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October 31, 2023Accounting for cryptocurrency and tokens can be a complex task for accountants. There are several challenges and no specific accounting standards or frameworks that provide clear guidance on how to treat these assets. At Papilio Services, we have encountered various debates and discussions with clients regarding the appropriate accounting treatment for cryptocurrencies.
To effectively account for cryptocurrency, it is crucial to first understand the specific cryptocurrency being used and any associated rights it may have. Additionally, having a comprehensive understanding of the client’s business model is essential to determine the actual business activities involving cryptocurrencies. Once these factors are understood, the accountant can then devise a strategy to account for the transactions and identify the necessary documentation required for the accounts and audit process.
One of the main obstacles in accounting for cryptocurrency is the absence of a universally accepted accounting standard or framework. This lack of guidance leaves room for interpretation and debate among accounting professionals. Institutions like the Association of Certified Chartered Accountants (ACCA) have attempted to address this issue by examining whether cryptocurrency should be treated as money, intangible assets, or financial instruments. However, due to the unique nature of each situation, there is no definitive answer.
What is Cryptocurency?
Cryptocurrency is generally defined as an intangible digital token that is recorded on a distributed ledger technology such as blockchain. These tokens can be utilized in various ways. They may represent ownership interests, rights to use specific assets or services, or even act as a medium of exchange.
The problems of accounting for cryptocurrency
Our experience has shown that applying existing accounting standards to cryptocurrency can be challenging. The traditional financial investments are covered by a range of international and local accounting standards. The same level of coverage does not exist for cryptocurrency and tokens. Consequently, we often find ourselves in situations where the transactions involving cryptocurrency do not fit neatly within existing standards. That is forcing us to rely on best-fit scenarios, which is less than ideal.
The debate surrounding the accounting treatment of cryptocurrency centres around whether it should be classified as money, a financial instrument, an intangible asset, or even an inventory item.
Is cryptocurrency money?
Cryptocurrency is often seen as a form of digital currency and International Account Standard (IAS) 7 and IAS 32 defines what cash is. However, cryptocurrency is not generally considered cash. Why? Because the general opinion is that it cannot be readily exchanged for goods or services. Increasingly though we are seeing clients taking payments for their invoices in cryptocurrency as a form of payment. Such form goes against this viewpoint but still, this is a choice by a business. Also, there is no legal requirement to do so as cryptocurrency is not seen as a legal tender.
IAS 7 defines cash as “short term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value”. This introduces the concept of volatility in price. Most cryptocurrencies and tokens are susceptible to this concept and thus would rule them out of being classified as money.
However, what if the cryptocurrency is stable? What if that coin is not being used for investment purposes? What if its used everyday by business to receive payments from customers and make payments to suppliers? As an example, the USD Coin is a stable coin that is intended to not fluctuate, has an exchange of 1:1 with the US Dollar and is fully supported with US Dollar assets. This is in direct contrast to coins such as Bit Coin and Ethereum which do have price volatility. So, if the USDC is being used as a form of payment in exchange of services or goods could it be argued that it should be classified as a cash and cash equivalent?
Is cryptocurrency an intangible asset?
Treating cryptocurrency as an intangible asset is generally deemed the closest and most appropriate classification. IAS 38 defines an intangible asset as a non-monetary asset without physical substance. And, it can be separated from the holder or sold individually. This aligns with the nature of cryptocurrency. Intangible assets can be measured at cost or revaluation. Although, most cryptocurrency assets have active markets that enable reliable pricing, they would typically be considered to have an infinite lifespan. It’s important to note that even if not amortized, intangible assets must be tested for impairment annually.
While classifying cryptocurrency as an intangible asset may be suitable for certain situations, such as when dealing with non-fungible tokens (NFTs) or assets held by day traders or investors, it may not fit well in more traditional trading business that is buying and selling a service but being paid in cryptocurrency i.e. just replacing fiat currency as a means of receiving and making payment?
Should we account using inventories?
An alternative viewpoint suggests that cryptocurrency could be accounted for as inventories under IAS 2. Particularly, in cases where entities hold cryptocurrencies for sale in the ordinary course of business. IAS 2 can also be applicable to the holding of intangible assets.
An entity may hold cryptocurrencies for sale in the ordinary course of business. And, that is the case it could be argued that cryptocurrency assets could be treated as inventory. In most circumstances the recognition method would be the lower of cost and realizable value. However, if the entity acts as a broker trader of cryptocurrencies, then IAS 2 states that the inventory should be valued at fair value less costs to see. The purpose of the inventory is sell in the near future and generating profit (hopefully) from positive price fluctuations. However, what does this cover? An entity that is receiving payment in cryptocurrency for services? And, is not speculating on margin but is using it as digital currency? If the cryptocurrency is used as the main currency in a more traditional trading entity does it fit in as inventory.
Let’s summarise
The above outlines a few of the issues and these issues can be compounded further if you have two different types of cryptocurrency with two completely different characteristics where there is an argument to classify each one differently as per above. Should you classify separately or look for a better model that caters for all? Taking into consideration the reader of the financial information and understandability of the classification to the user of this information further highlights some of the problems that may arise.
Ultimately, understanding the unique characteristics of each cryptocurrency and the specific business model is essential for determining the appropriate accounting treatment. Due to the growing use of digital assets, it is evident that more comprehensive guidance is needed to ensure consistent and accurate accounting practices in this evolving landscape.