SEC Objects To MicroStrategy Accurately Valuing Its Billion-Dollar Bitcoin Stash

What Occurred

MicroStrategy has been buying bitcoin since 2020 as part of its capital allocation technique. The corporate holds over 120,000 BTC as of the tip of December 2021. As a U.S. public firm, MicroStrategy is required to report earnings and transactions associated to bitcoin beneath Usually Accepted Accounting Rules (GAAP) commonplace. Nonetheless, correctly accounting for these transactions in GAAP monetary statements is an rising space. The present GAAP requirements that classify digital property as intangible property with indefinite lives (much like goodwill and emblems of a enterprise), fail to seize the true monetary conduct of bitcoin holdings. This remedy requires corporations to report a loss when digital property’ costs fall beneath the fee; nonetheless it prohibits marking up digital property to it is true worth when costs later get better. This discrepancy can negatively affect an organization’s web earnings, which might incorrectly translate into cheaper price per share. 

To handle the shortcomings of GAAP earnings on account of bitcoin impairment losses, MicroStrategy added a “Non-GAAP Monetary measures” part to Kind 10-Q (Quarterly monetary report public corporations file with the SEC) for the quarter ended September 20, 2021. Nonetheless, the SEC objected to this new remedy

Key Ideas

The Monetary Accounting Requirements Board (FASB) is the IRS of the accounting world. The FASB is liable for creating Usually Accepted Accounting Rules (GAAP). As of the date of posting, there are nonetheless no cryptocurrency particular GAAP guidelines.

Within the absence of those crypto particular guidelines set by the FASB, in 2020, a working group fashioned by the American Institute of CPAs (AICPA) got here up with a Digital Asset Practitioner Information addressing learn how to classify cryptocurrencies in GAAP monetary statements.

How Cryptocurrencies are Categorized on GAAP Financials

In accordance with the white paper issued by the AICPA, crypto property can’t be labeled as “money or money equivalents” on GAAP monetary statements as a result of they aren’t backed by a sovereign authorities or thought-about authorized tender. They can’t be labeled as a monetary instrument or a monetary asset as a result of they aren’t money (see above why) and don’t symbolize any contractual proper to obtain money or one other monetary instrument. Moreover, since cryptocurrencies are intangible, they don’t clearly meet the definition of stock and can’t be labeled as stock on the steadiness sheet both.

After going via the method of elimination, we’re left with just one class to categorise cryptocurrencies beneath: intangible property with indefinite life. That is how MicroStrategy at present classifies bitcoin of their monetary statements. 

(3) Digital Property: The Firm accounts for its digital property as indefinite-lived intangible property in accordance with Accounting Requirements Codification (“ASC”) 350, Intangibles—Goodwill and Different. The Firm’s digital property are initially recorded at price. Subsequently, they’re measured at price, web of any impairment losses incurred since acquisition” (10-Q, web page 11)

Sensible Mismatches with Intangible Asset Remedy

There are a number of issues with classifying cryptocurrencies as intangible property with indefinite life. Virtually talking, this accounting remedy doesn’t align with the truth. Cryptocurrencies like bitcoin are liquid and work extraordinarily much like money. The aim of GAAP monetary statements is to color an correct, unbiased image of the underlying entity’s monetary state of affairs. By treating crypto property as intangible property, GAAP financials fails to speak the excessive liquidity of crypto property. 

Second, as soon as an merchandise is assessed as an indefinite life intangible asset, it must be examined for impairment. This implies, if the worth of the crypto asset has gone down on the finish of the reporting interval, the enterprise will get to write down off that quantity as an impairment loss (to not be confused with tax losses) on the earnings assertion. Nonetheless, if the worth goes again up (which is widespread on account of excessive volatility), the enterprise does NOT get to mark up the worth of the asset. This overly conservative method typically leads to companies exhibiting poor working outcomes beneath GAAP which detrimental impacts investor sentiment and inventory value. 

For instance, MicroStrategy reported $65,165,000 of impairment losses for the three months ending September 30, 2021, as a result of the market worth of bitcoins went beneath their buy value. Though this 65M impairment loss was not a money outflow from the enterprise, it was the most important working expense which contributed to a web lack of $36,136,000.     

Equally, throughout the three months ending September 30, 2021, Tesla reported 51M of impairment loss. Sq. reported 6M of bitcoin impairment loss in the identical interval. 

To make clear the state of affairs and present the true efficiency of the enterprise to buyers, MicroStrategy added a bit named, “Non-GAAP Monetary Measures” of their 10-Q. This part reveals what would their working earnings be with out taking impairment and few different non-GAAP quantities (not associated to digital property) into consideration. 

In accordance with this schedule, if impairment loss was not thought-about (and few different gadgets not related to bitcoin), the corporate would have a web earnings of $18,566,000. 

SEC Letter to MicroStrategy

The SEC objected MicroStrategy’s Reconciliation of non-GAAP web earnings schedule above. On December 3, 2021, it despatched the corporate a remark letter and suggested the corporate to take away it beneath the Rule 100 of Regulation G.

Reg G requires public corporations to “disclose or launch such non-GAAP monetary measures to incorporate, in that disclosure or launch, a presentation of probably the most straight comparable GAAP monetary measure and a reconciliation of the disclosed non-GAAP monetary measure to probably the most straight comparable GAAP monetary measure”. 

Though we do not know the specifics of the state of affairs, it’s clear that MicroStrategy’s 10-Q contains GAAP financials & a reconciliation of non-GAAP web earnings schedule permitting readers to match numbers simply. The corporate’s objective is to obviously talk the true working efficiency of the corporate minus the “paper bitcoin losses” which is required to report beneath incompatible GAAP guidelines. Subsequently, the particular concern the SEC has with the presentation is unclear. It’s also fascinating to see that the letter is simply speaking concerning the “adjustment for bitcoin impairment prices” amongst different gadgets included within the Reconciliation of non-GAAP web earnings schedule reminiscent of share-based compensation, curiosity expense and earnings tax results. 

On a subsequent letter from MicroStrategy dated December 16, 2021, the corporate accepted SEC’s feedback and eliminated the adjustment for bitcoin impairment on the reconciliation of non-GAAP web earnings schedule. 

Lastly, the rising inflation and the uncertainly of rates of interest have moved the market sentiment from investing in dangerous corporations to worth shares of worthwhile corporations. Microstrategy could discover it difficult to indicate a web revenue beneath GAAP within the coming months if the worth of BTC strikes sideways in a bearish market or declines additional creating extra impairment losses. Even when BTC goes up, Microstrategy will be unable to indicate a revenue beneath GAAP except they promote it. This example might unfairly have an effect on the inventory value of the corporate. If a spot BTC ETF will get permitted, buyers could be higher off straight investing within the ETF in comparison with utilizing Microstrategy as a approach to get publicity to BTC.

Subsequent Steps

Control how SEC approaches Non-GAAP disclosures associated to bitcoin for different public corporations holding bitcoin. 

Additional Studying

·      Fast Information To Submitting Your 2021 Cryptocurrency & NFT Taxes

·      How The Infrastructure Invoice Is Brewing A Crypto Tax Compliance Nightmare

·      How To Keep away from Frequent NFT Tax Pitfalls.