Reviewed October 2020
Cryptocurrency and its underlying Blockchain technology have created an era of technological disruption. Products of this disruption include the creation of new types of assets which struggle to fit into existing frameworks defining tangible and intangible assets. Until accounting standards are adapted or created to specifically consider these new types of assets, our only option is to account for them and the resulting transactions within the frameworks of the existing accounting standards.
With these limitations in place, we discuss a selection of considerations that tech companies and their investors should be mindful of, particularly when it comes to preparing compliant financial statements for external reporting purposes.
How have you acquired your Cryptocurrency?
They’re not government issued fiat currencies, not considered to be legal tender, and aren’t backed by an underlying asset or commodity. Yet so many cryptocurrencies are in circulation, functioning as a ‘virtual currency’ and serving as a widely accepted means of exchange. Given that each cryptocurrency has specific characteristics and your cryptocurrency holdings may have been acquired for a host of reasons, what would be the most appropriate way to account for it? The answer may be obtained by asking yourself a simple question – how and why have you purchased or mined Cryptocurrency?
In the absence of specific accounting standards for cryptocurrencies, we look to guidance from two1 existing standards to evaluate potential options for the most appropriate accounting treatment. At this point, we note that evaluations need to be made on a case by case basis – circumstances surrounding the acquisition of cryptocurrencies will ultimately determine which existing standard is most suitable for application.
AASB 138 Intangible Assets
Recognising your cryptocurrencies as intangible assets is likely to be the most appropriate classification. Intangible assets are defined as “an identifiable non-monetary asset without physical substance”. Cryptocurrencies meet the three components of the criteria as follows:
(i) Identifiable: cryptocurrencies can be traded on exchanges or via peer-to-peer transactions.
(ii) Non-monetary asset: cryptocurrencies don’t have a fixed value and are subject to fluctuations based on supply and demand.
(iii) Without physical substance: as a form of digital money, cryptocurrencies don’t have physical substance.
AASB 102 Inventories
What if your company’s cryptocurrency assets are held for sale as part of the ordinary course of your business operations? If so, it is likely to be best recognised as digital assets (inventory) at the lower of cost and net realisable value. The exception here is in the case of digital assets held by commodity broker-traders, in which case, they will need to be measured at fair value less costs to sell.
The process doesn’t stop here. Once you have established which standard is applicable, consideration needs to be made as to how these assets are measured – both initially, and on an ongoing basis. External factors to consider include the availability of an active market and/or the impacts of supply and demand, which will ultimately drive the valuation of cryptocurrency.
What’s your Accounting Policy?
The next step is to develop an accounting policy.. The policy should disclose how all holdings of cryptocurrency have been measured and accounted for. It should also contain sufficient information about the nature of the holding such that it is relevant to the economic decision-making needs of users. It must be reliable – by applying this policy, are the financial statements prudent, free from bias, and do they accurately represent its economic substance?
Have you accounted for all your Cryptocurrencies?
The mechanics of cryptocurrency is such that your company could be the rightful owners of different cryptocurrency assets that you might not even be aware of. This could put the “completeness” of your Financial Statements at risk. Consider, for example, the two hard fork events that took place on the Bitcoin blockchain in 2017, when all participating nodes adopted a change applied to the underlying protocol. Here, all participating nodes holding Bitcoin received Bitcoin Cash (BTC) and Bitcoin Gold (BTG) in a 1:1 ratio – from a financial reporting perspective, this event somewhat represents a ‘spin-off’. BTC and BTG both represent new digital assets with economic value and ownership belonging to the Company. Have these currencies been accounted for?
The matters discussed above have focused on holding cryptocurrency as an investment or for the purposes of trading. What about if you want to issue a cryptocurrency yourself, via an Initial Coin Offering (ICO)?
Are you launching an Initial Coin Offering?
Initial coin offerings (ICOs) are an innovative new path for a start-up company to raise funds. The issuing company creates digital tokens on a blockchain using smart contract applications and sells to the tokens to the general public. A document known as a ‘white paper’ is prepared and distributed to the public, which typically outlines the technical details of the token’s functionality and explains the value proposition of the system they underpin e.g. what the project is about, what need(s) the project will fulfil upon completion, how much money is needed to undertake the venture, what type of money is accepted and how long the ICO will run for.
There are two types of tokens:
- Security tokens, which pay dividends, share profits, pay interest or invest in other tokens or assets to generate profits for the token holders; and
- Utility tokens, where the token provides access to the goods or services that the project will launch in the future e.g. future access to software, or cloud storage.
The legal issues and considerations around ICOs have been actively debated, but what is the accounting impact on your business? Are these tokens classified as equity, liabilities or revenue?
There is no single answer to this question, as it will depend on the finer details of how the specific token has been designed. The vast majority of companies undertaking ICOs are steering clear of classification as an equity token, to avoid bordering too closely to an IPO and the stringent requirements around issuing a prospectus. For this reason, most companies are designing their ICOs to be ‘utility tokens’. Structuring the ICO in this way allows the tokens to exhibit qualities similar to deferred revenue (a liability on the balance sheet).
Applying accounting standards, there are new revenue recognition rules under AASB 15 Revenue from Contracts with Customers (‘AASB 15’) which prompt us to question whether the satisfaction of performance obligations happens as at a specific point in time, or over a period of time. The answer to this question has implications for how and when this revenue is recorded in the company’s books.
In a scenario where the performance obligation is satisfied at a specific point in time, the accounting treatment should be straightforward – record the revenue in the income statement, the asset (be it cash or another cryptocurrency) in the balance sheet, and account for any tax considerations. However, when the performance obligation is satisfied over time, the revenue is recorded as deferred income on the balance sheet until the obligation is satisfied. Consider what happens as a result of fluctuations in the price of the token? Does this impact the income statement? What accounting policy have you outlined to cater for these considerations?
It is evident that disruptive technology presents a number of unanswered questions for financial information preparers. What is clear though is the need to consider each scenario on a case by case basis. In the absence of clear guidance from accounting standard setters, a solution must be identified within the realms of existing standards, supplemented by relevant professional advice.
[1] AASB 138 and AASB 102 are likely to be the most suitable standards, however discussions have suggested that cryptocurrencies could be accounted for as cash and cash equivalents or as a financial asset. However, given its decentralised nature and lack of contractual relationship, these options have not been considered in this article.
