How To Account & Report NFTs in Financial Statements?

In 2021 alone, Non-Fungible Tokens (NFTs) spiked 21000% to a gigantic $17 Billion industry and is growing at a much higher pace.

The industry has become a sensation for digital creators and marketers across the globe and experts expect it to be a $231 Billion industry by the end of this decade.

While individuals and small & medium-sized entities have started owning NFTs, there are still no hard and fast rules and principles on accounting for the NFTs in both GAAP and International Accounting Standards.

This article focuses on the accounting implications of NFTs and addresses any confusion you may have.

How to Account for NFTs?

Before jumping into the NFT accounting, let me first categorize NFTs and it will give you a starting point to account for Non-Fungible Tokens.

The Accounting Nature of NFTs

NFTs are NOT current assets because they are not primarily held for resale purposes, or cannot be readily converted into cash. They also don’t count as property, plant, and equipment because they don’t have a physical form.

Non-Fungible Tokens are intangible assets and are accounted for as per the rules of “International Accounting Standard 38 Intangible Assets”. Here’s why NFTs fit in IAS38:

1. They are long-term assets with an indefinite useful life
2. They don’t have a physical substance
3. They are separable and arise from contractual or other legal rights.

However, an NFT is treated as an inventory item in some situations. That’s when it is purely obtained for reselling purposes or when the organization primarily buys and sells NFTs. Therefore, it’s essential to first identify whether the particular NFT is an intangible asset or an inventory item.

Accounting For NFTs Identified as Intangible Assets

According to IAS 38 Intangible Assets, the accounting treatment of NFTs on the acquisition, valuation, and disposal is as follows:

Acquisition of NFTs

When you first acquire an NFT and categorize it as an intangible asset, the double-entry performed is:

Microstrategy, one of the world’s largest crypto holders of the world has identified its cryptographic assets as “Digital Assets” on its financial statements. Therefore, you can also use the term “Digital Assets” to record your NFTs in the financial statements.

Revaluation of NFTs

Once you have recorded the acquisition of the NFT, the next step is to perform its subsequent measurement. This is simply making sure whether the value recorded in the financial statements is in parallel with the market value of the underlying asset.

There are TWO revaluation models for NFTs — The Cost Model and the Revaluation Model.

In the cost model, the NFT is valued at the cost less amortization cost.

Note: NFTs typically don’t have ammortisation and therefore, most organizations don’t use this model and is not recommended to value NFTs in the financial statements.

In the NFT Revaluation Model, the NFT is recorded at the 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.

Read our detailed article on Fair Value less Costs to Sell

However, the fact that the price of most NFTs cannot be determined easily is a challenge in using this model. Generally, the value of an underlying NFT increases with the reputation and achievements of the original artist. Though this increase is considered, it’s not recorded in the statement of profit or loss until the NFT is sold out.

Once it is sold, the profit can then be recognized in the statement of profit or loss.

Should You Charge Amortization?

Intangible Assets are generally amortized. It’s the same as depreciation charged on tangible non-current assets such as property, plant, and equipment.

Basically, the initial cost of the asset is divided by its useful life and recorded in the income statement to reflect the wear and tear of the asset. However, NFTs don’t have a definite life span and therefore, no amortization cost is charged.

Accounting for NFTs When Recognized as Inventory

As already mentioned, when NFTs are purely acquired for resale purposes, they are recognized as inventory items and should be recorded as per IAS2 — Inventories.

If you have recognized it as an inventory item, here’s the accounting treatment:

NFT Acquisition (Inventory)

Record the NFT as a current asset at the purchase price and other directly attributable costs. For example, if you have paid $1,000 to acquire the NFT and the transaction has cost you $100 in exchange costs, you should record the NFT at $1,100 to reflect the full amount paid to acquire the NFT.

Subsequent Measurement

Once recorded as a current asset, the NFT is then carried at the lower of cost and net realizable value (NRV). NRV is simply the price for which the asset could be sold minus the selling costs.

ILLUSTRATION

Suppose that an NFT is carried at $1500 in business books but the business is now looking to perform the subsequent measurement. It was acquired for $2000 and can be sold for $3500 in an active market. Additionally, the business will have to incur an additional $500 cost to sell the asset. What will be the revised carrying value?

In the above example, we need to compare the cost and NRV in order to calculate the carrying value. The cost is already given and is $2000. The NRV is $3000 (3500-500). Therefore, we will carry the NFT at the lower ie $2000.