Despite the increasing prevalence of cryptocurrency in public discourse, there remains an absence of formal guidance from professional standards boards as to the appropriate financial reporting treatment for cryptocurrency.
The most recent official material is an agenda decision from the IFRS Interpretations Committee (IFRIC) June 2019 meeting, the outcome of which is summarised below. This discussion primarily concerns cryptocurrencies.
More recently, in July 2020, The European Financial Reporting Advisory Group (EFRAG) issued a discussion paper in recognition of the ongoing evolution and growth potential of cryptocurrency.
In this briefing, we look at some differences between IFRS and FRS 102, however it is our view that the financial reporting treatment of cryptocurrencies is consistent between both financial reporting regimes.
Before concluding on the accounting treatment of a transaction, it is important to determine purpose and utility (ie how the asset derives its inherent value) of the cryptocurrency in the context of the reporting entity. The underlying business model of the entity, as well as the purpose for which it is interacting with cryptocurrency, must also be understood.
IFRIC agenda decision in June 2019
The committee observed that a holding of cryptocurrency meets the definition of an intangible asset in IAS 38 (Intangible Assets) on the grounds that it is capable of being separated from the holder and sold or transferred individually and it does not give the holder a right to receive a fixed or determinable amount of units of currency.
The committee goes on to conclude that IAS 2 (Inventories) should be applied to cryptocurrencies that are held for sale by an entity in the ordinary course of business. Where IAS 2 is not applicable, the committee concluded that IAS 38 (Intangible Assets) should be applied to holdings of cryptocurrencies.
EFRAG discussion paper in July 2020
The paper identified three possible approaches on the way forward for addressing IFRS requirements for cryptocurrency:
- No amendment to existing IFRS requirements.
- Amend and/or clarify existing IFRS requirements.
- A new standard on crypto-assets (liabilities) or a broader category of digital assets (liabilities).
The window for feedback from constituents will run to 31 July 2021 and it is expected that further clarification may be issued thereafter.
Recognition as intangible assets
Based on the current standards, the general consensus is that intangible assets provides the most appropriate basis for recognition of cryptocurrencies.
Under IFRS (IAS 38), intangible assets are defined as “identifiable non-monetary assets without physical substance”.
We have taken each component of this definition in isolation as follows:
- Under IAS 38, an asset is identifiable if it either:
- Is separable, ie capable of being separated from the entity and sold, transferred, rented, exchanged or licensed; or
- Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or other rights and obligations.
- As individual cryptocurrencies are capable of being traded on exchanges or in peer to peer transactions, they are identifiable.
- IAS 38 defines monetary assets as “money held and assets to be received in fixed or determinable amounts of money”.
- Cryptocurrencies are subject to major price volatility as a result of ever changing supply and demand. The value of cryptocurrencies is not therefore fixed and cannot be predicted or determined at any one point in time.
- Cryptocurrencies are therefore non-monetary in nature.
Without physical substance
- Cryptocurrencies are a form of digital money and do not have physical form or substance.
- Cryptocurrencies are intangible digital records recorded on a distributed ledger using DLT.
- DLT creates a unified transaction log and allows data to be transferred, stored or traded electronically.
- Cryptocurrencies are therefore without physical substance.
Recognition as inventories
Although the general consensus is that the recognition of cryptocurrencies as intangibles will typically be the most appropriate basis, there are instances where it may be appropriate for cryptocurrencies to be recognised as inventory.
This would apply for entities which purchase and sell cryptocurrencies as part of their ordinary course of business, such as crypto exchanges. This could also apply to other entities which substantially deal in cryptocurrencies, such as crypto miners.
Under both IFRS and FRS 102, inventory is measured and recognised at the lower of cost and estimated selling price less costs to complete and sell.
Given the volatility associated with cryptocurrencies it is likely that an impairment would be required should their estimated selling price less costs to complete and fall below cost.
It is also permissible under both standards to measure inventory at fair value through profit and loss, although this is only applicable in certain circumstances which are dependent on the entity’s business model.
Disregarded accounting treatments for cryptocurrencies
Cash and cash equivalents or foreign currency
FRS 102 and IAS 7 (Statement of Cash Flows) define cash equivalents as ‘short term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value’. Given the significant volatility that some of the more notable cryptocurrencies have been subject to, the final part of this definition would appear to preclude these assets as being recognisable as cash equivalents under both reporting standards.
IAS 32 (Financial Instruments) provides further guidance as to the definition of currency, stating that ‘this is a financial asset because it represents the medium of exchange and is therefore the basis on which all transactions are measured and recognised in financial statements’. It would appear inappropriate to apply such a statement to cryptocurrencies.
Although there might appear to be logical merit in likening cryptocurrencies to foreign currencies, given that cryptocurrencies appear to fall short of meeting the definition of cash, it follows that they are unable to be recognised as foreign currencies.
Other financial assets
Another commonly suggested recognition basis for cryptocurrencies to be classified as includes other financial assets, such as investments.
Under both FRS102 and IFRS, financial instruments are defined as “a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity”.
One crucial defining characteristic of a financial asset is that it conveys the contractual right to cash, or another financial asset. Given that no counterparty exists with a contractual obligation to repurchase cryptocurrencies, they cannot meet this definition.
Accounting for cryptocurrencies as intangible assets: the cost model or the revaluation model?
Table chart 1 – Accounting for cryptocurrencies as intangible assets
Accounting for cryptoassets other than cryptocurrencies
Other cryptoassets include security tokens, asset-based tokens and utility tokens (together commonly referred to as ‘crypto tokens’) which are held by an entity.
Crypto tokens are units of accounting and a medium of exchange. It is difficult to refer to tokens as a store of value; as the intrinsic value of a token is tied to the utility it brings to the token holder:
The same guidance applied here as for cryptocurrencies and therefore this is likely to be the most appropriate recognition for most other cryptoassets.
IAS 2 does not require inventories to be in physical form, but must consist of assets held for sale in the ordinary course of business. Inventory accounting may be appropriate if this criteria is met.
An entity that actively trades cryptoassets, purchasing them with a view to their profitable resale in the near future might consider whether commodity broker-trader guidance in IAS 2 should be applied.
However, if the entity holds crypto tokens for investment purposes (ie capital appreciation) over extended periods of time, it would likely not meet the definition of inventory.
Crypto tokens may provide the holder with a right to future goods or services, ie a prepayment. Where the prepayment does not meet the criteria of an intangible asset, the accounting will be similar to other prepaid assets. This is may be found when dealing with utility tokens.
Cash or currency or foreign currencies
Judgement is required here but generally cryptoassets lack the properties of cash (as described previously), and therefore are unlikely to be considered cash or currency under both FRS 102 and IFRS.
Financial assets other than cash
Certain crypto tokens give the holder a right to cash or a financial asset. This could be based on future performance of a platform, a residual interest in net assets, or the value of an underlying asset. Unless crypto tokens provide the holder with a legally enforceable right to cash or another financial asset, they will not meet the definition of a financial asset.
If you have any specific queries relating to financial reporting and cryptoassets, please speak to your usual Saffery partner.