In 2021, a new trend to bid on and/or purchase high-value collectibles known as non-fungible tokens (NFTs) captured the attention of people around the world. What stands out immediately is the magnitude of wealth being used to purchase these NFTs. In March 2021, for instance, the first purely digital artwork (NFT) by the artist known as Beeple was sold by Christie’s for a record $69M USD. Shortly after, Twitter founder Jack Dorsey auctioned off his first tweet as an NFT for $2.9M USD.
What is an NFT and why all the hype?
Simply put, an NFT is a one-of-a-kind digital asset that has no tangible existence. An NFT can be a digital one-of-a-kind piece of artwork, a digital autograph or multiple copies of these items with each copy being individually identifiable. The uniqueness of an NFT is its ability to be independently verified using blockchain technology. NFTs come with a digital certificate of ownership and, theoretically, no one can create a copy or alter an NFT.
Given the unique characteristics of an NFT, you can see how they would be useful to collectors of “things” or investors in rare “things.” Instead of a rare stamp or painting which you physically possess, NFTs are being hailed as the digital solution to collectibles.
It’s conceivable that as NFTs become more prevalent and accepted that you could see them showing up on balance sheets. This has led to interesting discussions about how to properly account for and value NFTs.
Valuing purchased NFTs
Under Canadian Accounting Standards for Private Enterprises, NFTs meet the definition of an intangible asset with an indefinite life. When an intangible asset with an indefinite life is purchased, it’s recorded at cost. If circumstances indicate the intangible asset’s carry amount exceeds its fair value, it’s subsequently measured for impairment. In the case of NFTs, impairment could easily happen, for instance, if someone famous who has created an NFT falls out of public favour—demand for anything associated with that individual drops. Determining the fair value in such a case becomes exceedingly difficult given markets for NFTs are in their infancy stage and lack history. An expert in the area pertaining to that particular NFT asset may need to be consulted.
Valuing internally generated NFTs
Accounting for internally generated intangible assets with indefinite lives is an accounting policy choice. Development costs can be either expensed or capitalized. If your policy is to capitalize NFT development costs, the NFT must meet the following criteria:
- It is technically feasible to complete and be available for sale
- There is an intention to use it or sell it
- It is able to be used or sold
- There are adequate technical, financial and other resources available to complete the development
- The development expenditures are reliably measurable
- There is an ability to generate future economic benefits
Capitalizing the costs of an internally generated NFT may seem futile given the abstract nature of the asset and, in some cases, the minuscule costs of creating an NFT. However, if you have an NFT asset that could generate considerable fair market value, it’s understandable that you would want to show this internally generated NFT on your balance sheet no matter how insignificant the costs.
Moving forward, as NFTs become more mainstream and historical sales data accumulates, accounting and valuing NFTs will continue to evolve. Whether or not you choose to invest in an NFT will be up to you.
Written by Brian Legge from DMCL. This document was written for our quarterly bulletin, Canadian Overview, published by Canadian member-firms of Moore North America.