Customer Asset Protection
BACKGROUND
Customer asset protection often involve management and safekeeping of assets or property on behalf of another person or entity. Typical asset protection relations are relations between a bank and its depositors. Other similar relations include brokerage firms keeping customer investments, crypto exchanges receiving customer assets, etc.
Custodial or asset protection relations became a more prominent topic in light of recent scandals involving crypto exchanges and how they safeguard (or should safeguard) customer’s assets.
The first main accounting question involving custodian relations is whether the assets received from customers are considered custodian assets. In other words, should customer assets be reported on custodian balance sheet?
The second question involve segregation of assets provided by customers (e.g., customer deposits) from corporate assets. The question is referred to as comingling of customers assets. Part of the question is whether customer assets are accounted for at the individual customer level or combined with other customer assets.
Segregation of customer assets, as opposed to mixing all assets in one big “pot”, is important as it contributes to security and safety of the assets in question.
EXECUTIVE SUMMARY
Assets or proceeds provided to a custodian should be reported on custodian’s balance sheet if the proceeds are considered assets, from the custodian perspective.
Three essential characteristics of an asset are: (a) it embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash inflows, (b) a particular entity can obtain the benefit and control others’ access to it, and (c) the transaction or other event giving rise to the entity’s right to or control of the benefit has already occurred. (par. 26 of FASB CON 6.)
Generally, custodian assets reported on its balance sheet are subject to claims by custodian creditors.
As an example, a commercial or retail bank will use customer deposits to make loans, which the bank expects to benefit from. The bank can limit the other party’s access to the funds. Therefore, customer cash deposits are considered the bank’s assets and should be recorded on the bank’s balance sheet.
Accounting practices for reporting customer assets vary depending on the industry, including broker-dealer, debt servicing, payment processing, crypto exchanges, etc. Custodians should carefully analyze contractual, legal terms associated with customer proceeds and consult their advisors to establish proper accounting treatment.
