The popularity of cryptocurrencies has brought them into the corporate world, which in turn has brought accounting matters into focus. This is certainly the case for our team, as we work with an increasing number of fintech business and cryptocurrency holders & traders.
With no reference under UK GAAP (Generally Accepted Accounting Practice) for cryptocurrencies, existing standards need to be carefully considered to see how they fit with this new asset class. In this article, we will consider the key accounting questions presented by Bitcoin, Ethereum, Ripple and other cryptocurrencies. (Other classes of digital assets / tokens that are not cryptocurrencies may have different accounting treatments.)
Are cryptocurrencies cash?
Under FRS 102, i.e. the UK’s Financial Reporting Standard, cash and cash equivalents are defined as:
Cash on hand and demand deposits and 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.
Cryptocurrencies fall short of this definition under UK GAAP because:
- They are not legal tender backed by any government or state
- They are highly volatile where valuations are concerned
- They have low liquidity into fiat currency
- A relatively small number of outlets accept them
Are cryptocurrencies a financial instrument?
No again. Under UK GAAP, a financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
Although it may be possible through an exchange to convert a cryptocurrency into cash, the holder does not have the right to cash from holding the cryptocurrency, nor does it result in an equity instrument in another entity.
Under FRS 102 therefore there are only two viable options left for accounting for cryptocurrencies: inventories and intangible assets. (Derivative products linked to a cryptocurrency, such as a future or an option, would meet the definition of a financial instrument however.)
Inventories are defined as assets held for sale in the ordinary course of businesses. Arguably, businesses which simply buy and sell cryptocurrencies as the entity’s main activity would be able to account for them as inventory.
The result would be to hold the assets at the lower of cost and estimated selling price (net realisable value) using the ‘first in, first out’ or ‘weighted average’ cost formula.
To fall into the category of intangible asset, a cryptocurrency would need to be:
An identifiable non-monetary asset without physical substance. Such an asset is identifiable when:
(a) it is separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or
(b) it arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations
Cryptocurrencies are identifiable in this way, as they can be separated from the entity and can often be sold on a cryptocurrency exchange.
FRS 102 allows an accounting policy choice, by class of intangible asset, between the cost and revaluation models.
Under the cost model, the cryptocurrency is simply recorded at cost less accumulated impairment loss.
Under the revaluation model, a cryptocurrency would be carried at its market value, assuming this value can be reliably measured.
One of the essential criteria is the need for an active market for an intangible asset, in order to adopt the revaluation model allowed. This will exist for some, but not all, cryptocurrencies. Therefore, the specific circumstances of each asset must be considered case by case.
It is our viewpoint that in the majority of cases, it would be appropriate to account for cryptocurrencies as an intangible asset under FRS 102.
What about IFRS?
Having considered FRS, it is also important to consider IFRS i.e. International Financial Reporting Standards. There are four International Accounting Standards that are relevant to cryptocurrencies:
- IAS 7 Statement of Cash Flows
- IAS 39 Financial instruments: Recognition and Measurement
- IAS 2 Inventories
- IAS 38 Intangible Assets
Under certain circumstances it may be appropriate to account for cryptocurrencies as inventory, but in most cases IAS 38 should be applied.
The challenge for businesses
It’s clear that the accounting legislation hasn’t yet caught up with developments in the digital world. Under current accounting standards, it seems most appropriate to treat cryptocurrencies as intangible assets.
However, when thinking about how to account for digital assets your business holds, remember the need to consider the nature of each asset including any rights or entitlements that may come with them. The challenge of considering the specific circumstances of each cryptoasset is much less difficult with the support of experienced financial services accountants.
To hear about the latest developments in how the Financial Conduct Authority is approaching cryptocurrency and other digital assets, look out for our regular roundups of fintech news by following us on social media.