The Metaverse — Accounting Considerations Related to Nonfungible Tokens
Background
The metaverse has recently drawn a lot of excitement and headlines, but what is it
really? The concept has actually existed for decades — it is an immersive digital
environment that allows users to interact with their surroundings and one another in
a shared space. Early metaverses were primarily related to online gaming activities
in which users had limited rights on platforms. Enabled by other maturing and
converging technologies, the next evolution of metaverses holds the promise of a
transformational shift that unlocks value for users and platforms alike.
This future state will be empowered by digital economies that offer enhanced and
immutable rights for users while providing new opportunities for companies to engage
with their customers and generate new revenue streams. Users may have true ownership
over their in-game items and the ability to monetize their property and transfer
value off platform. For example, if a user owns a plot of virtual land with a right
of use on platform, he or she could allow another party to hold a virtual concert or
sell the rights to the virtual land in exchange for digital assets or fiat
currency.
Such an enhanced user experience could shift demand for digital goods and services
from traditional companies. For example, a retail shoe company could enter an
entirely new market and sell its branded digital shoes in a metaverse. In a manner
similar to how they try on clothes in the physical world, people may dress their
digital “selves” (i.e., their avatars) as a means of self-expression and
functionality in a metaverse as they explore and interact. Perhaps the shoes are
especially fashionable and exclusive, or offer additional utility by allowing the
avatar to run faster or jump higher. The prospect of making high-margin digital
sales while expanding brand presence may be enticing for companies facing saturated
and competitive physical markets.
The metaverse does not have to be an entirely separate space. Indeed, it can
potentially link physical and digital worlds. The endless scrolling of current
online shopping could be replaced with an immersive and engaging experience. Imagine
strolling into a digital store where the trendy ambience and music match the brand’s
style. You select a shirt to try on and watch your avatar wear it down the runway
toward you. The avatar matches your exact dimensions and looks just like you. You
decide that the shirt looks a little large and adjust one size smaller to see
whether it fits better. It looks great — and after a couple of clicks, the
real-world version of the shirt is on its way to your home.
There are numerous ways in which companies could use the metaverse as a part of their
business strategy. The future state of the metaverse that holds this vast potential
will take time to evolve and mature, but we are already seeing early adopters forge
ahead. One day, we could see interoperable metaverses that use Web3 applications and
leverage augmented reality (AR) and virtual reality (VR) technologies to blur the
lines between the physical and digital worlds.
While we are just beginning this journey, these new digital economies are already
raising some interesting accounting questions, particularly for blockchain-enabled
metaverses. One effective medium for transacting in a digital world is nonfungible
tokens (NFTs), units of data stored and transferred on a digital ledger (i.e., a
blockchain) that each represent a unique digital item and therefore are not
interchangeable. They can represent rights associated with digital files such as
art, audio, videos, items in video games, and other forms of creative work. NFTs can
also provide other rights, such as ownership of virtual land or even real-world
assets and services. NFTs give users true ownership over their entitlements and
enable them to monetize and transfer value.
Because NFTs are becoming an increasingly important aspect of users’ experiences in a
blockchain-enabled metaverse, they are the focus of the accounting considerations
discussed below.
Accounting Considerations
The first step to grasping the accounting implications of transactions that involve
NFTs is fully understanding the rights represented and what has actually been
transferred. This is critical to determining the appropriate accounting treatment,
including the applicable accounting guidance.
Issuer’s or Developer’s Accounting for NFTs
Some of the accounting considerations for issuers or developers of NFTs in a
metaverse are similar to those for traditional gaming companies (e.g., sales of
virtual items that are consumable or durable) and hardware manufacturers (e.g.,
sales of headsets or glasses for AR/VR experiences). However, the nature of NFTs
sold in a metaverse poses unique accounting challenges. The discussions below
highlight common accounting considerations for companies that issue or develop
NFTs.
Revenue Recognition
Companies that issue or develop NFTs for a metaverse may
conclude that their arrangements to sell NFTs are subject to the revenue
guidance in ASC 606.1 A company’s arrangement to sell an NFT will generally be within the
scope of ASC 606 if it represents a contract with a counterparty that
obtains an NFT in exchange for consideration and the NFT is an output of the
company’s ordinary activities. In addition, if the arrangement is within the
scope of ASC 606, the company will need to make a determination of when a
contract exists by assessing various criteria, such as whether there are
enforceable rights and obligations and whether the consideration is
collectible. For further guidance, see Chapters 3 and 4 of Deloitte’s
Roadmap Revenue
Recognition.
Some rights associated with NFTs may not be subject to the
guidance in ASC 606. For example, a company may sell an NFT that does not
provide the purchaser with any ownership or license rights to the underlying
intellectual property (IP). Rather, the company may retain all rights to the
IP and only sell to the purchaser a right to future revenue streams
associated with the IP. For instance, the company may own music rights and
sell an NFT that provides the purchaser with a percentage of the royalties
that the company earns on those music rights. In this circumstance, the
company must carefully evaluate whether the transaction represents the sale
of future revenue that is subject to the guidance in ASC 470.2
Performance Obligations
The rights attached to NFTs may include multiple promised goods and
services. Companies that sell NFTs will need to evaluate whether those
promised goods and services are separate performance obligations.
Identifying performance obligations is critical because a performance
obligation is the unit of account for which revenue is recognized, which
could affect the timing of revenue recognition.
For example, a company may sell an NFT in a metaverse that represents the
user’s digital rendering of its avatar. That NFT may provide the user
with various digital rights, including free digital collectibles,
loyalty rewards, enhanced gaming experiences, and VIP access to events
in the metaverse (e.g., virtual concerts). Some NFTs may also convey a
right to a tangible good, such as a luxury bag or pair of sneakers.
Because there are multiple promised goods and services, the company must
determine whether each promised good or service is distinct and
therefore a separate performance obligation.
If multiple performance obligations are identified, the
company will generally need to determine their respective stand-alone
selling prices (SSPs) and allocate the transaction price on the basis of
those SSPs. Determining SSPs can be challenging, particularly when
selling NFTs in a metaverse is a new business model for the company. The
company will also have to assess how control of each performance
obligation is transferred to the customer (i.e., at a point in time or
over time) to determine the appropriate timing and pattern of revenue
recognition. For example, revenue related to a performance obligation
that represents a license to functional IP may be recognized at a point
in time, whereas revenue related to a performance obligation that
represents a hosting service or gaming experience may be recognized over
time.3
Transaction Price
A company that sells an NFT to a customer may charge a fixed fee for that
NFT. However, the customer may also be required to pay variable
consideration (e.g., usage-based fees). In addition, if the customer has
the right to sell the NFT (whether on or off platform), the company that
originally issued or developed the NFT may be due a royalty upon each
sale. Therefore, the total transaction price for an NFT may include
various payment streams. Variable consideration is generally estimated
up front and is subject to a “constraint” to ensure that it is probable
that a significant reversal in the amount of cumulative revenue
recognized will not occur. However, there are certain exceptions in ASC
606 that would not require the company to estimate variable
consideration at contract inception. Further, the company may receive
crypto-assets or other digital assets in exchange for the NFT rather
than fiat currency. In those circumstances, the company would be
required to measure any noncash consideration at its estimated fair
value at contract inception. For further guidance, see Chapter
6 of Deloitte’s Roadmap Revenue
Recognition.
License of IP
Many NFTs do not transfer control or ownership of the underlying IP but
grant the purchaser a license to it. For example, a company may retain
ownership of digital art and grant a purchaser of an NFT an exclusive
license to use and display such digital art. In this circumstance, the
company should consider the supplemental guidance in ASC 606 that
addresses the licensing of IP. For further guidance, see Chapter
12 of Deloitte’s Roadmap Revenue
Recognition.
Principal-Versus-Agent Considerations
Sometimes an intermediary is involved in the sale of NFTs. For example,
NFTs that are collectibles may be sold by companies in off-platform
marketplaces. When more than one party is involved in providing an NFT
to an end customer, the parties must determine which party controls the
NFT before it is transferred to the end customer.
If the company that issues or develops the NFT controls the NFT before it
is transferred to the end customer, the issuer or developer is the
principal in the transaction with the end customer, recognizes revenue
on the basis of the gross amount paid by the end customer, and
separately recognizes the cost of the amount paid to the marketplace for
facilitating the transaction. Because the marketplace does not obtain
control of the NFT before the NFT is transferred to the end customer, it
is an agent in the transaction and recognizes revenue on the basis of
the net amount retained.
By contrast, if the marketplace obtains control of the NFT before the NFT
is transferred to the end customer, it is the principal in the
transaction with the end customer, recognizes revenue on the basis of
the gross amount paid by the end customer, and separately recognizes the
cost of the amount paid to the issuer or developer for the NFT. In this
case, the issuer or developer is the principal in the transaction with
the marketplace (i.e., the customer of the issuer or developer is the
marketplace rather than the end customer) and recognizes revenue on the
basis of the amount received from the marketplace (not the gross amount
paid by the end customer).
A company that develops and operates a metaverse may also offer
third-party creators (who may also be users in the metaverse) the
ability to develop and sell their own NFTs. The same
principal-versus-agent considerations described above would apply to the
company that offers a creator economy.
For further guidance, see Chapter 10 of Deloitte’s
Roadmap Revenue Recognition.
Development Costs
In addition to determining the appropriate accounting for the sale of NFTs,
companies that develop NFTs must determine the appropriate accounting
treatment for development costs incurred, including which accounting
guidance to apply. Depending on the applicable accounting guidance, those
costs may be (1) capitalized or deferred on the balance sheet or (2)
expensed as incurred. Therefore, a company that develops NFTs in a metaverse
will need to understand the underlying IP being developed, the rights that
will be conveyed to the purchaser, and the nature of the costs incurred.
Because an NFT typically conveys digital rights rather than tangible
property, the development costs will most likely not be subject to the
inventory guidance in ASC 330. Instead, much of the development costs may be
associated with developing software.
If development costs are software costs and the purchaser of the NFT will
obtain possession of the software, the software development costs are
subject to the guidance in ASC 985-20. Under ASC 985-20, most software
development costs are expensed as incurred because such costs are considered
research and development expenses until technological feasibility is
established. Because technological feasibility is typically established late
in the development cycle, often very little is capitalized.
On the other hand, it is possible that the purchaser lacks the ability to
take possession of the software and that the developer of the NFT will host
the software on its own platform. For example, an NFT may give the purchaser
the right to virtual items in a metaverse that are only accessible online
and hosted by the developer. In that circumstance, the software development
costs for those virtual items are subject to the guidance in ASC 350-40.
Under ASC 350-40, certain software development costs incurred during the
application development stage are capitalized. Because the application
development stage typically occurs before technological feasibility is
established, more software development costs tend to be capitalized under
ASC 350-40 than under ASC 985-20. For further guidance on scope
considerations related to the accounting for software and software-related
costs, see Deloitte’s June 2020 Technology
Spotlight.
Investor’s or Purchaser’s Accounting for NFTs
Today, most investors in NFTs are individuals. However,
companies have begun exploring investments in NFTs, including ownership of
virtual land in metaverses. Like an NFT issuer or developer, an NFT investor or
purchaser must determine the nature of the rights the NFT conveys to determine
the appropriate accounting treatment. For example, the NFT may convey the right
to a plot of virtual land in the metaverse that, like other digital assets,
would generally be subject to the guidance in ASC 350 rather than ASC 360.4 Because of the unique nature of the NFT, it may be difficult for the
investor or purchaser to determine (1) whether the asset should be amortized
and, if so, over what estimated life; and (2) whether the asset is impaired and,
if so, by how much. In addition, the investor or purchaser may receive a bundle
of rights with the purchase of the NFT, such as a right to physical goods (e.g.,
branded clothing or physical artwork), entrance to a virtual concert, lifetime
membership to an elite club, and other items that could include services to be
received in the future. The transaction price paid by the investor or purchaser
would typically need to be allocated to the multiple elements acquired on the
basis of their fair values, which, like the SSPs that an NFT issuer or developer
uses to allocate the transaction price to multiple performance obligations, may
be challenging to determine. Further, the investor or purchaser would have to
evaluate the nature of the underlying rights acquired to determine which
accounting guidance to apply to each right. For example, if the investor or
purchaser pays up front and will receive services in the future (e.g., hosting
of virtual items associated with the NFT, gaming experiences), the allocated
cost may represent a prepaid asset.
Looking Ahead
As the metaverse evolves, the accounting issues may likewise change. The accounting
considerations for transactions in the metaverse can be complex, and the appropriate
treatment will depend on the specific facts and circumstances.
Where to Find Additional Information
For more information about NFTs, see Deloitte’s Corporates Using NFTs: How NFTs Might Fit Your Business and What to
Watch For.
If you have questions about
accounting issues related to the metaverse, please contact any of the following
Deloitte professionals:
|
Sandie Kim
Partner
Deloitte & Touche LLP
+1 415 783 4848
|
Mark Crowley
Managing Director
Deloitte & Touche LLP
+1 203 563 2518
|
|
Amy Park
Partner
Deloitte & Touche LLP
+1 312 486 4515
|
Macaela Karnick
Senior Manager
Deloitte & Touche LLP
+1 612 659 2748
|
Footnotes
1
For titles of FASB Accounting Standards
Codification (ASC) references, see Deloitte’s “Titles of Topics and
Subtopics in the FASB Accounting Standards
Codification.”
2
Further, digital assets vary in complexity and may
contain features that are not subject to the guidance in ASC 606.
For example, certain digital assets may represent or include
financial instruments that are subject to the guidance in ASC 815 or
ASC 860. This publication does not address all features that may
exist in an NFT and therefore does not discuss all accounting
guidance that may apply.
3
If a company provides storage or custodial
services for its customers’ NFTs, it should also consider the
applicability of the guidance in SEC Staff Accounting Bulletin No.
121.
4
This publication does not address accounting
considerations for companies that apply specialized industry guidance,
such as that in ASC 940 or ASC 946.