With minimal guidance and high potential for misunderstanding, Initial Coin Offering (ICO) or Token Generating Events (TGE) can create a challenging understanding of when and how revenue is recognized within an entity’s financial statements. Tokens are generally seen as Utility, providing a holder the right to use with benefits to access of the platform, or Security, providing a holder the right of investment with benefits of gain on investment. With limited direct guidance we are left to use accounting principles and fair interpretation of existing guidance to apply to cryptocurrency.
IRS Notice 2014-21 set understanding that all virtual currency (now defined as Digital Assets) is treated as property for federal tax purposes. Thus, working in conjuncture with Treasury Regulations 26 CFR 1.482-4 on method to determine taxable income from transfer of tangible property, it seems to align in both form and function of a token offering. The IRS further discusses in Revenue Ruling 2019-14 when discussing hard forks that a taxpayer does not “receive” cryptocurrency if the taxpayer is not able to exercise dominion and control over the cryptocurrency. This part is particularly important as to how it plays into Accounting Standard Revenue Recognition 606 with the core principle being an entity should recognize revenue to depict the transfer of goods or services to customers. Following the 5 Steps; 1. Identify the Contract, 2. Identify the performance obligations, 3. Determine the transaction price, 4. Allocate the transaction price, and 5. Recognize revenue when or as the entity satisfies a performance obligation. Steps 1-4 can be accomplished by properly setting up a Smart Contract and receiving clear and clean reports that provide the details required. Step 5 will require additional information housed in the issued Whitepaper detailing the steps and process of release or future usage of the tokens.
Once the above has been defined and the nature of the ICO or TGE has been laid out the next step is recording the transactions into your financial statements. What does this look like from a debits and credits perspective. It’s important to note that newly issued tokens will have a zero basis prior to offering and all expenses in development will be expensed as incurred.
Under most TGE situations the revenue received for exchange of created token will be recognized as ordinary revenue upon exchange.
Debit – Assets Received (Asset)
Credit – Token Offering Revenue (Income Statement - Revenue)
However, through ICO, if there are time restrictions (a lockup period) or performance restrictions (usage of token for services) revenue would be deferred and recognized upon release of assets to purchaser or in exchange for services. All of this follows the ability to exercise dominion and control and would create unearned revenue as the accounting offset upon receipt of assets.
Debit – Assets Received (Asset)
Credit – Unearned Revenue (Deferred Revenue Liability)
Once performative aspects have been achieved the unearned revenue would convert to earned revenue.
Debit – Unearned Revenue (Deferred Revenue Liability)
Credit – Token Offering Revenue (Income Statement - Revenue)
Notice the difference between the first example of control being released directly vs control being granted via time or access.
Now if the Whitepaper defines the ICO or TGE as an Equity event whereby the holder of the token is eligible for distributions via residual interest from the entity this would create a different set of entries and may run into additional issues with SEC filings. Please consult your accountant and legal advisor on how to property map out this process.