Non-Fungible Tokens (NFTs) have become a new sensation among digital creators and investors across the globe. This blockchain-based platform is expected to gain further traction and become a gigantic $231 billion industry by the end of this decade.
Since NFTs have gained the limelight recently, accounting firms and freelance accountants are still not on the same page regarding their accounting implications. Neither an International Accounting Standard (IAS) nor a GAAP principle talks explicitly about how to account for NFTs. However, you still have to account for it because of its financial and commercial side.
Though confusing initially, there is a pretty straightforward technique to account for NFTs. Whether you’re a freelance accountant, running an accounting firm, or a creator/holder of NFTs, here’s how you can account for NFTs in 2022:
Accounting For NFTs in 2022
Like for every asset, there are multiple accounting implications of NFTs such as accounting for NFTs on the acquisition, disposal, impairment, and revaluation. However, before getting into the details of NFT accounting, we need to first identify the accounting nature of NFTs.
Since NFTs don’t have a physical form and are long-term assets, they classify as intangible assets and are usually accounted for as per the rules of intangible assets. However, the accounting implication may vary — depending on the purpose that the NFT serves. For example, if you have acquired an NFT for resale purposes then instead of classifying it as an intangible asset, classifying it as an inventory item makes more sense.
Here’s the accounting treatment of NFTs on the acquisition, revaluation, and disposal:
Accounting For NFTs on Acquisition
If you are someone who deals in NFTs meaning that if buying and selling NFTs is your primary business activity, then you need to recognize every NFT you acquire as an inventory item. The initial double-entry of the purchase will be:
Debit Inventory
Credit Cash/Bank
Add the asset (NFT) to the current asset figure in the balance sheet and deduct the amount paid from the cash or bank account. You should only include directly attributable costs in the purchase price such as direct exchange costs and other legal costs associated with the underlying NFT. Once you recognize the NFT as an inventory item, you should then value it at the lower of cost and net realizable value (NRV) in subsequent years. For example, if you have acquired the NFT for $20,000 and it’s now worth $25,000, you should value it at $20,000 since it is lower.
At times, there could also be extra costs associated with selling the NFT in an active market in which case you need to deduct these costs from the above $25,000 figure. For example, if you have to pay an extra $7,000 in exchange costs to sell the NFT, you need to deduct $7,000 from $25,000 to arrive at the NRV. Therefore, the NFT will be valued at $18,000 (25,000-7,000) — the lower of cost (20,000) and NRV (18,000).
However, if the NFT is not acquired for resale purposes meaning that if you have acquired it as an investment to realize its long-term potential, then you need to treat it as an intangible asset just like other cryptographic assets such as Bitcoin and Ethereum. The double-entry for NFTs acquired for investment purposes will be:
Debit Non-current Asset
Credit Cash/Bank
Microstrategy, one of the world’s largest business intelligence, mobile software, and cloud-based service providers in the world has roughly invested $4 billion in cryptographic assets like Bitcoins. They have used the term “Digital Assets” for the investment in their financial statements. Since NFTs and cryptographic assets have the same accounting treatment, we will use the word “Digital Assets” for NFTs acquired for investment purposes in the balance sheet.
Subsequent Measurement of NFTs
Generally, we use either the cost model or the revaluation model for subsequent measurement of intangible assets. In the cost model, the asset is valued at cost less amortization costs whereas, in the revaluation model, the asset is valued at fair price which is basically the price for which the asset could be sold in an active market less any costs associated with selling the asset.
However, NFTs have revaluation challenges since each NFT is unique and there may not be an active market for the particular NFT. Its carrying value is based on the perception of buyers and sellers, and the uniqueness of the underlying NFT. Therefore, you need to perform the revaluation in a slightly different manner.
Here’s how you can perform the revaluation of NFTs:
Since the value of NFT is significantly associated with the artist, the current reputation and achievements of the artist greatly influence the fair value of the NFT. However, the valuation gain cannot be recognized in the statement of profit or loss until and unless the NFT is sold. Once the NFT is sold, recognize any surplus amount in the SOFP.
Though both techniques — The cost and revaluation models are challenging to apply to NFTs, the revaluation model relatively makes sense since it can perfectly incorporate the volatility reward/loss of NFTs. In contrast, the cost model requires an asset to have a definite useful life with periodic amortization cost or impairment checks. At times, it can become challenging and you may never find relevant data because of the varying nature of every NFT.
Should You Charge Amortization For NFTs?
Generally, intangible assets that have a definite useful life are amortized which means their initial capital cost is divided by their useful life and is charged each year in the SOFP. However, NFTs usually have an indefinite useful life and therefore, you don’t need to charge any amortization cost.
Final Thoughts
The NFT industry is experiencing a compound annual growth rate of 33.7% and it’s about time accounting firms and freelance accountants understand the accounting implications of NFTs.
The good thing is that you don’t need to learn any new accounting standard or principles, and IAS38 has all that you need to incorporate your clients’ NFTs into their business books and financial statements. Being an early adopter, you can gain an edge over your competitors and leave a digital and modern impression on your current and potential clients.