Between the volatility, transaction volume, and the sheer number of digital assets to track, accurately calculating carrying values across an organization's portfolio is easier said than done. At best, it is an incredibly time-intensive manual process, which is why many organizations struggle with impairment testing for digital assets –– or worse, don’t do it at all.
But regulators require rapidly-growing and public-facing organizations that hold digital assets to conduct these tests regularly. But lack of guidance introduces audit risks, which are getting increasingly expensive. In the US, audit fees grew 3.7% in 2020 to $2.52 million.
This guide will provide an overview of impairment testing for digital assets and learn how organizations that keep digital assets on their balance sheets can remain compliant and rest easy during audit season.
What is Impairment of Intangible Assets?
Let’s start unpacking three crucial concepts: intangible assets, impairment, and carrying value.
Intangible assets are non-physical. Examples include goodwill, intellectual property, and digital assets. Impairment is an expense that reflects the fact that the value of an asset has dropped below its cost basis.
Impairment of digital assets, therefore, can be thought of as an accounting procedure intended to measure and account for the reduction of the asset’s value. For digital assets that are traded on exchanges and for which there is a known market price, impairment analysis is tied to the price fluctuations of the underlying asset.
Impairment of intangible assets example: goodwill
Time for a brief history lesson.
Before digital assets emerged over a decade ago, goodwill was the most common intangible asset. Goodwill can be considered value created by brand recognition, for example.
Imagine your organization was going to buy a public company for $5 billion. $3 billion might account for physical assets like production lines, equipment, inventory, etc. From an accounting perspective, the additional $2 billion of value derived from the brand may be considered goodwill, which will be included on the acquiring company's balance sheet as an intangible asset.
Historically, intangible assets like goodwill weren’t regularly traded like digital assets today. As a result, accounting standards like the U.S. GAAP (Generally Accepted Accounting Principles) or International Financial Reporting Standards (IFRS) mandate that public organizations test intangible assets for impairment at least once per reporting period. Hence, their records reflect their current value.
As a result, intangible assets are typically tested at least annually. In the example of goodwill impairment, organizations do nothing if its value increases. But if it decreases, you have to book a loss and write down the value of that goodwill. In the example above, we would write down that $2 billion, which is our impairment.
This makes sense for assets of this class, but what about digital assets?
Why test digital assets for impairment?
Because technology changes faster than regulators keep up. And when there is no clear guidance, organizations have to follow existing classifications and typically follow a process of elimination similar to this:
- Are they inventory? No, digital (intangible) assets aren’t an array of goods used in production or finished goods held by a company during its ordinary course of business.
- Are they securities? No, legally, securities give owners rights to profits or ownership, so the SEC does not classify digital assets as securities.
- Are they currencies? No, because currencies must be issued by governmental entities.
Because digital assets aren’t considered inventory, securities, or currencies, we’re currently left with one remaining classification: intangible assets. So consequently, the digital assets must be tested for impairment.
But for the reasons we outlined at the start, impairment testing for digital assets is easier in concept than in practice.
What are the challenges of digital assets impairment?
With the inherent volatility of digital assets, the cost basis is constantly changing. Complications include:
- Portfolios must be tested for impairment asset-by-asset (BTC, ETH, AVX) and lot-by-lot (e.g. ETH purchased in 2021 vs. ETH purchased in 2016).
- Large organizations regularly make millions of transactions a month, which makes capturing and maintaining these values an arduous process.
- Digital assets like NFTs are hard to price
How to calculate impairment for intangible (digital) assets
The analysis for impairment of digital assets must be performed regularly, at least at every reporting period or more frequently if events or changes in circumstances indicate it is more likely than not that the asset is impaired.
There are four steps:
- Impairment testing is to be performed at the individual lot level; thus, it is very important to track each individual digital asset separately
- Compare the purchase price—the cost basis—of the digital asset with the current market value of the digital asset
- Suppose, at any point in the reporting period, the price of the underlying intangible asset drops below its purchase price. In that case, the asset is impaired. The company would have to write down the digital asset's value to the lowest point within the reporting period, along with recognizing a corresponding loss.
- As long as the company holds the digital asset, the asset must undergo continual impairment testing until it is sold, disposed of, or traded.
In the U.S., if impairment occurs and a write-down is necessary, this reduction is permanent. The intangible (digital) asset’s value is written down on the balance sheet, and a corresponding loss is recognized on the income statement. International accounting standards allow organizations to recover that impairment and essentially reverse it.
GAAP AND IFRS standards require digital assets to be tested once a year, but as you can see, in the case of crypto, it doesn’t reflect the nature of price fluctuations that happen far more frequently.
Organizations must shrink the period down to a month, week, or even daily to get a more accurate picture. But manually conducting impairment tests for intangible digital assets could easily be a full-time job in and of itself.
What if there was a better way?
Time-intensive manual spreadsheet updates or one-click impairment testing for intangible digital assets? You decide.
Bitwave is built to adapt to your business's unique requirements and is the only accounting software for digital assets that provide flexible impairment cycles (Daily, Weekly, or Monthly) and allows users to switch between the close or low of the day, respectively.
Ready to learn more? Reach out today and schedule a full demo.
Disclaimer: The information provided in this blog post is for general informational purposes only and should not be construed as tax, accounting, or financial advice. The content is not intended to address the specific needs of any individual or organization, and readers are encouraged to consult with a qualified tax, accounting, or financial professional before making any decisions based on the information provided. The author and the publisher of this blog post disclaim any liability, loss, or risk incurred as a consequence, directly or indirectly, of the use or application of any of the contents herein.
