The sweeping growth and prolific collection of technologies that make up cryptoassets today have made it incredibly challenging for regulators worldwide to standardize and issue authoritative guidance. Professional accounting standard-setting bodies, like the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are certainly no exception.
What started out as just bitcoin in 2009 and a handful of coins in 2013 with a combined market value of approximately $1 billion quickly grew to about $800 billion by the fourth quarter of 2017. Bitcoin alone transacts multiple billions of dollars every 24 hours. Over $3.2 billion have been invested in crypto startups through Initial Coin Offerings (ICOs) in 2017. As of the time of writing, there are approximately 1,600 cryptoassets. And while bitcoin accounts for approximately 42% of total cryptoassets’ market value, there are also utility tokens such as Ether, Ox and Civic, which are intended to provide access digitally to an application or service by means of a blockchain-based infrastructure, as well as security tokens that function like stocks and bonds and other traditional securities, including the tokenization of traditional assets such as real estate, and even crypto collectible tokens which are unique and limited in quantity.
However, it seems that currently, in the USA in particular, this emerging asset class is not fitting well into the existing regulatory environment, which is not surprising if you consider that much of the applicable regulation was enacted long before even the birth of the internet. So far we’ve seen the IRS ruling of 2014 to have bitcoin taxed as property in the USA effectively limited it for its intended purpose i.e. payment for goods and services. We have also seen dozens of crypto-startups leave the US because of regulation such as the BitLicense in New York. In addition to the SEC and the IRS, we have a litany of other regulators weighing in on the Initial Coin Offering (ICO) craze including the US Commodity Futures Trading Commission (CFTC), Financial Crimes Enforcement Network (FinCEN) and the Financial Industry Regulatory Authority (FINRA).
Meeting the definition of an asset
As yet, no specific guidance for cryptocurrencies has been issued under either US GAAP or IFRS. So how are companies accounting for cryptoassets and are existing accounting standards sufficient and appropriate to be applied to this new emerging asset class? It’s important to consider whether cryptocurrencies do, in fact, meet the definition and recognition criteria of an asset under IFRS and US GAAP. Under IFRS, an asset is a “resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.” Once an item meets the definition of an asset, it is recognized when it is probable that any future economic benefit associated with the item will flow to the entity and the item’s cost or value can be measured with reliability. Under US GAAP, an item that meets the definition of an asset is recognized when its cost or value can be measured reliably. Unlike IFRS, the probability criteria of any future economic benefit associated with the item owing to the entity is not a recognition requirement under US GAAP. The term “probable” under IFRS is defined as “more likely than not”, i.e., a probability of greater than 50%. Under US GAAP, probable is defined as “likely” and is not defined by reference to a percentage threshold.
Entities will need to assess whether each cryptocurrency held meets such criteria, and that the uncertainty around the future economic benefits, due to volatility, is not sufficiently high that an asset does not exist. If it has been determined that the definition and recognition criteria of an asset have been met, then attention should turn to classification. For example, the significant volatility of cryptocurrencies alongside the fact it is not considered legal tender due to the absence of backing by a federal government and the lack of widespread acceptance as a medium of exchange would prevent holders from being able to “convert to a known amount of cash”, which means cryptocurrencies cannot be classified as cash or cash equivalents under US GAAP or IFRS.
Financial instruments under both IFRS and US GAAP would seem like a natural classification for cryptocurrencies, allowing measurement at fair value, with changes in fair value recorded in profit and loss (P&L). However, cryptocurrencies generally do not provide the holder with a contractual right to receive or exchange cash or a financial instrument and thus are not financial assets. That said, certain cryptocurrency futures (contracts to buy or sell cryptocurrencies in the future) that settle in cash could be considered derivatives and accounted for as financial instruments. Another standard that would allow cryptocurrency holders to account for their investments at fair value through P&L is investment property under IFRS. There is no specific definition of “investment property” under US GAAP, as such it is accounted for as property, plant and equipment.
The scope of investment property under IFRS is narrow, and defined as tangible “property (land or a building — or part of a building — or both). There may be circumstances in which an entity holds cryptocurrency as an investment that falls within the scope of “investment company status” under US GAAP which will result in accounting for such investment initially, and subsequently, at fair value. However, cryptocurrencies are not tangible property and therefore cannot be accounted for as such.
Inventory or Intangible Asset?
If we accept that cryptocurrencies are often mined or purchased with the intention of reselling them, it can be argued that it meets at least part of the definition of “inventories” under both IFRS and US GAAP. However, as cryptocurrencies are not tangible in nature they cannot meet the definition of inventory under US GAAP. Since under IFRS inventories do not need to be tangible, a case can be made that it may meet the definition, although it should be questioned whether the volume of trading is sufficient to qualify. An additional consideration would be if the inventory standard was chosen to account for cryptocurrency, it would need to be held at the lower of cost and net realization value under both IFRS and US GAAP. It’s fair to say that accounting for cryptocurrency under the aforementioned measurement criteria in today’s volatile market would not provide useful information to users of financial statements. One exception would be commodity broker dealers when buying or selling cryptocurrencies within the normal course of business, with the purpose of generating a profit from fluctuations in price or broker dealer margins. This gives the ability to value cryptocurrencies at fair value, less costs to sell, with changes in fair value recognized in the profit and loss.
Being purely digital in nature, cryptocurrencies meet the definition of “intangible assets” under both IFRS and US GAAP. Cryptocurrencies such as bitcoin, generally have indefinite useful lives with no expiry date or limit on the period in which it can be exchanged for cash, goods or services. Cryptoassets, however, can have diverse terms and conditions that would need to be considered for appropriate accounting treatment. Under US GAAP, indefinite-lived intangibles will be initially measured at cost and would need to be tested for impairment annually. A decline below cost as quoted on a cryptocurrency exchange may be considered an event indicative of impairment. IFRS allows for intangible assets to be accounted for either at cost or revaluation at its “fair value at the date of the revaluation less any subsequent… accumulated impairment losses.” The revaluation model can only be applied if the fair value can be determined by reference to an active market which is defined as “a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis”. The net increase in fair value above the initial cost is recorded in other comprehensive income (OCI). A net decrease in fair value below cost is recorded in profit or loss. Recycling of gains from OCI to profit or loss is not allowed.
Further guidance needed
Looking ahead, it would appear that the most appropriate accounting treatment under IFRS and US GAAP is to account for cryptocurrencies as intangible assets with potential circumstances for inventory or investment accounting by an investment company. However, it’s fair to say that even though cryptocurrencies meet the definition of an “intangible asset” under IFRS and US GAAP, these accounting standards were written before the birth of blockchain and cryptoassets and so do not provide for their unique makeup. Careful consideration should therefore be given to the facts and circumstances of each cryptocurrency after consulting with accounting advisors who understand the associated intricacies. We encourage accounting guidance from both the FASB and the IASB for this dynamic new asset class specifically addressing recognition, measurement, presentation and disclosure requirements.