnings volatility following the adoption of fair value accounting was widely discussed in the context of the Current Expected Credit Losses (CECL) standard.
Nicola White of Bloomberg reported that the SEC warned companies to be mindful of Regulation G when considering CECL-related non-GAAP adjustments:
“Before CECL went live for public companies in 2020, the SEC added another warning: Companies can’t use just unofficial metrics showing their earnings as if they hadn’t switched over to the new accounting.”
Can we learn from past SEC comment letters about the dos and don’ts of presenting fair value-related non-GAAP adjustments? Using the Audit Analytics Comment Letters database, we found a few examples that could be helpful.
· On November 19, 2020, the SEC issued a comment letter to Heartland Financial USA, INC (HTLF) asking the company to “to refrain from disclosing performance measures that exclude the provision for credit losses” because provision for credit losses is a normal and recurring business charge. The company agreed to avoid using the metric in future filings.
· On June 24, 2020, the SEC issued a comment letter to Fifth Third Bancorp (FITB) requesting that the company refrains from disclosing the Adjusted Net Income metric that excludes credit losses because the metric “which exclude a portion of the provision for credit losses, substitute individually tailored recognition and measurement methods for those of GAAP”. The company agreed to refrain from using this metric in future filings.
· On June 4, 2020, the SEC issued a comment letter to American Express, Co (AXP) requesting that the company refrains from disclosing Adjusted Diluted EPS that excludes credit reserve builds because the metric that “…excludes a portion of the provision for credit losses, substitutes individually tailored recognition and measurement methods for those of GAAP”. The company agreed to refrain from disclosing Adjusted EPS excluding provisions for credit losses attributable to reserve builds in future filings.
In the cases described above, the primary objections of the SEC appeared to be related to either the recurring nature of the provision of credit losses or because removing parts of provisions of credit losses would create a tailored accounting that substitutes GAAP.
The SEC comment letter to Credit Acceptance Corp (CACC) is a notable exception. On December 9, 2020, the SEC issued comments to Credit Acceptance requesting that the company refrains from disclosing non-GAAP measurements that exclude provision for credit losses. In contrast to Heartland Financial, Fifth Third, and Amex, Credit Acceptance explained that the metrics are not misleading because of the unique characteristics of the company’s business:
“On January 1, 2020, we adopted Accounting Standards Update 2016-13, Measurement of Credit Losses on Financial Instruments, which is known as the current expected credit loss model, or CECL. Our response to the Staff’s 2017 comment letter explained why we believe the GAAP methodology we employed prior to January 1, 2020, did not provide sufficient transparency into the economics of our business due to its asymmetrical treatment of favorable and unfavorable changes to expected future net cash flows. While CECL eliminated that asymmetrical treatment of changes in expected future net cash flows from the GAAP methodology we employ, it introduced a different asymmetry by requiring us to recognize at the time of the loan’s assignment to us a significant provision for credit losses expense for amounts we never expect to realize and to recognize in subsequent periods finance charge revenue that is significantly in excess of our expected yields. Our floating yield adjustment enables us to provide measures of income that are not impacted by GAAP’s asymmetrical treatments of estimates.”
To summarize, the discussion of crypto non-GAAP accounting under the fair value model is currently hypothetical because the new standard is not applicable until 2025. We do not know if comparing CECL and crypto no-GAAP accounting is the best approach because the standards and instruments are different. Yet, it would be safe to assume that companies would need to consider SEC December 13, 2022, C&DI, including questions 100.01 through 100.04, should they elect to modify the non-GAAP metrics for the new crypto accounting standard.