By CA. Pradeep Sriram
Cryptocurrencies are a vast and growing field. Accounting for cryptocurrencies is a diverse and complex topic with many nuances centered around cryptographic assets, accounting for initial coin offerings, accounting for cryptocurrency miners, accounting for cryptocurrencies held on behalf of third parties, etc. This article focuses on the fundamental principles of cryptocurrency accounting applicable in most standard use cases.
The Oxford Dictionary defines ‘cryptocurrency’ as ‘a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank’. There is no legal definition of cryptographic assets. It is important to note that there are various subsets of cryptographic assets. Cryptographic assets are used for a variety of purposes, including as a means of exchange, as a medium to provide access to blockchain-based goods or services, and to raise funding for an entity developing activities in this area.
History of Accounting for Cryptocurrencies:
While Cryptocurrencies have been around for more than a decade now and have proliferated rapidly, they first caught the attention of the standard-setting bodies and regulators after a landmark ECJ ruling in October 2015. On 22 October 2015, the ECJ issued a landmark ruling on the digital currency known as Bitcoin. While the subject matter of the case and the ruling was not directly related to the legitimacy of Bitcoin as a ‘currency’ or the accounting aspects of the same, the ruling was a watershed moment in many ways. While we will not go into the details of the case and the judgment, suffice to state that the ECJ acknowledged Bitcoin as a ‘currency’. (Note: Currencies, Cash & Cash equivalents have a different connotation under Accounting standards, and cryptocurrencies do not qualify as one – Explained later in this article)
ECJ Judgment paraphrased below:
The ‘bitcoin’ virtual currency with bidirectional flow, which will be exchanged for traditional currencies in the context of exchange transactions, cannot be characterised as ‘tangible property’… given that, as the Advocate General has observed… that virtual currency has no purpose other than to be a means of payment.”
This innocuously worded paragraph embedded deep within a voluminous judgment offered a precedent for regulators worldwide and clarified any doubts regarding the legitimacy of cryptocurrencies like Bitcoin.
It was almost a year after this judgment, in December 2016, that the Accounting Standards Advisory Forum (ASAF) of the IASB held its first meeting on the topic. The first thought paper around accounting for cryptocurrencies was pioneered by AASB (Australian Accounting Standards Board) led by Henri Venter. Things then moved rapidly culminating with an IFRIC meeting decision in June 2019.
IASB was presented with options to address the problems. The options inter alia were:
- Issue a new IFRS.
- Amend the definition of cash or cash equivalents.
- Amend the definition of a financial asset.
- Amend the measurement guidance in IAS 2 and IAS 38
Considering the advantages and disadvantages of different options, IASB decided to go ahead with an IFRIC guidance on accounting for digital currencies with specific measurement guidance around IAS 2 and IAS 38.
What Cryptocurrency is not:
An impulsive accounting approach during the initial years when cryptocurrencies were introduced, was to treat cryptocurrency as a financial instrument/currency/cash (as the ECJ judgment also did, though the context was different) and apply the relevant standard on financial assets. However, cryptocurrency fails the most important test required to qualify as a financial asset – it is not backed by a contract. There is no contractual right to receive cash or another financial asset in exchange for cryptocurrencies.
Currency (cash) is a financial asset because it represents a medium of exchange and is therefore the basis on which all transactions are measured and recognised in financial statements. A cryptocurrency fails this important criterion – It is still not ‘widely’ accepted as a medium of exchange, nor is used as the monetary unit in pricing goods or services to such an extent that it would be the basis on which all transactions are measured and recognized in financial statements – the pricing is usually done in “normal” currency and then pricing in cryptocurrency is derived from regular currencies.
The IFRIC judgment of June 2019 proffered guidance for accounting for cryptocurrencies on the following lines:
Step 1: Are the cryptocurrencies held for sale in the ordinary course of business / in the process of production for such sale / as materials or supplies to be consumed in producing goods / rendering services.
IAS 38 – Intangible Assets
Intangible Assets are defined as ‘an identifiable non-monetary asset without physical substance’. An asset is identifiable if it is separable or arises from contractual or other legal rights. An asset is separable if it ‘is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability’. IAS 21 The Effects of Changes in Foreign Exchange Rates states that ‘the essential feature of a non-monetary item is the absence of a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency’.
A cryptocurrency meets the definition of an intangible asset in IAS 38 on the grounds that (a) it is capable of being separated from the holder and sold or transferred individually; and (b) it does not give the holder a right to receive a fixed or determinable number of units of currency.
IAS 2 – Inventory
IAS 2 applies to inventories of intangible assets. Paragraph 6 of that Standard defines inventories as assets:
- held for sale in the ordinary course of business;
- in the process of production for such sale; or
- in the form of materials or supplies to be consumed in the production process or the rendering of services.
An entity may hold crypto-currencies for sale in the ordinary course of business. In that circumstance, a holding of crypto-currency is inventory for the entity, and, accordingly, IAS 2 applies to that holding. There is a special exception given to a broker-trader of crypto-currencies. Commodity broker-traders can measure their inventories at fair value less costs to sell as the crypto-currencies are principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin.
Crypto-assets are proliferating rapidly and many large publicly traded companies have Bit-coin on their Balance sheets today. Fortune 500 companies including the likes of Microsoft have started accepting Bit-coin as a form of payment. The IFRIC guidance is very recent and offers clarity on accounting for crypto-currencies in a uniform, consistent and comparable manner. Users of financial statements are very keen to understand the assumptions, risks, materiality, and judgments involved in recording and reporting crypto-currency transactions. In the coming years, crypto-currency accounting could evolve into an independent accounting standard with detailed recognition/ de-recognition rules, measurement criteria, and disclosure requirements.
The author is a member of ICAI and can be reached at email@example.com.