This is one article in a collection of 52 articles published weekly throughout 2023 on the basics of Bitcoin. The series is intended for people unfamiliar with Bitcoin or people wishing to enhance their understanding of the fundamentals that underpin the technology. Please contact us if you have any questions or comments.
Earlier this year the Federal Accounting Standards Board (FASB) made a subtle change to the accounting practices surrounding the valuation of bitcoin that could have a dramatic impact on how businesses use the technology moving forward. Under the old system, bitcoin was treated as a long-lived intangible asset. As a result of being a long-lived intangible asset the underlying asset, in this case bitcoin, must be periodically tested for impairment to the underlying asset. Therefore, a business which held bitcoin on its balance sheet must periodically check for an impairment and mark down the balance sheet if the price of bitcoin has fallen. This is reasonable enough. However, price appreciation is not similarly reflected for long-lived intangible assets.
To the contrary, and detrimentally, a business does not reflect any appreciation of a long-lived intangible asset. Therefore, a business that held bitcoin on its balance sheet could not reflect the appreciation of the bitcoin on its books if the price of bitcoin rose if the business was unwilling to sell the bitcoin. This antiquated classification of bitcoin as a long-lived intangible asset is mercifully being updated under a new set of rules being released by FASB.
Under the new set of rules scheduled to be adopted by FASB, bitcoin will be reflected under the fair market standard. Under the new standard, the value of bitcoin held will need to be adjusted each accounting period to reflect the fair value of the bitcoin at that particular period of time. The new FASB standard will allow companies who hold bitcoin to have the benefit of bitcoin appreciation as opposed to only the burden of bitcoin price depreciation under the old system.
To explain why the FASB rule change could dramatically impact the way companies view bitcoin consider the following example. Suppose company ABC purchases 50 bitcoin at $20,000 per bitcoin under the old FASB standard. After the purchase the price of bitcoin plummets to a low of $15,000 and trades around that value for several years. At that point ABC would need to amend its books to reflect the impairment of the long-lived intangible asset, in this case bitcoin, to $750,000 (a loss of $250,000).
Eventually the market cycle turns as a halving occurs and the price soars to $50,000 per bitcoin. Under the old FASB system ABC’s books would only be able to reflect the value of the bitcoin position of ABC at $750,000. However, despite the dramatic rise in price to $50,000 per bitcoin, ABC would not be able to reflect the gain in value on its books to $2,500,000 of the bitcoin. Instead, ABC’s books would reflect the price of the long-lived intangible asset at $750,000. These outdated rules that companies currently have to operate under only allow companies to reflect the decreased value of the long-lived intangible asset without any benefit of the gain! It is not hard to see why this is an unattractive option for businesses.
When the new rules are in place, which is expected to occur as soon as 2025 but possibly earlier for companies that apply, ABC would be able to have its books reflect bitcoin’s massive price appreciation to align with the true value of the underlying asset. Bitcoin is an interesting alternative for companies to review for myriad reasons. However, as opposed to cash, which the federal reserve tries to inflate at two percent, bitcoin’s print schedule is known and no matter what there will only ever be 21 million bitcoin! Our next article regarding bitcoin adoption explains why this feature may make bitcoin an attractive piece of a company’s reserves moving forward once the new FASB rules are in place.
