The emergence of cryptocurrencies attracted attention from entities and investors across the globe in recent years. But what type of asset are cryptocurrencies?
There is diversity in respect of the accounting treatment of cryptocurrencies because of the differing interpretations and application of the current accounting guidance in International Financial Reporting Standards (IFRS). Furthermore, the International Accounting Standards Board (IASB) has indicated that it would not pursue a separate project on cryptocurrencies as it believes that there is currently adequate guidance to account for cryptocurrencies in financial statements. There is a consensus that cryptocurrencies should be presented as assets. However, the question is – what type of asset? Firstly, we need to understand the characteristics of cryptocurrencies.
Characteristics of cryptocurrencies
Cryptocurrencies are built on the use of cryptography with underlying algorithms that control the creation of cryptocurrencies and verify related transactions. The cryptography which represents the algorithms protecting the information and facilitating the transactions is built on blockchain. Blockchain records the transactions and ownership on a distributed ledger by providing a continuous record of transactions. Cryptocurrencies exist purely in digital form and are held in a digital wallet and unique keys link the wallet with the holder. Despite cryptocurrencies being created with the intention of acting as a medium of exchange, they are different from fiat currencies. While they both facilitate transactions, cryptocurrencies are not legally tendered in most jurisdictions. Furthermore, cryptocurrencies are volatile due to regulatory uncertainty. These uncertainties stem from their volatile prices and insufficient information relating to cryptocurrencies.
Cryptocurrencies as assets
Since cryptocurrencies can be identified as assets, the current accounting guidance is considered when determining the type of asset that cryptocurrencies should be classified as. The following classification categories are considered; cash, cash equivalents, financial assets, intangible assets, and inventories.
Firstly, cryptocurrencies do not meet the definition of cash or cash equivalents. Even though cryptocurrencies act as a medium of exchange, they have no legal backing and therefore cannot be classified as cash. Additionally, cryptocurrencies are not cash equivalents due to their volatility. Similarly, cryptocurrencies cannot be classified as a financial asset based on the current definition in IAS 32 because they are not cash.
Secondly, cryptocurrencies do not represent a contractual right as there is no contractual relationship that results in a financial asset for one party and a financial liability for the other. Despite cryptocurrencies not meeting the definition of a financial asset, some entities in practice still classify their holdings as financial assets, which contributes to diversity in practice.
However, cryptocurrencies meet the definition of an intangible asset because they are identifiable as they can be sold or exchanged and have a digital form. Cryptocurrencies are also non-monetary items.
Given the classification of cryptocurrencies as intangible assets or inventory, what are the material issues with the measurement of cryptocurrencies? The fundamental nature of cryptocurrencies and traditional intangible assets is different because cryptocurrencies are traded on exchanges, accepted as a form of payment, and experience significant volatility − unlike traditional intangible assets where IAS 38 assumes that these assets are used to produce cash inflows for the entity within its business operations.
In subsequent periods, IAS 38 mentions that an entity shall choose either the cost model or the revaluation model as its accounting policy. If an intangible asset is accounted for using the revaluation model, all the other assets in its class shall also be accounted for using the same model, unless there is no active market for those assets. Under the cost model, the cryptocurrency is subsequently measured at its ‘cost less any accumulated amortisation and any accumulated impairment losses’. In contrast, the revaluation model requires the cryptocurrency to be carried at its revalued amount being the fair value (measured with reference to an active market) at the revaluation date less any subsequent accumulated amortisation and any subsequent accumulated impairment losses.
Specifically looking at IAS 2, it is noted that inventories are ‘measured at the lower of cost and net realisable value’. Cost in this instance would be the price that the holder paid to acquire the cryptocurrency. In applying a historical cost basis to cryptocurrencies, it means that cryptocurrencies that are identical assets may be reported at different amounts, which could necessitate the use of cost formulas such as FIFO (first-in, first-out). Therefore, this reduces the comparability of the financial statements.
If the cost model is used in IAS 38, increases in the value of cryptocurrencies will only be recognised and realised when it is disposed which defers the exposure to the changes in fair value. Similarly, under IAS 2, the only change in value is if the net realisable value of the cryptocurrency is lower than its cost. Hence, the maximum value of cryptocurrencies held as inventory is its cost. However, IAS 2 applies a measurement exception to those inventories held by commodity broker-traders and measured at fair value less costs to sell. This means that both increases and decreases in the fair value less costs to sell are recognised. The holder should therefore have a business model and actively buy and sell cryptocurrencies. Given the lack of clarity and further guidance, this exception may only be applied in narrow circumstances based on the business model, purpose of selling in the near future and generating profit from fluctuations in the price which could result in further diversity as measurement of inventories.
The characteristics of cryptocurrencies are affected by the variability in cash flows and they are sensitive to market factors as well as other risks. Therefore, the cryptocurrency’s historical cost will differ from its current value. Additionally, users want to see information about the change in value of cryptocurrencies and therefore, a cost model may not result in relevant information because the cost model does not provide timely information about the change in value. An entity may choose to measure the cryptocurrency using the revaluation model only if an active market exists, which requires trading with sufficient frequency and volume. Cryptocurrencies are largely traded on exchanges and thus it may be possible to determine that an active market exists. However, the holder should apply judgement in determining whether it is an active market for cryptocurrencies. More popular cryptocurrencies such as Bitcoin may be traded daily and extensively and as such, an active market may exist.
Cryptocurrencies and financial statements
In terms of the presentation of cryptocurrencies in the financial statements, cryptocurrencies will be presented as intangible assets under assets on the face of the statement of financial position of the holder. Furthermore, traditional intangible assets will be presented as non-current assets as the benefits are expected to be received over more than one period. Additionally, where cryptocurrencies are classified as intangible assets but are held with the intention of being sold within the next 12 months, IFRS 5 will apply. This is because IFRS 5 specifies that these assets should be classified as current assets when they meet the ‘held for sale’ criteria. While inventories are always presented as current assets in terms of IAS 2.
While cryptocurrencies may meet the definitions of an intangible asset or inventory, their measurement principles do not provide relevant and useful information.
Author
Professor Ahmed Mohammadali Haji, Associate Professor & Subject Head: Accounting; Milan van Wyk CA(SA), Senior Lecturer in Accounting at University of Johannesburg and Naazneen Moosa CA(SA), Manager in Accounting Advisory, KPMG Ireland
