What CPAs Need to Know About NFTs

Many accountants express skepticism over digital assets, says an a recent article in the Journal of Accountancy, written by Stacey Ferris, CPA, and Peter Rehm, CPA. “Yet, despite the doubt, digital assets are foundational to the evolving Web3 vision of the internet, e-commerce, and peer-to-peer transactions. By 2030, many companies, public and private, as well as individuals, will likely have accounting and financial reporting challenges related to digital assets.”

NFTs are a method of demonstrating ownership of physical, intangible and digital assets. “They have far more uses than buying and selling pixelated JPEGs. For instance, visual artists and musicians can use them to sell works directly to fans.”

According to the authors, “NFT records kept on blockchains are crucial to auditors evaluating assertions around the existence and valuation of digital assets and the rights and obligations held by those who own them. Many startups and other ‘digital native’ companies are already seeking accountants, tax specialists, auditors, regulatory personnel and CFOs who can help them correctly record and report NFTs and other digital assets. Enterprising CPAs have teamed up with developers to bring crypto modules to market that can hook up to an existing accounting system.”

NFTs are a cornerstone of Web3, say Ferris and Rhem. “NFTs are controllable digital records that allow for digital and physical assets to be represented as unique, valuable, and easy-to-transfer “tokens.” NFTs can also be described as the tokenization of anything and everything, whether physical or intangible, to enable blockchain-based recording. NFTs have two distinct traits: They are unique (nonfungible), and they are always linked to a physical, intangible, or digital item.

CPAs should be aware that NFTs can be used to generate taxable revenue and create value (see the graphic “How NFTs Generate Accounting Events,” below). A prime use case for NFTs is allowing visual artists or musicians to earn royalties each time their creation is used, say in a game or played on a streaming service. Currently, artists receive less than pennies on the dollar for each play or sale of their work, and nothing for resales. NFTs solve this by providing a cryptographically protected immutable Web3-enabled code that tracks the use of the artistic product and financially rewards the artist each time their work is used. These rights and processes are established at the time of “minting,” or creation. The value of this kind of NFT can be approximated as the value of the future cash flows (i.e., the royalties) from the NFT for views and plays plus value for the accompanying music, art, or other content.

NFTs are a cornerstone of Web3, say Ferris and Rehm. “NFTs are controllable digital records that allow for digital and physical assets to be represented as unique, valuable, and easy-to-transfer ‘tokens.’ NFTs can also be described as the tokenization of anything and everything, whether physical or intangible, to enable blockchain-based recording. NFTs have two distinct traits: They are unique (nonfungible), and they are always linked to a physical, intangible, or digital item.”

NFTs are distinguished from other digital assets in that they are always linked to an underlying item that could be digital, intangible or physical. “The most common type of NFTs in existence in 2022 are those linked to a graphic art file (e.g., JPEG, PNG, GIF). NFTs’ ability to prove ownership and provide an auditable trail of activity via a blockchain has been revolutionary for graphic artists because it allows them to have irrefutable proof that they created and own or have rights to an image.”

Although, currently, a GAAP standard over digital assets, including NFTs, does not exist, accounting standards bodies and government regulatory agencies are aware of the gap and are evaluating the area. “Until a formal standard cements the definitions and treatment of all types of digital assets,” advise Ferris and Rehm, “CPAs can look to the AICPA’s Digital Assets Working Group’s practice aid Accounting for and Auditing of Digital Assets for information.”

For the details and much more, see What CPAs need to know about NFTs - Journal of Accountancy.