Coinbase May Be Facing Regulatory Action Over Its Accounting For Crypto Assets.

Is the cryptocurrency exchange creating an individually tailored metric by adjusting out crypto impairment costs in non-GAAP accounting?

Coinbase’s stock has rallied on the approval of bitcoin ETFs, but some analysts say it’s actually bad for the cryptocurrency exchange.

Coinbase Global Inc. may be at risk of a regulatory enforcement action over its accounting for crypto assets, according to accounting experts, who reviewed the crypto trading site’s numbers before and after it opted for early adoption of a new rule.

The rule, agreed last year by the Financial Accounting Standards Board, or FASB, changed the accounting and disclosure for crypto assets to a fair-value model from a cost-less-impairment model. The rule is due to come into effect in 2025, but early adoption is allowed.

The rule change came after requests from companies that hold large amounts of crypto, including MicroStrategy and Tesla Inc., for rules governing their accounting for those assets, which are typically volatile.

The rule will allow companies to capture the most recent value of a crytpo asset, unlike the current accounting practice, which is to treat them as intangible assets. Intangible assets include such items as brands, copyright and intellectual-property markers, such as trademarks.

Under that treatment, companies had to record crypto assets at the historical price at which they were acquired, and then make an assessment every reporting period as to whether the value had declined, in which case they would record an impairment.

“Companies complained because they could write the value down but not back up if the asset increased in value,” said Olga Usvyatsky, a former vice president for research at Audit Analytics and author of Deep Quarry, a Substack publication focused on accounting.

That’s important given the huge swings in crypto assets such as bitcoin, which has gained about 50% to date in 2024.

Usvyatsky wrote last year that the new rule was welcomed by 82 out of 83 respondents to the FASB on the grounds that the fair-value model “would provide investors with more decision-useful information.”

She also noted it would likely introduce volatility into company earnings if holders had to continually record gains and losses on their income statements.

Companies often deal with items that create volatility by stripping the effect out using nonstandard metrics, or those that do not comply with Generally Accepted Accounting Principles, or GAAP, the U.S. standard.

Under accounting rules, companies are allowed to include non-GAAP measures in their financial reports, but they must lead with GAAP-compliant ones, give equal prominence to both and offer a reconciliation of the two.

Above all else, companies are not allowed to create individually tailored metrics when using non-GAAP measures.

But Coinbase has done exactly that, according to Usvyatsky.

Before it adopted the new rule, the company stripped crypto-impairment costs out of its adjusted Ebitda reconciliation. Ebitda is an acronym for earnings before interest, taxation, depreciation and amortization.

That creates tailored accounting, as it strips out normal, recurring operating expenses, as the following table illustrates.

Then, in the first quarter, when adopting the new rule, the company stripped out the fair-value volatility, which again creates tailored accounting, she said.

As the next table shows, the company has categorized crypto assets into four new items on its balance sheet — for investment, for operating purposes, as borrowed crypto assets, and as collateral for loans to customers and others.

Coinbase accounts for all of these kinds of crypto assets the same way, at fair value, with changes reflected in net income each period. However, the way that the fair value of the assets is determined — which impacts the magnitude of the gain or loss reflected when market values change — varies.

Crypto assets held long term for investment and those held as collateral are remeasured at fair value on a specific identification basis at the end of each reporting period.

Crypto assets held short term for operational purposes are initially recorded at the transaction price of the crypto assets at contract inception and are subsequently remeasured at fair value on a first-in, first-out basis at the end of each reporting period.

Crypto assets borrowed are initially recorded at cost, and fair value is determined using the average costing method at the end of each reporting period.

Coinbase responded to a request for comment on the matter by referring to its 10-Q filing with the SEC summarizing the change: “Effective as of January 1, 2024, we adopted ASU 2023-08, which requires us to measure crypto assets held at fair value at each reporting date, with fair value gains and losses recognized through net income. Fair value gains and losses can increase the volatility of our net income, especially if the underlying crypto asset market is volatile.”

The company also pointed to its revised definition of adjusted Ebitda, “to change what is adjusted with respect to gains and losses on crypto assets in connection with the adoption of ASU 2023-08, adjusting post-adoption only for gains and losses on crypto assets held for investment, as they do not represent normal, recurring, operating expenses (or income) necessary to operate our business.”

In other words, because the assets are held for investment, the company believes they are not part of normal operating activity and stripping the volatility does not remove normal recurring operating expenses.

Usvyatsky looked at past comment letters the Securities and Exchange Commission has sent to companies, challenging non-GAAP adjustments that removed bitcoin impairments.

In one dated Sept. 22, 2022, the SEC sent a comment letter to Bit Digital Inc., directly suggesting that adjusting for impairments would substitute individually tailored metrics and violate Reg. G.

“Please explain why you believe that adjusting for impairment of digital assets provides useful information to investors given that you use your digital assets to, in part, fund your operations and also considering the recurring nature of this charge,” the regulator wrote.

“Please also tell us how you considered whether these
measures substitute an individually tailored recognition and measurement method for those of GAAP which results in a misleading non-GAAP measure that violates Rule 100(b) of Regulation G.”

The SEC had raised similar issues in an earlier letter to MicroStrategy from Oct. 7, 2021, which it followed on Dec. 3 of that year with a follow-up letter objecting to the adjustment and ordering the company to remove if from future filings.

Usvyatsky noted that earnings volatility was a topic that was widely discussed around the introduction in 2016 of the Current Expected Credit Losses standard, or CECL.

CECL was implemented to address a weakness in GAAP accounting that resulted in the delayed recognition of impairment losses on financial assets. CECL allowed companies to use an impairment model rather than an incurred loss model.

The SEC had cautioned companies about Reg. G ahead of the introduction of CECL.

Usvyatsky took a look at other comment letters the SEC sent to regional banks Heartland Financial USA Inc. and Fifth Third Bancorp. regarding their adjustments that excluded credit losses.

Both banks agreed to stop using the metric in their future filings.

Francine McKenna, author of the Dig on Substack and a former journalist and academic, said Coinbase is engaged in a contentious battle with the SEC over whether it has acted as an unregistered securities exchange, broker and clearing agency because many of the crypto assets it invests in, which flow through its operations and which it borrows or accepts as collateral, such as tokens, are not registered as securities.

“Coinbase is following the best advice its billions can buy from its Big 4 auditor, Deloitte, about how to follow the letter of the accounting standards with regard to assets on its balance sheet the SEC claims are breaking the law,” she told MarketWatch. (McKenna is a former MarketWatch reporter.)

Coinbase’s stock has gained 25% to date in 2024 and is up 254% in the past 12 months.