SEC Issues Staff Accounting Bulletin on Accounting for Obligations to Safeguard Crypto-Assets
Overview
On March 31, 2022, the SEC issued Staff
Accounting Bulletin (SAB) No. 121 (SAB 121), which:
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Provides the SEC staff’s view that it would be appropriate for an entity that has an obligation to safeguard crypto-assets held for platform users to record a liability and corresponding asset on its balance sheet at the fair value of the crypto-assets.
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Adds Section FF to SAB Topic 5;1 this section includes “interpretive guidance for entities to consider when they have obligations to safeguard crypto-assets held for their platform users.”
Background
The SEC staff has recently observed an increase in the number of
entities that give platform users the ability to transact crypto-assets and
provide a service to safeguard these assets. Currently, there is diversity in
practice related to how entities disclose their obligations to safeguard
crypto-assets held for platform users. In the SEC staff’s view, there are unique
risks and uncertainties (e.g., technological, legal, regulatory) associated with
safeguarding crypto-assets. Accordingly, the SEC staff released SAB 121 because
the staff believes that it 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.”
Scope Considerations
SAB 121 applies to entities that file with the SEC under either
U.S. GAAP or IFRS® Standards. Further, the SAB applies to a public
business entity that safeguards crypto-assets for its platform users, whether
safeguarding is provided by the entity or by an agent acting on behalf of the
entity.
SAB 121 describes the term “crypto-asset” as follows:
For purposes of this SAB, the term “crypto-asset” refers to
a digital asset that is issued and/or transferred using distributed ledger
or blockchain technology using cryptographic techniques.
Connecting the Dots
SAB 121 includes specific transition guidance for
certain private companies whose financial statements are filed with the
SEC. (See the Transition section below.) Furthermore, private
companies that are considering an initial public offering should
consider the potential impact of SAB 121 on their financial statements,
footnotes, and disclosures as well as the related internal controls over
financial reporting (ICFR).
Accounting Considerations
The interpretive guidance in SAB 121 dictates that if an entity
is responsible for safeguarding crypto-assets held for its platform users, the
entity should record a liability on its balance sheet for its obligation to do
so (this liability is hereafter referred to as a “safeguarding liability”). The
safeguarding liability should be “measured at initial recognition and each
reporting date at the fair value of the crypto-assets held for [the entity’s]
platform users.” In determining the fair value of the crypto-assets held, the
entity should apply ASC 8202 or IFRS 13.3
An entity should record a corresponding asset at the same time as it records the
safeguarding liability. This asset is similar to an indemnification asset as
described in ASC 805 and IFRS 34 (hereafter referred to as a “safeguarding asset”) and should be measured
at the fair value of the crypto-assets held for the entity’s platform users. In
a manner similar to the guidance in ASC 805 and IFRS 3, the measurement of the
safeguarding asset would also factor in any potential loss events.
To illustrate how to apply the guidance, SAB 121 adds the following example to
SAB Topic 5.FF:
Facts: Entity A’s business includes operating a platform that
allows its users to transact in crypto-assets. Entity A also provides a
service where it will safeguard the platform users’ crypto-assets,
including maintaining the cryptographic key information necessary to
access the crypto-assets. Entity A also maintains internal recordkeeping
of the amount of crypto-assets held for the benefit of each platform
user. Entity A secures these crypto-assets and protects them from loss
or theft, and any failure to do so exposes Entity A to significant
risks, including a risk of financial loss. The platform users have the
right to request that Entity A transact in the crypto-asset on the
user’s behalf (e.g., to sell the crypto-asset and provide the user with
the fiat currency (cash) proceeds associated with the sale) or to
transfer the crypto-asset to a digital wallet for which Entity A does
not maintain the cryptographic key information. However, execution and
settlement of transactions involving the platform users’ crypto-assets
may depend on actions taken by Entity A.
Question 1: How should Entity A account for its obligations to
safeguard crypto-assets held for platform users?
Interpretive Response: The ability of Entity A’s platform users to
obtain future benefits from crypto-assets in digital wallets where
Entity A holds the cryptographic key information is dependent on the
actions of Entity A to safeguard the assets. Those actions include
securing the crypto-assets and the associated cryptographic key
information and protecting them from loss, theft, or other misuse. The
technological mechanisms supporting how crypto-assets are issued, held,
or transferred, as well as legal uncertainties regarding holding
crypto-assets for others, create significant increased risks to Entity
A, including an increased risk of financial loss. Accordingly, as long
as Entity A is responsible for safeguarding the crypto-assets held for
its platform users, including maintaining the cryptographic key
information necessary to access the crypto-assets, the staff believes
that Entity A should present a liability on its balance sheet to reflect
its obligation to safeguard the crypto-assets held for its platform
users.
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. 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. [Footnotes omitted]
Connecting the Dots
Generally, an entity currently does not report the
crypto-assets of its platform users on its balance sheet unless the
entity has control over those assets. The new SAB’s interpretive
guidance will result in a significant change to the accounting and
financial reporting for these entities, since the fair value of the
crypto-assets will now be recorded as a liability, along with a
corresponding asset, when an entity does not control the crypto-assets.
The safeguarding asset is not the crypto-asset itself
and therefore would not be recognized as an intangible asset as is the
common practice when an entity accounts for certain crypto-assets5 like bitcoin that the entity controls. ASC 350 requires an entity
to initially measure the intangible asset at cost; the asset would also
be subject to impairment. The accounting for these crypto-assets is not
discussed in the SAB since the safeguarding asset in the SAB is not the
crypto-asset. Rather, the safeguarding asset would be recorded at the
fair value of the crypto-assets held. The entity would factor in
potential loss events (e.g., theft, loss of the private key, loss of the
crypto-asset, cybersecurity hacks) that could affect the measurement of
the safeguarding asset. The occurrence of such a loss event would result
in a difference between the safeguarding asset and the safeguarding
liability.
Disclosure
As discussed in the sections below, SAB 121 requires an entity to provide a
significant number of additional disclosures related to safeguarding obligations
for crypto-assets held for the entity’s platform users.
Financial Statement Footnote Disclosures
The SAB indicates that an entity should disclose the following in the
footnotes to its financial statements:
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The “nature and amount of crypto-assets that [the entity] is responsible for holding for its platform users, with separate disclosure for each significant crypto-asset.”
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Vulnerabilities “due to any concentration in such activities” (see ASC 275-10-50 and IAS 16).
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Fair value disclosures related to the “crypto-asset safeguarding liabilities and the corresponding assets” (see ASC 820 and IFRS 13).
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Description of the “accounting for the liabilities and corresponding assets” (see ASC 235-10-50 and IAS 1).
In connection with the above disclosures, entities should
also consider disclosing the following:
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Who holds the cryptographic key information.
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Who maintains the internal recordkeeping of those assets.
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Who is obligated to secure the assets and protect them from loss or theft.
Connecting the Dots
Determining the fair value of crypto-assets may be
complex. In making this determination, an entity may need to
carefully consider how to apply ASC 820 or IFRS 13 to these types of
assets. For example, the entity may find it challenging to determine
its principal market given that crypto-assets generally trade in
multiple markets. In addition, these markets trade 24 hours a day,
365 days a year, and do not have a traditional market close.
Entities will want to establish a policy related to the critical
judgments used in making this determination as well as appropriate
controls for maintaining this policy. The AICPA Practice Aid
Accounting for and Auditing of Digital Assets7 contains additional nonauthoritative guidance related to fair
value measurements for crypto-assets that an entity may want to
consider.
Disclosures Outside the Financial Statements
An entity may be required to provide the following disclosures outside its
financial statements (i.e., description of the business [see Regulation S-K,
Item 1018]; risk factors [see Regulation S-K, Item 1059]; or MD&A [see Regulation S-K, Item 30310]):
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“[S]ignificant risks and uncertainties associated with the entity holding crypto-assets for its platform users.”
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If material, “the types of loss or additional obligations that could occur, including customer or user discontinuation or reduction of use of services, litigation, reputational harm, and regulatory enforcement actions.”
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“[D]iscussion of the analysis of the legal ownership of the crypto-assets held for platform users,” including consideration of what would happen in the event of the entity’s bankruptcy.
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“[P]otential impact that the destruction, loss, theft, or compromise or unavailability of the cryptographic key information would have to the ongoing business, financial condition, operating results, and cash flows of the entity.”
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If material, “information about risk-mitigation steps the entity has put in place,” such as insurance coverage.
ICFR Considerations
As entities consider SAB 121’s guidance in preparing their
financial statements and related disclosures, they should be cognizant of the
ICFR implications. Entities that safeguard crypto-assets for their platform
users may have to (1) document new or different judgments (e.g., determinations
of fair value) and (2) gather and track information that they may not have
previously monitored. As a result, entities may need to create or modify
processes, controls, and information systems; assess the reliability of new
information; and test the controls. Furthermore, because the safeguarding
liability is established on the basis of the risk associated with safeguarding
assets held for platform users, management’s assessment and the auditor’s
attestation, as applicable, may also take into account controls over the
safeguarding of platform user assets and the cryptographic key information
necessary to access those assets. If a service organization is used to custody
the crypto-assets, an entity may need to consider controls at the service
organization.
Transition
The SAB 121 transition guidance applicable to an entity will
depend on whether it is defined as a public entity or an “other entity” as
follows:
- Entities that are current SEC filers (hereafter
referred to as “public entities”):
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Entities that file reports in accordance with Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934.
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Entities that must file periodic and current reports in accordance with SEC Regulation A, Rule 257(b).11
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- All other entities, including but not limited to
(hereafter referred to as “other entities”):
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Entities that have submitted or filed an initial registration statement under the Securities Act of 1933 or Securities Exchange Act of 1934 that is not yet effective.
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Entities submitting or filing an offering statement or post-qualification amendment under Regulation A.
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Private operating companies whose financial statements are included in filings with the SEC in connection with a business combination involving a shell company, including a special-purpose acquisition company.
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The table below summarizes the transition requirements for these two types of
entities.
|
Entity Type
|
Transition
|
Application for Calendar-Year-End
Entities
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|---|---|---|
|
Public entities
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No later than 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 and annual period is
related.
|
These entities will need to adopt the
guidance in SAB 121 no later than their Form 10-Q for
the second quarter of 2022, with retrospective
application as of January 1, 2022. For the 2022 Form
10-K, the comparative period as of December 31, 2021,
will not be required to reflect the recognition of the
safeguarding asset and safeguarding liability.
|
|
Other entities
|
In the entity’s next submission or filing with the SEC,
if the subsequent interim period includes the
application of SAB 121, the SAB applies to the interim
period and applies retrospectively to the beginning of
the most recent annual period ending before June 15,
2022.
|
For a registration statement submitted in January 2023,
SAB 121 would apply to the 2021 annual financial
statements as well as the financial statements for the
nine months ended September 30, 2022.
|
|
In the entity’s next submission or filing with the SEC,
if the filing does not include a subsequent
interim period that reflects the application of SAB 121,
the SAB would apply retrospectively to the beginning of
the two most recent annual periods ending before June
15, 2022.
|
For a registration statement submitted in April 2022, SAB
121 would apply to the 2020 and 2021 annual financial
statements.
|
Connecting the Dots
Because of the transition guidance provided, the
accounting treatment reflected in the historical financial statements of
public entities for the periods before those described in the transition
guidance is not considered an error.
Transition Disclosures
An entity will need to consider the following additional
disclosures in implementing the SAB’s transition guidance, since such
implementation represents a change in accounting principle:
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SAB Topic 11.M (SAB 74)12 disclosures — SAB 74 indicates that a registrant should disclose the effects of recently issued accounting standards that are not yet effective “unless the impact on [the registrant’s] financial position and results of operations is not expected to be material” (footnote omitted). SAB 74 disclosures have been a focus for the SEC staff, and the staff continues to emphasize the importance of providing these transition disclosures. Public entities should evaluate the appropriateness of the SAB 74 disclosures in their Form 10-Q for the first quarter of 2022, in advance of adoption in their Form 10-Q for the second quarter of 2022. In addition, an entity should ensure its ICFR appropiately addresses the transition disclosures.
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Disclosures in the financial statements — ASC 250 and IAS 813 require disclosure, in the period in which an accounting change is made, of the nature and reason for the change in accounting principle, the impacts on the financial statements, amounts recognized at transition, a description of prior-period amounts that have been adjusted (if applicable), and any indirect effects of the change in accounting principle.
In applying SAB 121, entities may need to use
judgment and consider their specific facts and
circumstances in addition to consulting with their
accounting and SEC advisers. Entities should also
continue to monitor the evolving regulatory
landscape.
Footnotes
1
SEC Staff Accounting Bulletin Topic 5.FF,
“Miscellaneous Accounting; Accounting for Obligations to
Safeguard Crypto-Assets an Entity Holds for Its Platform
Users.”
2
For titles of FASB Accounting Standards
Codification (ASC) references, see Deloitte’s “Titles of Topics and
Subtopics in the FASB Accounting Standards
Codification.”
3
IFRS 13, Fair Value Measurement.
4
IFRS 3, Business Combinations.
5
Crypto-assets, as defined in Question 1 of AICPA
Practice Aid Accounting for and Auditing of Digital
Assets, are accounted for as intangible
assets. Note that SAB 121 refers to crypto-assets more broadly
than the definition used in Question 1 of the AICPA Practice
Aid. See the Scope Considerations section for additional
discussion.
6
IAS 1, Presentation of Financial Statements.
7
See Questions 16–21 in the AICPA Practice
Aid.
8
SEC Regulation S-K, Item 101, “Description of Business.”
9
SEC Regulation S-K, Item 105, “Risk Factors.”
10
SEC Regulation S-K, Item 303, “Management’s Discussion and Analysis
of Financial Condition and Results of Operations.”
11
SEC Regulation A, Rule 257(b), “Tier
2: Periodic and Current Reporting.”
12
SEC Staff Accounting Bulletin Topic 11.M
(SAB 74), “Miscellaneous Disclosure; Disclosure of the
Impact That Recently Issued Accounting Standards Will
Have on the Financial Statements of the Registrant When
Adopted in a Future Period.”
13
IAS 8, Accounting Policies, Changes
in Accounting Estimates and Errors.