Simplifying Accounting for Income Taxes and How it Affects Your Business

Flerida Rose Matalang

Accounting Staff

Simplifying Accounting for Income Taxes and How it Affects Your Business


Business professionals are often challenged by the complexities of ASC 740, Accounting for Income Taxes. To ease the difficulties usually encountered in this standard, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2019-12 (“Update”) on December 18, 2019, to simplify accounting for income taxes specifically intended to reduce complexity, minimize cost, and improve the quality of the information provided to the financial statement users.

Background  

In 2014, FASB launched a simplification initiative to improve and simplify accounting standards through a series of projects, adding to its technical agenda simplifications to the accounting rules for income taxes under ASC 740.
Part of the FASB’s overall Simplification Initiative is to update and address complexities in income tax accounting. The Simplification Initiative aims to identify, evaluate, and improve areas of generally accepted accounting principles (GAAP) that can reduce cost and complexity while improving the usefulness of the information provided to financial statement users. 

Existing contents of ASC 740 before the amendment  

Before the amendment, the following extraordinary items were included as part of the exceptions in applying ASC 740:
  1. An exception to the incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or a gain from other items.
  2. An exception to the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment.
  3. An exception to the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary.
  4. An exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year.
These exceptions were eliminated in FASB updates of ASU 2019-12. The amendments also improved the consistent application of and simplified GAAP for other areas of Topic 740 by clarifying and amending the existing guidance.

Eliminated Exceptions:

Intraperiod Tax Allocation
Previously, GAAP provided an exception in determining the effect of income tax on income from continuing operations without considering the impact of items not included in continuing operations. The exception requires an entity with a loss from continuing operations to consider all items, including discontinued operations and other comprehensive income when calculating the tax benefits from continuing operations.

The update removed this exception to the incremental approach for intraperiod tax allocation, and as a result, the effects of items outside continuing operations, even at a loss, are not considered when calculating the tax effect on continuing operations.

Deferred Tax Liabilities (DTL)Changes from a Subsidiary to an Investment

Before the update, an entity was required to recognize a DTL where the book basis exceeds the tax basis in a foreign equity method investee. However, an exemption to this general rule was provided under ASC 740, which states that an entity does not need to recognize a DTL related to the transition-date outside-basis difference if it had been asserting indefinite reversal to its investment in the former subsidiary when there is a change from a foreign subsidiary to equity method investee. 

Under the amended provisions, an entity should recognize a DTL on the entire outside basis differences of a foreign subsidiary that became a foreign equity method investment. This would create consistency with the general principle of the current U.S. GAAP, where an entity recognizes DTL for a taxable outside-basis difference in the equity method investment if it is no longer eligible to assert indefinite reinvestment of earnings. 

Changes from an Investment to a Subsidiary
Previously, an entity was required to continue to recognize a DTL for a foreign equity method investment that became a subsidiary. The amendment removes the exception under ASC 740-30-25-16 that freezes the DTL on the outside basis of the difference recorded before the investment became a subsidiary. Consistent with the current U.S. GAAP, an entity needs to reverse the DTL and recognize a tax benefit if it has indefinite reinvestment of earnings of the subsidiary. 

Interim-Period Tax Calculation
ASC 740-270 provided an exception to the general methodology for the interim-period income taxes calculation if the year-to-date loss exceeds the anticipated loss for the year. The guideline limits the recognition of income tax benefits when an entity with an ordinary loss for the interim period exceeds the anticipated ordinary loss for the year. The income tax benefit is limited to the amount that would be recognized if the year-to-date ordinary loss were the anticipated ordinary loss for the full fiscal year.

The update removed the exception on the limits of the income tax benefit recognized in the interim period to the income tax benefit recognized as though the year-to-date ordinary loss were the expected loss for the current year. As a result, there will no longer be limitations to the tax benefits recognized in the interim period, and the computation of the income tax benefits at each interim period is based on its estimated annual effective tax rate.

Also read: Tax Planning Strategies that Can Make a Big Difference

Simplifying Accounting for Income Taxes

Franchise Tax or other Similar Taxes

In some jurisdictions, franchise taxes are calculated based on the greater of two calculations — income-based and non-income-based. ASC 740 does not apply franchise taxes on a non-income-based measure (e.g., capital) when there is no additional tax-based income. It further states that franchise taxes on income-based measures should only be included as income tax expense if it exceeds the capital-based tax. 

Under the current updates, an entity must first account for the franchise tax or similar tax as a portion of income tax expense and account for any incremental amount as a non-income-based tax portion in pretax income. In addition, entities must record deferred taxes using the statutory income tax rate, and the entity does not need to consider the effect of potentially paying a non-income-based tax in future years when evaluating the realizability of deferred tax assets. The update is consistent with the accounting for other incremental taxes.
Step up in tax bases of goodwill

When an entity enters a business combination transaction that results in goodwill under ASC 805, amounts presented and recognized for income tax and financial reporting purposes may differ. Under the current guidelines, a deferred tax asset (DTA) is recognized only when the tax basis of goodwill exceeds the book basis of goodwill. However, no recognition of DTL is allowed under ASC 805. If the step up in the tax basis of goodwill relates to the portion of goodwill from a previous business combination for which a DTL was not recognized, then-current guidance prohibits an entity from recognizing a DTA for the increase in tax basis, except up to the extent that the tax-deductible goodwill exceeds the remaining book balance of goodwill. This results in the non-recording of DTA for the step-up based on goodwill unless it would have recorded a deferred tax asset when the business combination had occurred. These principles are also important to understand within the context of nonprofit financial reporting, where proper recognition and compliance with ASC guidelines remain critical despite differing organizational structures.

The update removed the existing guidelines under ASC 740-10-25-54 and requires that an entity determine whether the tax basis step-up transaction relates to a prior business combination in which the book goodwill was initially recognized or to a separate transaction. ASU 2019-12 includes factors to consider that may indicate that the step up in tax basis relates to a separate transaction, which includes but is not limited to the following:
  • A significant lapse in time between the transactions has occurred.
  • The tax basis in the newly created goodwill is not the direct result of the settlement of liabilities recorded in connection with the acquisition.
  • The step up in tax basis is based on a valuation of the goodwill or the business that was performed as of a date after the business combination.
  • The transaction resulting in the step up in tax basis requires more than a simple tax election.
  • The entity incurs a cash tax cost or sacrifices existing tax attributes to achieve the step-up in tax basis.
  •  The transaction resulting in the step up in tax basis was not contemplated at the time of the business combination.

If the step-up tax basis transaction is part of the business combination, DTA should be recognized only when it exceeds the remaining balance of book goodwill recognized in that business combination. However, if the step-up tax basis transaction relates to a separate transaction, an entity should record a DTA for the additional tax basis on goodwill.

Separate financial statements of entities not subject to tax

Previously, the guidelines did not specify a requirement to allocate the consolidated amounts of current and deferred tax expenses to entities not subject to taxes. 

The update provides that an entity is not required to allocate the consolidated amount of current and deferred tax expenses to legal entities that are not subject to tax in their separate financial statements. However, legal entities that are not subject to tax and disregarded by taxing authorities may elect to allocate the consolidated amount of current and deferred tax expenses. 

Read more: CECL Adoption Is Just Around the Corner – Is Your Business Ready?

Enacted changes in tax laws
Under the old guidelines, an entity is required to recognize the income tax effects of an enacted change in tax law on deferred tax assets or liabilities on the date of enactment or on the period during which the law is effective, whichever occurred later. When there is a change in income tax rate enacted in one interim period but effective in another, complexities arise concerning deferred tax balances and taxes payable.

The update requires entities to reflect the effect of a change in tax law used in the computation of the annual tax rate in the period it was enacted instead of the period that includes the effective date.

Transition Requirements and Effective DateChanges in ownership of foreign equity method investments or foreign subsidiaries must be accounted for using a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. 

Franchise taxes partially based on income must be accounted for using either a retrospective basis for all periods presented or a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. 

Allocation of income taxes for entities not subject to tax should be applied retrospectively for all periods presented.  

All other amendments should be applied on a prospective basis.

For public business entities, ASU 2019-12 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and for interim periods within fiscal years beginning after December 15, 2022. Early adoption of the amendments is permitted. 

Complexities about Accounting for Income taxes?Accounting for income taxes is about determining the amount of taxes payable or refundable in the current year and deferred tax assets and liabilities for the future tax consequences of events recognized in an enterprise’s financial statements or tax returns. Recognition, timing, presentation, and disclosures needed for deferred tax assets and liabilities are just one of the complexities hurdled by every entity. In addition, an entity may not be well versed in reconciling differences and recognizing them in the accounting books versus state laws. All of these situations can pose challenges to accurate income tax reporting.

How Scrubbed Can Help

We can assist you by evaluating specific scenarios related to your industry related to the changes in ASC 740. We provide technical consultation on complicated accounting transactions, prepare accounting memos, and provide audit support. Our team can help you ease the burden and complexities of ongoing reporting requirements and the application of complex accounting matters, while also considering the implications for risk and SOX compliance where applicable.

CONTACT US
How Scrubbed Can Help

Related Content

Blogs

September 15 Estimated Tax Deadline: Strategies for Pass-Through Entities

September 15 Estimated Tax Deadline: Strategies for Pass-Through Entities

For growing pass-through entities, the September 15 tax deadline often creates a collision between cash flow and internal capacity. Guessing at estimated payments leaves companies vulnerable to IRS penalties or unnecessarily traps critical working capital meant for Q4 growth. By establishing a Safe Harbor floor and utilizing the Annualized Income Installment Method, companies can align tax outlays directly with actual revenue. When this execution is handled proactively, finance leaders stop playing defense against deadlines and reclaim their time for strategic planning. When a high-growth pass-through entity, such as an S-Corp or a Partnership, comes off an unexpectedly strong summer, revenue is up. This should be a moment for leadership to celebrate and plan their Q4 investments. Instead, the internal finance team often finds themselves staring down a cash crunch they didn't anticipate. The pressure point is September 15. For growing operations, this date is often a collision course. It is not only the deadline for Q3 estimated tax payments, but it is also the extended filing deadline for Forms 1065 and 1120-S . When you have an internal team trying to finalize the previous year's historical data while simultaneously projecting the current year's performance, the structure usually begins to strain. This isn't about a team dropping the ball. It's simply what happens when internal workflows haven't scaled up to match a company's growth. When two major deadlines collide, and the volume is too high, a stretched team has no choice but to improvise. The Cost of "Guesstimating" In a pass-through entity, the business itself generally does not pay federal income tax. Because income from partnerships and S corporations generally passes through to their owners, owners may need to make individual estimated tax payments based in part on their share of the entity’s taxable income When internal teams don't have a dedicated workflow for this, they often get bogged down trying to predict exact year-end profits during a busy quarter. Without a clear mechanism to manage this, I frequently see companies do one of two things: they either underpay and leave themselves vulnerable to IRS penalties, or they overpay to "be safe." Overpaying might feel like the responsible choice in the moment, but it unnecessarily ties up working capital. When these distributions are sized off gross revenue rather than a projection that accounts for deductions or state-level elections, the company pulls more cash out of the operating account than the owners actually owe. That excess traps liquidity that could have been used to fund critical Q4 growth initiatives—like a marketing push or inventory expansion—without seeking outside financing. Establishing an Estimated-Tax Safe Harbor  When our tax professionals step in to manage this process, the very first thing we do is establish a predictable foundation. We immediately build a "Tax Compliance Calendar" integrated with a "Safe Harbor Floor." A useful starting point is determining which estimated-tax safe harbor applies. For many taxpayers, one option is to base required annual payments on 100% of the prior year's tax, increasing to 110% for certain higher-income taxpayers. The current-year 90% test may also apply. Meeting the applicable requirements through timely payments can generally reduce exposure to estimated-tax underpayment penalties. Once that floor is established, we can adjust for the reality of the current year. Aligning Outlays with Actual Cash Flow If a company sees a massive spike in revenue during Q3, the standard installment method might demand a payment that creates a sudden cash flow imbalance. Good intentions won't balance the cash flow at this stage; you need a precise mathematical approach. To stabilize cash flow during a sudden revenue surge, one strategy to consider is the Annualized Income Installment Method . Instead of assuming income is earned evenly throughout the year, the Annualized Income Installment Method determines the owner's required installments based more closely on income earned during the applicable annualization periods State-level PTE tax elections may also provide federal tax benefits by allowing qualifying state income taxes to be paid and deducted at the entity level rather than being subject to the individual SALT deduction limitation. The result? Depending on the state's PTE tax regime, entity-level payments may reduce the state estimated-tax payments otherwise required from individual owners. A deductible PTE tax payment may also reduce the taxable income passed through to owners for federal purposes, which can affect their projected federal estimated-tax liability. Restoring Strategic Headspace When tax planning is handled consistently throughout the year, it changes how a leadership team operates. It can significantly reduce the risk of an "April Surprise." When Q3 estimates are calculated accurately and tied to a deliberate strategy, leadership knows exactly how much capital is truly theirs to spend. Tax shifts from a looming, unpredictable liability into a manageable line item. Just as importantly, the internal finance leader gets their time back. Instead of spending the first two weeks of September finalizing and issuing K-1s, calculating thresholds, and worrying about penalties, they can focus on high-level financial modeling and operational efficiency. A strong tax partner doesn't just run the numbers; they take the friction out of the process so your team can focus forward. When an experienced team handles the heavy lifting behind the scenes, you stop playing defense against IRS deadlines and start using tax strategy as a genuine tool to fund your growth. See how our tax professionals support growing operations and keep execution predictable. Let's talk through how we can support your finance function. Comparing Q3 Tax Strategies: Safe Harbor vs. Annualized Method vs. PTE Strategy Ideal for Primary Benefit Risk Level  100%/110% Safe Harbor  Rapidly growing companies  Provides protection from estimated-tax underpayment penalties when applicable safe-harbor requirements are satisfied  Low (May temporarily tie up cash if revenue drops)  Annualized Method  Seasonal or late-year spiking revenue Align tax outlays directly with timing of taxable income  Moderate (Requires meticulous record-keeping) PTE Tax Election Entities in high-tax states May provide an entity-level federal deduction for qualifying state income taxes while providing state tax benefits to eligible owners Low (Requires state-specific eligibility and election compliance) Key Takeaways: The Deadline Collision: The simultaneous timing of Q3 estimates and extended historical filings places severe strain on internal finance teams when workflows haven't scaled. The Cost of "Guesstimating": Overpaying estimated taxes based on gross revenue ties up liquidity that could otherwise fund critical Q4 growth initiatives without requiring outside financing. Building a Safe Harbor Floor: Establishing a baseline payment based on 100% or 110% of the prior year's tax liability can provide protection from estimated-tax underpayment penalties when the applicable safe-harbor requirements are satisfied. Aligning Cash Flow: The Annualized Income Installment Method stabilizes cash positions by calculating tax based on income earned during the applicable annualization periods rather than an arbitrary quarterly fraction. Restoring Strategic Headspace: When tax planning is handled reliably behind the scenes, internal finance leaders get their time back to focus on high-level financial modeling instead of chasing K-1s.

Read More >
Blogs

Decoding the Digital Ledger: Navigating FASB’s New Standards for Crypto Assets and Intangibles (ASU 2023-08)

Decoding the Digital Ledger: Navigating FASB’s New Standards for Crypto Assets and Intangibles (ASU 2023-08)

In a groundbreaking move reflecting the swift evolution of the financial landscape, the Financial Accounting Standards Board (FASB) has taken a significant step with the release of the final Accounting Standards Update (ASU) 2023-08 titled “Accounting for and Disclosure of Crypto Assets.” This authoritative guidance specifically addresses Crypto Assets within the Intangibles—Goodwill and Other category, marking a crucial advance in establishing standardized accounting practices for these assets. Bridging the Gap: A Brief Background The rise of digital assets, from cryptocurrencies like Bitcoin and Ethereum to unique non-fungible tokens (NFTs), has challenged traditional accounting norms. Without specific Generally Accepted Accounting Principles (GAAP) guidance, accounting professionals relied on analogies and interpretations, resulting in a diverse patchwork of practices.  Our article “Rise of Digital Assets in Business” explored the evolving landscape, highlighting the AICPA Practice Aid titled “Accounting for and Auditing of Digital Assets” as a crucial guide within the constraints of the existing accounting framework. We are witnessing a groundbreaking shift with the finalized FASB’s ASU on Crypto Assets, effective December 15, 2024, which will change how the world sees crypto assets. Who Will Be Affected? The new ASU applies to a wider range of entities than you might think. Any entity holding crypto assets that meet specific criteria will be impacted. These criteria include: Meet the definition of an intangible asset. Do not grant enforceable rights or claims on underlying goods, services, or assets. Exist on a blockchain-based distributed ledger or similar technology. Are secured using cryptography. Are fungible. Are not created or issued by the reporting entity or its related parties. Crypto assets falling within these criteria must be measured at fair value, with changes in value recognized in their income statement each reporting period. Moreover, transaction costs incurred in acquiring these assets, such as commissions and related fees, will be expensed unless other industry-specific guidance dictates otherwise. A Closer Look at the New ASU  Mandating Relevance: Fair Value Measurement  The update mandates the fair value measurement of crypto assets at each reporting period. This focus on fair value measurement stems from the belief that fair value offers investors more relevant information about the assets’ sale value and changes in that value. The Board rejected historical cost and net realizable value as alternatives due to limitations in reflecting downward and upward price movements. The existing guidance in Topic 820 was deemed sufficient for fair value measurement, given its applicability to other assets and current use by reporting entities. As financial reporting evolves, organizations offering ESG reporting services may also need to consider how such valuation updates intersect with broader transparency and sustainability disclosure requirements. Beyond Annual Assessment: Recognizing Both Gains and Losses Unlike the existing ASC 350 model, which mandates an annual assessment of crypto asset value that only recognizes gains upon sale, the update embraces a more dynamic approach. The new method captures both negative and positive market movements, addressing longstanding concerns about the traditional model’s failure to reflect the true and current economic nature of crypto assets at each reporting period. As well as providing a more comprehensive understanding of the underlying economics and an entity’s financial position, the shift signifies a progressive step toward a more responsive and accurate representation of the financial impact of market fluctuations on digital holdings. Enhancing Transparency: Disclosure Requirements The ASU prioritizes transparency, incorporating detailed disclosure requirements for asset categorization, impairment considerations, and, notably, the separate presentation of crypto assets from other intangible assets in the statement of financial position. Entities must disclose the following for annual and interim reporting periods: 1. Details of significant and less significant crypto asset holdings, including name, cost basis, fair value, and quantity. 2. Information on restricted crypto assets, covering fair value, nature, the remaining duration of restrictions, and circumstances for the potential lapse. For annual reporting periods, additional disclosures are required: 1. A roll forward of crypto asset activity, including additions, dispositions, gains, and losses. Specify the income statement line item for unrecognized gains and losses if not presented separately. 2. Detail dispositions of crypto assets, including sale price, cost basis difference, and relevant activities. 3. The method used to determine the cost basis of crypto assets. These changes enhance transparency and understanding of crypto asset holdings, ensuring comprehensive disclosure for annual and interim reporting periods. Nevertheless, entities immediately converting crypto assets received as noncash consideration or contributions into cash are exempt from the above annual additional disclosures. The Countdown Begins: Timeline and Adoption The final standard takes effect for all entities in reporting periods beginning after December 15, 2024, including interim periods within those fiscal years. Early adoption is permitted, allowing entities to embrace the changes ahead of the mandated timeline. However, early adopters must use a modified retrospective approach, requiring recording a cumulative effect adjustment to equity (or net assets) from the commencement of the adoption year. What Lies Ahead: Implications for the Future The issuance of the finalized ASU 2023-08 represents a proactive response to the growing significance of crypto assets in today’s financial landscape. The finalized ASU is a significant milestone in our journey toward a standardized and transparent future for crypto asset accounting, offering consistency in financial reporting across diverse industries engaged with crypto assets. The FASB’s move acknowledges the need for accounting standards that keep pace with technological advancements and reflect the realities of the modern economy. Stay tuned for further developments. How Scrubbed Can Help You? Navigating the opportunities and challenges of crypto assets demands expertise, whether you’re an individual investor or a business. At Scrubbed, our comprehensive range of services empowers you to stay ahead: • Compliance Experts: Navigate crypto regulations effortlessly with our seasoned professionals. From taxes to reporting, we’ve got your compliance needs covered. • Rock-Solid Controls: Establish secure systems and ensure compliance with the latest financial reporting standards like GAAP and IFRS. • Innovative Strategies: Beyond the numbers, we offer strategic insights about market tren ds and help you make wise decisions. As we collectively pioneer a new era of financial reporting, Scrubbed is committed to bridging the gap between traditional accounting norms and the groundbreaking shifts introduced by the FASB on Crypto Assets. Our Technical Accounting Group is ready to assist your business in decoding the digital ledger, ensuring effective operations, and maintaining compliance with evolving regulations. We also provide specialized biotech accounting services, supporting organizations in highly regulated industries with tailored financial reporting solutions. For a comprehensive consultancy assessment tailored to your specific needs, reach out to [email protected].

Read More >
Blogs

The Rise of Digital Assets in Business

The Rise of Digital Assets in Business

Companies are beginning to set foot into unconventional investments, such as Bitcoin, and Ethereum, which are cryptocurrencies, a form of digital assets. With their tremendous potential for growth and unique portability and transparency, digital assets are an alluring venture. This can transform how financial markets operate, and investors interact with the traditional financial system. Also, as more companies embrace up-to-date and open technology, digital assets could become a more common medium of exchange and a streamlined, transparent, and cost-efficient form of value transfer. Like all other investments, digital assets should conform to the broader investment strategy developed by companies. With the endless opportunities and possibilities in digital assets comes a wide variety of risks including the well-known volatile market for cryptocurrencies and NFTs, digital hacking, security breach, and theft (depending on how users store these assets); regulators continue to evaluate how to oversee the ever-evolving digital landscape. The rules of play are provisional, which makes risk assessment of digital assets critical. Digital asset investments will require constant and frequent monitoring of the market and several risk factors. The risk and liquidity of digital assets will also need to be evaluated and paralleled with the companies’ investment strategy. As these innovative digital investments and currency forms are becoming more prevalent and interlinked with the regulated financial system, there’s an increasing likelihood that companies will come across digital assets in any way. Fundamental accounting and risk and SOX compliance with digital assets are challenging. However, the more we comprehend how digital assets work, the easier it will be to adhere to laws and regulations. What is a Digital Asset? There is currently no precise definition for this type of asset; however, we can refer to the executive order issued by US President Joe Biden last March 9, 2022, titled, “Ensuring Responsible Development of Digital Assets” . As outlined in the order, the term “Digital Assets” is the umbrella term that refers to all cryptography-based assets and other representations of value, regardless of the technology used, that are issued or represented in digital form through the use of distributed ledger or “blockchain” technology. With the vast range of this topic, the most well-known forms of digital assets include: (a) Cryptocurrencies – such as Bitcoin, Ethereum, Tether, and Cardano; (b) NFTs – a unique and non-divisible token that allows for authentication to prove its legitimacy and ownership, usually associated with artworks, media files, documents, and even a unique item within an online game.; and (c) Asset-Backed Tokens – which derives their value on conventional physical assets, such as gold, oil and even real estate, which are “tokenized” and traded among users on the blockchain. Tokenization of these assets can help with asset liquidity problems and make them more accessible to a wider range of investors and users, at lower administrative costs. Common Accounting Considerations As we deal with digital assets, below are the common accounting questions regarding this type of asset: How are these: Classified in the accounting records? Initially recognized and measured? Assessed for valuation and impairment? Derecognized?   To date, the US Generally Accepted Accounting Principles (“GAAP”), as represented by FASB Codification, has yet to provide specific guidance on accounting for digital assets. With this, publicly available information such as the American Institute of Certified Public Accountants Practice Aid titled, “Accounting for and Auditing of Digital Assets” , is used as a guide and reference in the meantime. The practice aid conclusion stated that the characteristics of digital assets meet the definition of indefinite-lived intangible assets and would generally be accounted for under Accounting Standards Codification or ASC 350, Intangibles—Goodwill and Other.    In addition, when applying the existing US GAAP guidance by analogy, native digital assets generally do not meet the definitions of cash, inventory, or financial assets and are accounted for as an intangible assets. It emphasized that “digital” would not meet the definition of other asset classes within GAAP, as described in the following examples: • Digital Assets will not meet the definition of cash and cash equivalents as they are not considered legal tender and are not backed by sovereign governments.  • Digital Assets will not be financial assets as they do not represent a contractual right to receive cash or another financial instrument • Digital Assets, though may be held for sale in the ordinary course of business, they are not tangible assets and therefore may not meet the definition of inventory. However, the problem with digital assets that are accounted for as indefinite-lived intangible assets is that, it only captures negative volatility through impairment recognition. Note that under ASC 350, if an indefinite-lived intangible asset is impaired, an impairment loss is recognized, but any subsequent increase or recovery in value cannot be recognized until the asset is sold. As a result, this could be misleading to the users of financial statements and does not truly represent the economic nature of digital assets as these generally have actively traded markets.  While there is no official accounting model yet that considers the proper way to reflect the substance, liquidity, and value of the digital assets that are aligned with the economic reality, other models may be more appropriate, depending on the circumstances. This can vary widely, and, therefore, the accounting framework to be applied under US GAAP needs to be considered on a case-by-case basis. The type of digital asset will also be a critical factor in terms of accounting and financial reporting under existing accounting rules.  As the adoption of digital assets continues to soar, these issues will only become more prevalent and pervasive. Standard setters will continue to look into alternative and more refined approaches to accounting for digital assets to resolve practical problems and provide transparent financial reporting for users of financial statements.  Recent Developments With digital assets’ potential to transform the traditional financial system, the associated challenges are drawing considerable regulatory attention. To date, below are the relevant developments for the regulation of digital assets: • On March 9, 2020, US President Joe Biden signed an executive order on “Ensuring Responsible Development of Digital Assets,” which includes cryptocurrency and other assets such as NFTs. The executive order shows the commitment of the White House to participate in the research on cryptocurrencies and engage departments across the government to collaborate in creating a framework that will regulate digital assets. It also outlines a “whole-of-government approach to addressing the risks and harnessing the potential benefits of digital assets and their underlying technology.” Further, it serves as official recognition of the increasing impact of digital assets and the US federal government’s intention to regulate digital assets as a whole and cryptocurrencies, specifically. • On March 31, 2020, the US SEC issued a Staff Accounting Bulletin (SAB) on accounting for the obligations to safeguard crypto assets that an entity such as a crypto exchange holds for users. It clarifies how the agency expects companies to apply existing accounting standards to digital assets.  • On May 11, 2022, the FASB added a project to its technical plan to improve the accounting for and disclosure of certain digital assets. Previously, the FASB has received three agenda requests on digital assets since October 2020, all of which encourage the Board to address the financial reporting for digital assets. • And more recently, the US Treasury Department issued a “Greenbook” that includes budget proposals to modernize various tax rules, including those for digital assets. Rules will change for treating securities loans as tax-free to have other asset classes and address income inclusion, provide for information reporting by certain financial institutions and digital asset brokers for purposes of exchange of information, and require reporting by certain taxpayers of foreign digital asset accounts. In addition, the plan would amend the mark-to-market rules for dealers and traders to include digital assets. What’s Ahead? As the digital asset landscape continues to evolve across various types of market participants, products, and technologies, companies and other stakeholders of all kinds must be able to properly reflect and disclose these digital assets in their financials and assess the overall impact of the risks involved in owning these types of assets when making decisions. However, since digital assets are new and unique from other investments, the existing accounting models does not yet fully reflect these assets’ true nature and value in accounting and financial reporting. Also,  companies must be aware that regulators are rapidly evolving their guidance on reporting, so the rules of engagement today may be different in the future. Accordingly, accounting, assurance, and tax services for companies with digital assets have become more sophisticated and require professional advisors to understand the nature of those complexities. This is similar to the specialized approach required for nonprofit financial reporting, where unique compliance requirements demand expert knowledge and precision. We’d love to help. To ensure that all factors are considered in the pursuit of reliable financial reporting, effective and efficient operations, and compliance with law and regulations, our services can be scaled to accommodate your business needs. Our Technical accounting Group provides a thorough analysis on assessing the impact of complex and unusual accounting transactions.   E-mail us at [email protected] for a full consultancy assessment. Disclaimer: The information contained herein is general and is not intended to address the circumstances of any particular individual or entity. It is not intended to be relied upon as accounting, tax, or other professional services. Please refer to your advisors for specific advice. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. *Disclaimer: Services being offered do not require a state license. About the Author Reinald John Maliberan is a supervisor of the Technical Accounting Group of Scrubbed. He assists companies in preparing technical memoranda and performs an extensive review of US GAAP financial statements (i.e., 10-Q and 10-K reports), note disclosures, and account reconciliations. Before joining Scrubbed, he has almost five years of professional experience with Ernst and Young (EY) Philippines handling financial statement audits for public and private companies.

Read More >

Contact Information

SF Bay Area Headquarters
111 Anza Boulevard, Suite 320, Burlingame, CA 94010, United States

Phone: (800)837-5160
Email: [email protected]

"Scrubbed" is the brand name under which Scrubbed Advisory, LLC and Scrubbed Assurance, LLP provide professional services. Scrubbed Advisory, LLC and Scrubbed Assurance, LLP practice in an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations, and professional standards. Scrubbed Assurance, LLP is a licensed independent CPA firm that provides attest services to its clients, and Scrubbed Advisory, LLC provides tax, finance, and support services to its clients. Scrubbed Advisory, LLC is not a licensed CPA firm.

Copyright © Scrubbed. All rights reserved.