To be measured at fair value, a crypto must meet the accounting definition of a financial asset. And that’s where the wheels fall off
Studying this technical article and answering the related questions can count towards your verifiable CPD if you are following the unit route to CPD and the content is relevant to your learning and development needs. One hour of learning equates to one unit of CPD. We'd suggest that you use this as a guide when allocating yourself CPD units.
This article was first published in the May 2018 UK edition of Accounting and Business magazine.
Let’s start by defining cryptocurrency. Apart from being everyone’s latest and greatest way to get rich quickly, it is actually intended to be a medium of exchange, like the US dollar. And like the US dollar, cryptocurrency has no intrinsic value – it is not redeemable for another commodity, such as gold. However, unlike the greenback, cryptocurrency has no physical form, is not legal tender in many jurisdictions and is not currently backed by any government or legal entity. In addition, cryptocurrency supply is not determined by a central bank, and all transactions are performed and validated by the users of the system without an intermediary (such as a bank) facilitating these functions.
The term cryptocurrency is used because the underpinning technology is based on public-key cryptography. For those without a PhD in programming, this merely means that the communication is secure from third-party interference.
There are many different types of cryptocurrency in existence. The most popular, bitcoin, was the first cryptocurrency to appear, in January 2009. After a huge amount of research (OK, all I did was Google ‘who accepts bitcoin’), it appears that bitcoin is accepted by a number of large and small companies, including Microsoft’s Xbox store, Expedia and Helen’s Pizza restaurant in New Jersey. That’s not to say I can use it to buy groceries (yet), but it does seem to be gaining traction as a viable medium of exchange.
In addition, since the marketing companies have got hold of this, even funkier cryptocurrencies are emerging, such as ether, ripple and litecoin (I’m just waiting for IFRScoin to appear and then I’m investing). To be fair, though, many of these new cryptocurrencies have additional or improved features over bitcoin – for example, they have faster processing times for payments made in the cryptocurrency.
Where the accounting starts
The speed, ease and cost savings associated with this type of currency mean that it has the potential to become the popular choice for payments. Although the function of a cryptocurrency is to improve the ability of parties to transact digitally with each other, to date most investors in cryptocurrencies are investing in them with the hope of realising capital gains. And the capital gains have been substantial: the value of bitcoin increased approximately 700% between January 2017 and the beginning of November 2017.
Holdings of cryptocurrencies can be large and their value volatile, so users of financial statements probably want to know about them. However, today’s accounting standards were not written with cool cryptocurrencies in mind.
Most common sense accountants would agree that the best accounting for a cryptocurrency would be fair value. After all, that’s the value at which investors will either realise their investment or be able to transact in exchange for other goods and services. However, our good old bricks-and-mortar accounting rules haven’t quite moved with the times.
I think cryptocurrencies need to be accounted for as either inventory or an intangible asset. The logic for this view is as follows: in order for accountants to be able to measure a cryptocurrency at fair value, the crypto (as I dare to abbreviate it) needs to meet the accounting definition of a financial asset. And that’s where the wheels fall off the fair value approach, for the following reasons:
- cryptos are not legal tender (ie cash as defined)
- cryptos are not cash equivalents because their value is exposed to significant changes in market value
- cryptos are not a contractual right to receive cash or a cash equivalent.
Cryptos therefore fail the definition of a financial asset. Unfortunately, we are then left with only two possible positions:
- Cryptos are recognised as inventory and measured at cost. Some of those reasonable accountants I referred to before suggest we could maybe apply the commodity broker-trader guidance in IAS 2, Inventories, and measure cryptos at fair value. Unfortunately, even if an entity was actively trading in cryptos, I think it would not qualify for the commodity broker-trader exemption that would let it measure cryptos at fair value because cryptos are not a commodity.
- If cryptos are recognised as intangible assets, the default position is to measure them at cost. If the cryptos are accounted for as intangible assets, an entity might be able to justify there being an active market for them, in which case the cryptos could be measured at fair value. However, this still secures only the runners-up prize, because the movements in that fair value would be recognised through other comprehensive income, and the gain would not be recycled through profit and loss when the cryptos are realised.
A couple of people have challenged my assertion that cryptos are not cash as defined. Some pointed out that several jurisdictions do actually acknowledge that cryptos are legal tender. However, the most compelling argument I’ve heard to try and land in a sensible place is that IAS 32, Financial Instruments: Presentation, doesn’t actually define cash – probably because, when it was written, everyone knew what cash was. However, taking a look at paragraph AG3 of IAS 32, one might argue that, for accounting purposes, the words ‘cash’ and ‘currency’ are interchangeable.
Nor could I find any definition of currency in the all-powerful IFRS book. So again I engaged in hours of painful research (Googling the word ‘currency’). Following this, I think we could argue that a crypto meets the definition of currency and, therefore, cash, because a currency appears merely to need to be considered a reasonable medium of exchange. There is at least a judgment to be made about whether some of the more popular cryptos are mediums of exchange. And if we could get to cryptos as a form of cash, we could all breathe a collective sigh of relief in solving at least one of the 3,245 outstanding questions on cryptos.
Accounting for cryptos at fair value, with movements reflected in profit or loss, would provide the most useful information. There’s a strong argument that this can’t work under the current accounting requirements. But there may be a way of reading existing guidance that would allow for at least some cryptos to be classified as cash and, therefore, arrive at a sensible outcome. Sounds like a job for Superman, and if he’s not available, perhaps the IFRS Interpretations Committee.
Gary Berchowitz is a partner at PwC South Africa
CPD technical article
"To be measured at fair value, a crypto must meet the accounting definition of a financial asset. And that’s where the wheels fall off"