The crypto slump has highlighted the risks posed by cryptocurrency as a speculative asset, but for professionals in finance, the immediate challenge is working out how best to account for it. Gavin Fitzpatrick and Mike O’Halloran dig into the details.
Money, currencies and the methods by which people and businesses earn, store and exchange value have taken numerous forms throughout history.
The evolution of currency dates back many millennia, from the early days of bartering to modern methods, such as coins, notes, loans, bonds and promissory notes.
Introduced in 2009 with the launch of Bitcoin, cryptocurrency is the latest evolution in this process.
Despite a slow initial uptake, its popularity has risen dramatically in the past decade and, today, there are thousands of different cryptocurrencies in existence.
Views on their usefulness and longevity are somewhat fragmented, however. Investors who have been fortunate enough to acquire cryptocurrency at low prices sing its praises, whereas critics argue against its fundamentals and highlight the volatility of the cryptocurrency market.
For companies and the accounting profession, however, the immediate challenge is working out how these assets should be accounted for. Here are some common questions worth bearing in mind.
Is there a specific standard that accountants can apply to cryptocurrencies?
In short, the answer here is no—nor do cryptocurrencies fit neatly into any existing standard. Accounting for cryptocurrencies at fair value through profit and loss may seem intuitive. However, such an approach is not compatible with IFRS requirements in most circumstances, as cryptocurrencies may not meet the definition of a financial instrument as per IAS 32.
Should cryptocurrencies be treated as another form of cash?
IAS 7 Statement of Cash Flows states that cash comprises cash on hand and demand deposits. IAS 32 Financial Instruments Presentation notes that currency (cash) is a financial asset because it represents the medium of exchange. While cryptocurrencies are becoming more prevalent, they cannot be readily exchanged for all goods or services.
IAS 7 also considers cash equivalents—short-term, highly liquid investments that are readily convertible to known cash amounts and subject to an insignificant risk of changes in value. Given the considerable price volatility in cryptocurrencies, entities have not sought to apply policies where they define holdings in crypto assets as cash or cash equivalents.
In the absence of a specific standard, what guidance and methodologies can accountants follow when deciding how to account for these assets?
In practice, accounting policies defined to deal with cryptocurrencies follow the principles of accounting for intangible assets or, in some cases, accounting for inventory.
Intangible assets
IAS 38 Intangible Assets defines an intangible asset as “an identifiable non-monetary asset without physical substance”.
Identifiable – under IAS 38, an asset is identifiable if it “is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged.” Cryptocurrency holdings can be traded and are, therefore, identifiable.
Non-monetary – IAS 38 defines monetary assets as “money held and assets to be received in fixed or determinable amounts of money.” The value of a cryptocurrency is subject to major variations arising from supply and demand. As a result, its value is not fixed or determinable.
Without physical substance – as a digital currency, cryptocurrencies do not have physical substance.
As a result of applying the above logic, many companies classify holdings in cryptocurrencies as intangible assets. In line with IAS 38, companies can use one of two approaches to account for intangible assets:
Cost – cryptocurrency asset is carried at cost less accumulated amortisation and impairment. In applying this approach, companies must determine if the asset has a finite or indefinite useful life. Given that cryptocurrencies can act as a store of value over time, they have an indefinite useful life, meaning the asset would not be subject to an annual amortisation charge. Instead, an annual impairment review would be necessary.
Revaluation – under IAS 38, intangible assets can be carried at their revalued amount as determined at the end of each reporting period. To adopt this approach, the asset must be capable of reliable measurement. While active markets are often uncommon for intangible assets, where cryptocurrencies are traded on an exchange, it may be possible to apply the revaluation model. In order to present increases and decreases correctly (i.e. determining how much is presented in other comprehensive income versus profit and loss), entities must be able to track movements in sufficient detail across their holdings.
Establishing the cost of the crypto asset denominated in a foreign currency
According to IAS 21 The Effects of Changes in Foreign Exchange Rates, entities will record holdings in cryptocurrencies using the spot exchange rate between functional currency and the cryptocurrency at the date of acquisition.
As noted earlier, cryptocurrencies are not considered to meet the definition of monetary items. Therefore, holdings in cryptocurrencies measured at historical cost in a foreign currency will be translated using the exchange rate at the initial transaction date. Holdings measured using the revaluation approach shall be translated using the exchange rate applied when the valuation was determined.
Inventory
As demonstrated, holdings in cryptocurrencies can meet the definition of intangible assets under IAS 38. However, within the scoping section of IAS 38, it is noted that intangible assets held by an entity for sale in the ordinary course of business are outside the scope of the standard. This conclusion is drawn from the fact that such holdings should be accounted for under IAS 2 Inventories.
While the default treatment, under IAS 2, is to account for inventories at the lower cost and net realisable value, the standard also states this treatment does not apply to commodity broker-traders.
Such traders are required, under IAS 2, to account for their inventory at fair value less cost to sell, with changes in value being recognised in profit and loss.
Intuitively, it may seem appropriate for entities holding cryptocurrencies to follow the same accounting applied by broker-traders under a business model that involves active buying and selling.
However, since cryptocurrencies do not have a physical form aligning their accounting to a scope exception for commodity traders, it is a judgment call.
In practice, where there is a business model under which crypto assets are acquired to sell in the short term and generate a profit from changes in price or broker margin, the treatment described here from IAS 2 for broker-dealers has been applied.
Other considerations
So far, we have explored accounting for holdings of cryptocurrencies (IAS 38) and trading in cryptocurrencies (IAS 2). The standards referenced are not new.
To date, the IASB has focused on aligning accounting for cryptocurrencies to existing guidance, and practice has developed accordingly. While there is clear logic to the policies developed from this approach, there are still challenges.
For example, while applying the cost model of IAS 38 is straightforward, the balance stated in the financials may be significantly different to the market value. On the other hand, applying the revaluation model of IAS 38 can be difficult from the point of view of tracking movements in value to determine how much is presented in profit and loss versus other comprehensive income.
What about custodians?
As recently as March 2022, the US Securities and Exchange Commission (SEC) released their Staff Accounting Bulletin No. 121.
The bulletin provides guidance for reporting entities operating platforms allowing users to transact in cryptocurrencies, while also engaging in activities for which they have an obligation to safeguard customers’ crypto assets.
Until now, custodians may have concluded that they do not control the asset they safeguard. However, the SEC believes that stakeholders would benefit from the inclusion of a safeguarding liability and a related asset (similar to an indemnification asset), both measured at fair value.
This guidance is applicable to reporting entities that apply US GAAP or IFRS in their SEC filings. These entities are expected to comply in their first interim or annual financial statements ending after 15 June 2022. While this requirement applies to SEC filings, it is an essential development to be aware of.
Challenges ahead
Accounting policies designed to deal with cryptocurrencies have developed, in practice, from existing standards. While these policies are grounded in fundamental accounting principles, there are challenges.
As cryptocurrencies continue to become more prevalent, some of the key assumptions in these policies will be challenged.
For example, if the price of cryptocurrencies becomes less volatile, this would challenge the conclusion that they meet the definition of non-monetary assets under IAS 38. Instead, with less price volatility, it could be argued that they meet the definition of cash equivalents.
Given the current challenges and ongoing development of cryptocurrencies, many are calling for standard-setters to engage in a dedicated project to address these issues.
Gavin Fitzpatrick is a Partner in Financial Accounting and Advisory Services at Grant Thornton.
Mike O’Halloran is Technical Manager in the Advocacy and Voice Department of Chartered Accountants Ireland.
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