Accounting for NFT’s

According to US GAAP, NFTs are classified and defined under ASC 350 as intangible, goodwill and other assets (not including financial assets) that lack physical substance. GAAPs classification implies NFTs cannot be treated the same way as cash. As a result, there have yet to be accounting standards for intangible assets. However, some accounting considerations might be helpful when dealing with NFTs. These consideration include the following:

Capturing Revenue

The first challenge for NFT accounting is capturing revenue for NFT assets. Revenue capturing is often influenced by the nature and actors involved in the transaction. Where NFT creators sell their assets through marketplaces, such transactions involve the buyer, seller, and a financial intermediary which is the marketplace. If the NFT creator/owner has control of the asset to be sold, then the creator assumes the position of principal in the transaction. However, if the marketplace has control of the asset, then the marketplace assumes the position of principal. The principal often recognizes gross revenue as the amount paid by the buyer, while other costs incurred in the facilitation of the transaction are recognized as transaction costs. Importantly, where the marketplace has control, the creator recognizes their gross revenue based on the amount received from the marketplace, not necessarily the amount paid by the buyer.

Amortization

Some NFTs have a relatively short life span; these NFTs lose their relevance after a certain period and seize to contribute to the creators or company’s cash flow. When dealing with such assets, the best strategy is identifying the period that these assets would contribute to cash flow and amortize the asset for that period. This amortization will reduce the value of the NFT on the company’s balance of payments and capture expenses like depreciation in the company’s income statement. The amortization strategy is perfect for NFT assets like game characters that lose relevance as games become outdated.

Development Costing

Unlike other products, NFT development also presents some accounting challenges, especially in identifying the cost of putting these digital products together. To identify the cost of NFT development, creators must understand the nature of the NFT and the transferred rights upon purchase. Understanding the nature of the asset and the transferable rights enables the proper categorization of costs under the appropriate GAAP codification classification. GAAP’s codification Topic 350-40 Internal-Use Software Accounting Rules about Software covers “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” while ASC 985-20 covers “Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed.” The foregoing GAAP topics provide the perfect costing umbrella for NFTs. However, the NFT creator would determine what rights the buyer would get after purchase to apply the appropriate codification. Where NFTs remain the proprietary property of the creator and only provides access to the end-user, the development cost of the NFT would be classified as incurred cost as stipulated by ASC 350-40; however, where buyers have possession and control of the NFT after purchase, then the cost of development would be categorized under ASC 950-20.

Valuation

The valuation of NFTs presents, by far, the most complex problem not just because there exists no generally acceptable template for NFT valuation, but also because of the volatility and scarcity of the assets and the fact that the pricing of NFTs is based on the subject appreciation of the value of assets. This means that Mr. A can pay one ETH for a particular asset, and Mr. B can pay three ETHs for the same asset, making it impossible to arrive at an objective financial value for the asset. While some experts have argued that identifying the price floor (the lowest current price) could provide insight into the value of NFTs, the volatility of NFTs has made that a problematic strategy.