Digital Assets and Precious Metals: Alternative Reserves for Cash
The national and global economy changed dramatically over the past 20 years. These changes have seen the rise in e-commerce and instant delivery of products and services. With these changes, there has also been a rise in alternative asset and investment options. These reserves became more in focus with the severe impact of COVID-19 on the world’s economy.
Businesses have been diversifying into digital assets, such as Bitcoin and Ethereum, and precious metals, such as gold and silver. This diversification is prevalent across all industries, from professional services to SAAS to manufacturing.
In this post we will cover how to account for alternative investments in your bookkeeping. In particular, we’ll cover precious metals and digital assets. We will go over the basics of investment accounting, and how it applies to these alternative reserves.
Investment Accounting Basics
To understand the unique nuances with precious metals and digital assets, or cryptocurrencies, we first need to cover the basics of accounting for investments. Businesses will typically purchase financial instruments, or investments, to enhance the return on cash.
These investments can range from stocks to debt securities to ownership in another entity. The accounting for these investments will depend on the intent of the investor.
When management makes an investment purchase, they have a specific goal in mind. That goal may be to earn more interest in the short-term, or take advantage of companies experiencing upward trends.
Overall, the intent for making the investment will predicate how the investment should be recorded on the balance sheet. There are three primary areas that investments fall into. They are:
- Held to Maturity—Investments are held to maturity if management intends to hold an investment up to its maturity date. Typically, this is used for debt instruments. This type of investment is recorded on the balance sheet at historical cost. The balance will not be adjusted for ongoing market fluctuations unless there is an impairment.
- Trading—As the name indicates, these are investments that management plans to actively trade or sell in the short term. They are initially recorded at cost. Any changes in market value are adjusted against the investment recorded on the balance sheet and through current earnings on the income statement.
- Available for Sale—These investments are not actively traded, but they will not be held until maturity. These investments are initially recorded at cost and are periodically adjusted to fair market value. The change is considered unrealized holding gain or loss and is recorded in other comprehensive income. The change will not go to earnings until the investment is sold.
Some investments, such as ownership in another entity, fall under separate accounting guidance. Those types of investments are outside the scope of this article.
Ultimately, management’s intent on the use of the investment will dictate how the asset is recorded and if the balance is adjusted to market fluctuations.
Precious Metals
Inflation can gradually occur in an economy, or grow suddenly over a matter of months. When inflation occurs, a business’s purchasing power erodes. To counter this erosion, some businesses invest a portion of cash in certain alternative reserve assets, such as gold or silver. In this article, the broker/dealer industry and use of metals in product productions is outside the scope of this discussion.
The recording of the purchase of these metals creates a question as to where to record on the company’s balance sheet?
The first step is to determine what is management’s intent. If the metals are to be converted to cash or another investment within one-year, then the assets should be considered a short-term asset. However, most businesses will purchase precious metals to hold them longer than one year. So, logically, this purchase would be considered a long-term asset.
Now, should the value be adjusted periodically?
Generally Accepted Accounting Principles (GAAP) is silent on the treatment of precious metals in a business’s financial statements. However, the accountant can use the basic treatment on accounting for investments.
Should the metals be considered as held to maturity? The physical metals do not have any sort of contract on them. So, they technically cannot be ‘held to maturity’ as there is no maturity date.
Should the metals be considered as trading or available-for-sale? This depends on whether management is intending to sell the metals in the future. Most likely they are, but is the intent to create additional profit or to protect the company’s purchasing power?
If management intends to create additional profit, then a classification of either trading or available-for-sale is reasonable.
If management intends to protect the business’s purchasing power, then the recording becomes a little different. This intent does not mirror the standard investment accounting. As the asset is to be held to allow the business to protect purchasing power, then recording the investment at historical cost is reasonable.
The balance should not be adjusted for ongoing market fluctuations, as they intend it not to increase profits but to protect purchasing power. Additionally, the precious metals should be recorded as another long-term asset.
Regardless of the intent, the important key is that management documents this investment decision and the subsequent accounting. Until GAAP produces clear guidance, this internal documentation will govern the subsequent adjustments to the precious metals investment.
Digital Assets
Digital assets have grown exponentially over the past decade. More and more businesses are using and accepting cryptocurrencies. Several high-profile companies, such as Tesla, are moving parts of their cash reserve into digital assets. Bitcoin, Ethereum, Cardano, Litecoin, are just a portion of currencies available. Bitcon, however, is the world’s largest by market capitalization.
The problem for the accountant is how to properly account for these assets?
The easiest way to determine how to account for digital assets is to first understand what they are not.
- Digital assets are not considered legal tender and they are not backed by a government; therefore, they do not meet the Financial Accounting Standards Board (FASB) definition of cash or cash equivalents.
- As they do not meet the definition of cash or ownership interest in an entity or contract, they do not meet the definition of a financial instrument. Thus, they are not considered a ‘standard’ investment.
- There is no physical structure to the currency, so they are not considered a tangible asset. Thus, they don’t meet FASB’s definition of inventory.
As the digital assets lack physical presence, they don’t meet the definition of cash or financial instruments, they best meet FASB’s definition of an intangible asset. This means, until FASB issue guidance otherwise, that Bitcoin and other crytpocurrencies should be accounted for under the guidance for intangibles and goodwill.
When initially accounting for Bitcoin, and in particular for purchased coins, the coins should be recorded at the historical cost. The entry should be to credit cash or a payable, and debit the ‘Intangible-Bitcoin’ account.
After the initial recording, the digital asset should only be adjusted to market rates if the asset has become impaired. No increases in the market value should be recorded. These types of currencies have been known to be volatile and can have fluctuations in values of 15-25% in one week. So determining when the asset has become impaired will have to be subjective and examined over an extended time frame.
If it is determined that the Bitcoin asset is impaired, then the value should be adjusted on the balance sheet. The value of the asset cannot be increased subsequently, even if the market shows a significant increase.
The disclosure of cryptocurrency in the financial statement is unique. On one hand the asset is classified intangible, on the other the disclosures need to inform the reader of the volatility similar to disclosures for standard investments. Below is an example of disclosures from Tesla’s 2020 financial statements:
In January 2021, we updated our investment policy to provide us with more flexibility to further diversify and maximize returns on our cash that is not required to maintain adequate operating liquidity. As part of the policy, which was duly approved by the Audit Committee of our Board of Directors, we may invest a portion of such cash in certain alternative reserve assets including digital assets, gold bullion, gold exchange-traded funds and other assets as specified in the future. Thereafter, we invested an aggregate $1.50 billion in bitcoin under this policy and may acquire and hold digital assets from time to time or long-term. Moreover, we expect to begin accepting bitcoin as a form of payment for our products in the near future, subject to applicable laws and initially on a limited basis, which we may or may not liquidate upon receipt.
The prices of digital assets have been in the past and may continue to be highly volatile, including as a result of various associated risks and uncertainties. For example, the prevalence of such assets is a relatively recent trend, and their long-term adoption by investors, consumers and businesses is unpredictable. Moreover, their lack of a physical form, their reliance on technology for their creation, existence and transactional validation and their decentralization may subject their integrity to the threat of malicious attacks and technological obsolescence. Finally, the extent to which securities laws or other regulations apply or may apply in the future to such assets is unclear and may change in the future. If we hold digital assets and their values decrease relative to our purchase prices, our financial condition may be harmed.
Finally, as intangible assets without centralized issuers or governing bodies, digital assets have been, and may in the future be, subject to security breaches, cyberattacks or other malicious activities, as well as human errors or computer malfunctions that may result in the loss or destruction of private keys needed to access such assets. While we intend to take all reasonable measures to secure any digital assets, if such threats are realized or the measures or controls we create or implement to secure our digital assets fail, it could result in a partial or total misappropriation or loss of our digital assets, and our financial condition and operating results may be harmed.
The business should record digital assets as an intangible asset on their balance sheet. The asset should be recorded at historical cost. The value should only be adjusted for impairment. Given the volatile nature of digital assets, a unique policy for determining impairment will have to be developed. Gains or losses should be recognized when the asset is transferred or sold.
Conclusion
Accounting for alternative investments requires management to understand the exact intent of acquiring the asset. For physical assets, such as gold and silver, management needs to clearly communicate and document the purpose and intent of the investment. This will then drive how the asset should be recorded on the financial statements.
For digital assets, the transaction should be recorded as an intangible asset and reviewed periodically for impairment.
Ultimately, is important that the policies for recording and determining impairment are clearly outlined and followed.
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