Considerations for Existence, Rights & Obligations, and Valuation
As the digital asset landscape continues to evolve, CPAs with attest practices must stay ahead of the curve when it comes to accounting for and auditing digital assets. These assets, including cryptocurrencies and tokens, present unique challenges that require a tailored approach to ensure compliance with accounting standards and safeguard against risks of material misstatement.
In response to the growing need for clarity, the AICPA’s Accounting for and Auditing of Digital Assets practice aid has been a key resource. The practice aid is soon to be updated to include two critical new chapters that address key assertions when auditing digital assets: existence, rights & obligations and valuation. Let’s explore the key takeaways from these updates.
Existence, Rights & Obligations: Safeguarding Digital Assets
The first area of focus is the existence, rights, and obligations of digital assets. Given that many digital assets are held in self-custody or by third-party platforms, confirming their existence and ownership presents a unique challenge. The new guidance provides CPAs with audit procedures tailored to both situations, offering insights into how to validate the ownership of digital assets and ensure proper reporting.
One of the most notable challenges auditors face in verifying the existence of digital assets is evaluating the reliability of information obtained from blockchain records. The decentralized nature of blockchains means that while the information can be publicly accessible, its integrity and accuracy must still be scrutinized.
Blockchain Audit Procedures
To address this, the practice aid outlines three approaches that auditors can use to extract information from the blockchain:
Direct blockchain review: A detailed examination of blockchain records for relevant transactions.
Third-party service providers: Relying on blockchain forensic experts or platforms that aggregate blockchain data and provide enhanced transparency.
Digital asset confirmations: Conducting direct confirmations with the custodians of digital assets, particularly if the assets are held by third parties.
The importance of confirming digital asset holdings and ensuring that the entity has rightful ownership cannot be overstated. As part of the procedure, auditors must also carefully evaluate the effectiveness and reliability of the third parties involved, ensuring that any external verification methods align with established audit standards.
Valuation: Determining the Worth of Digital Assets
The second area of concern for CPAs working with digital assets is valuation. Since many digital assets, like cryptocurrencies, are traded in active or thinly traded markets, their fair value can fluctuate wildly, which presents a challenge when assessing the value of holdings.
The updated guidance provides considerations for auditors on measuring the value of digital assets and addresses the nuances of pricing in these often-volatile markets. Key considerations include:
Active vs. Thinly Traded Markets: For assets in active markets, the pricing is generally more straightforward, relying on observable market prices. However, for assets in thinly traded markets, auditors must rely on alternative valuation techniques, such as market quotes, pricing models, or even internal estimates, ensuring that these methods are consistent with Generally Accepted Accounting Principles (GAAP).
Indefinite-Lived Intangible Assets: Many digital assets are treated as indefinite-lived intangible assets. This means that auditors must conduct regular impairment tests to evaluate whether the asset’s carrying value is recoverable. This is particularly relevant in the face of volatility, where dramatic shifts in price could result in impairment charges.
Realized Gains or Losses: Auditors should also consider procedures for assessing when an entity has sold or exchanged its digital assets. This includes determining when realized gains or losses should be recognized and ensuring proper accounting treatment is applied.
The Importance of Q&A Format for Clarity
The updated chapters provide these insights in a Q&A format, which allows for practical, scenario-based answers to common questions that auditors may encounter during engagements involving digital assets. This approach is particularly useful in a field that continues to evolve rapidly, offering CPA firms actionable insights that can be implemented in real-world scenarios.
Expanded Appendix: Staff Accounting Bulletin No. 121
Another significant update to the practice aid includes an expanded Appendix B, which features the Staff Accounting Bulletin No. 121. This section now includes auditing Q&A that addresses procedures to respond to identified risks of material misstatement, specifically those related to safeguarding liabilities and safeguarding assets in accordance with the Bulletin.
In the world of digital assets, safeguarding assets and liabilities is critical. CPAs must ensure that the controls around digital asset holdings are robust, especially when they are entrusted to third parties, to avoid the risks associated with theft or mismanagement.
Preparing for the Future of Digital Asset Audits
As the digital asset market continues to grow and mature, CPAs with attest practices will face an increasing demand for expertise in auditing these assets. The updated practice aid from the AICPA provides essential guidance on how to handle key assertions, including the existence, rights & obligations, and valuation of digital assets.
With the complexity of digital assets in mind, it’s vital for CPAs to stay informed about best practices, audit procedures, and emerging guidance. By implementing the strategies outlined in the updated practice aid, auditors can help their clients navigate the world of digital assets with confidence, ensuring compliance and safeguarding the integrity of their financial statements.
In the ever-changing world of digital assets, your firm’s ability to adapt will be the key to providing exceptional audit services that meet the evolving needs of your clients. Stay ahead, stay informed, and continue to provide your clients with the trust and transparency they need to succeed in this new digital era.
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