CRYPTO: Accounting for non-monetary asset?

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Background

As you may have already knew, crypto-assets first gained traction (with the name ‘Bitcoin’ a.k.a. the ‘digital’ gold) following the 2008/9 global financial crisis – created by people who lost their trust and respect to governments and central banks.

Simply put, crypto-assets are digital assets – not linked to any physical currency – recorded in blockchain (Read about history of blockchain – click here). They act as the alternative way of making payments to cash or credit cards. The need to pass through the banking system is eliminated, hence, outside the control of any government and regulation by the financial watchdogs.

Crypto vs. fiat currency
From the old-school barter to Roman rulers paying their soldiers partly in salt (which gave the world the word ‘salary’ – from the Latin word salis) and coins (from gold and silver) to promissory notes to fiat currency. And, then came crypto.

Cryptocurrency still lacks the rife acceptance as a medium of exchange – i.e., not a legal tender unlike the fiat currency (i.e., USD, GBP, AUD, JPY, PHP, and other foreign currencies).

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Economists believe that money must serve three key purposes – which broadly impacts the demand for it: (i) a unit of account, (ii) a medium of exchange to facilitate trade, and (iii) a store of value. On the other hand, a good number of accountants sees the crypto rallying its way to become the new definition of money sooner rather than later.

Today, Bitcoin (both BTC and BCH) and Ethereum’s Ether (est. 2015) are the most famous and widely-used crypto-assets, but the market continues to expand producing ‘tokens’ and ‘coins’. (N.B. Token can have a functionality beyond an exchange of value.) Each, of course, differs in terms of security and centralization, energy consumption, transaction speed and functionality. Initial Coin Offerings (ICOs) are also gaining popularity but perceived to be high risk; accordingly, governments across the globe (e.g., UK’s Financial Conduct Authority, US’s SEC, among others) issued public warnings on the prevalence of scams.

Throughout this article we would be labelling other types of crypto-assets as if they are cryptocurrencies, hence, are interchangeable to reduce some complexities.

Blockchain: the distributed ledger technology
The ledger is virtually immutable. There is almost no risk of fraud or manipulation in participant-to-participant transactions on the blockchain itself (except during trades, there is the potential for market manipulation, and theft of private keys).

Transactions on public, permission-less blockchains such as the Bitcoin blockchain are pseudonymous. That means, anyone can view the ledger, which ownership of bitcoins and all transactions that have occurred upon it, but there is lack of connection between the Bitcoin address and an identifiable legal or natural person. Therefore, it is only with enough information or data overview that one could track activity to specific addresses, and addresses to individuals or parties involved in the blockchain.

Why ‘hot’ topic?
Bloomberg’s Nearly a Third of Millennials Say They’d Rather Own Bitcoin Than Stocks suggests that the Generation Y holds cryptocurrency in high regards as an investment and would actually choose to buy it rather than invest through equity or debt securities.

Certain fund managers and wealth coaches have also started to campaign in looking at it as a separate asset class with the appropriate graded-risk. This goes to show that the public sees it as an effective store of value – although has not yet been adopted as a medium of exchange.

JP Morgan Chase & Co, the biggest US bank (by assets), has issued its owned digital coins (i.e., JPM Coin). Facebook’s LIBRA, in partnership with other prominent names such as Visa, Mastercard, PayPal, Uber, eBay, Vodafone, among others, is expected to be launched in 2020 but must muscle through the Fed’s concerns over privacy, consumer protection and financial stability. Tokyo’s crypto-heists with the most recent one amounting to USD 32m (JPY 3.5bn) has gone missing from a so-called ‘hot wallet’ with Remixpoint who runs Bitpoint Japan exchange.

To date, the use of crypto and its trading market remain largely unsupervised and have faced allegations of money laundering and terrorist financing. The high volatility is among the factors that have dampened expectations about its ability to disrupt the global financial system.

(Learn more about Digital Literacy – click here)

Accounting for Crypto

In 2018, EY published IFRS (#) Accounting for Crypto-assets which highlights the noise and nuisances of crypto-assets – from the Accountants’ point of view –  albeit the ironically relative absence of the Accountants with the only most notable was the fact that the Australian Accounting Standards Board (AASB) submitted a discussion paper on DIGITAL CURRENCIES called Digital currency – A case for standard setting activity to the International Accounting Standards Board (IASB); and the Accounting Standards Board of Japan (ASBJ) issued an exposure draft for public comment on accounting for VIRTUAL CURRENCIES named Practical Solution on the Accounting for Virtual Currencies under the Payment Services Act. In addition, the IASB has since discussed certain features of transactions involving the digital/virtual currencies during its January 2018 meeting, and is expected to further discuss in the future whether to commence a research project in this area.

This highlights the lack of a standardized crypto-asset taxonomy – which makes it difficult to determine the applicability of standard setters’ published perspectives. Furthermore, due to the diversity and pace of innovation associated with it, the facts and circumstances of each individual case will differ – making it difficult to draw general conclusions on the accounting treatment. And, despite the market’s increasingly urgent need for accounting guidance, there have been no formal pronouncements on this topic to date (Ibid).

EY also claims that due to the challenge crypto poses to established beliefs about money, economic relationships and investing, questions arose about their appropriate financial reporting.

Worldwide: Pulse check
AASB’s Digital currency – A case for standard setting activity posits that cryptocurrencies are Intangible Assets. They could neither be cash or cash equivalents due to absence of broad acceptance as a means of exchange and is not issued by a central bank, nor could it be a financial instrument due to the lack of contractual relationship that results in a financial asset for one party and a financial liability for another. The paper concluded that it meets the definition of intangible assets since it is an identifiable nonmonetary asset without physical substance. Therefore, International Accounting Standards (IAS) 38, Intangible Assets, applies except when the asset is held for sale in the ordinary course of business – in which case, IAS 2, Inventories, would apply. However, the paper commented that it is still unclear as to how “held in the ordinary course of business” should be interpreted and would need to be further evaluated. The paper was discussed at the Accounting Standards Advisory Forum (ASAF), a consultative body of the IASB, in December 2016.

ASBJ’s Practical Solution on the Accounting for Virtual Currencies under the Payment Services Act suggests that a holder of virtual currencies should measure the same at market price at the reporting date if there is an active market – any difference between the market price and the carrying amount is recognised in profit or loss. If there is no active market, the measurement should be the lower of cost and the estimated disposal value – with any impairment (i.e., if estimated disposal value is lower than the carrying amount) not reversible in subsequent periods.

The United States of America’s (USA) Financial Accounting Standards Board (FASB) has performed significant research activities on the subject matter. However, the paper and discussion have yet to reach the public to date. Practitioners in USA generally account for it as indefinite-lived intangible assets under Accounting Standards Codification (ASC) 350, Intangibles.

Philippine Context
Philippine Financial Reporting Standards (PFRS) are currently fully converged with IFRS.

IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, requires that in the absence of a Standard or an Interpretation that specifically applies to a transaction, other event or condition, management shall use its judgment in developing and applying an accounting policy that results in information that is relevant and reliable.  In making the judgment management shall refer to, and consider the applicability of, the following sources in descending order: (a) the requirements and guidance in IFRSs dealing with similar and related issues; and (b) the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.

Safe to say that in accounting for crypto, Philippine Accounting Standards (PAS) 7, Statement of Cash Flows [as ‘cash and cash equivalents’], is out for the reasons already mentioned above; Philippine Financial Reporting Standards (PFRS) 7 and 9, Financial Instruments [as ‘financial assets other-than-cash’], may also not seem to be appropriate (similar to the treatment of gold bullion); PAS 40, Investment Properties, whilst plausible at first glance especially for capital appreciation holders, is not applicable since it lacks the physical substance – particularly being a land or building. With that, it leaves us with PAS 2, Inventories, PAS 38, Intangible Assets, and PFRS 13, Fair Value Measurements.

Absent the formal pronouncements, the author thinks the below accounting treatment from the perspective of crypto-holder would be compliant with (I)PFRS:

Initial recognition and measurement
Irrespective of the classification, recognition should be made from the time asset recognition criteria are met.

The initial measurement is the purchase price plus the directly attributable cost.

Subsequent measurement
Cost model
Under the cost model, the asset shall subsequently be measured at cost LESS ACCUMULATED AMORTIZATION AND IMPAIRMENT LOSSES. Since crypto is an indefinite-lived asset, amortization is not relevant. However, useful life of such asset shall be reviewed at each reporting period for any contradictory evidence, and impairment assessment shall be performed annually and whenever there is an indication that the asset may be impaired.

The provisions of PAS 36, Impairment of Assets, deal with the related subject matter. (Refer to the full text of the IAS 36 for details.)

Revaluation model
The use of revaluation model is only permitted if there is an ACTIVE MARKET in which they are traded.

Under the revaluation model, the asset shall subsequently be measured at FAIR VALUE less accumulated amortization and impairment losses. The increase as a result of revaluation shall be credited directly to equity under the heading REVALUATION SURPLUS, except if the increase represents a reversal of impairment loss. The decrease as a result of revaluation shall be charged against any outstanding balance of the revaluation surplus with any residual to be treated as an impairment loss.

The cumulative revaluation surplus included in equity may be transferred directly to retained earnings when the surplus is realised. The whole surplus may be realised on the retirement or disposal of the asset. However, some of the surplus may be realised as the asset is used by the entity; in such a case, the amount of the surplus realised is the difference between amortisation based on the revalued carrying amount of the asset and amortisation that would have been recognised based on the asset’s historical cost. The transfer from revaluation surplus to retained earnings is not made through the income statement.        

The aforementioned may not be applicable if you hold the crypto for sale in the ordinary course of business. In which case, the asset needs to be carried at LOWER OF NET REALIZABLE VALUE AND COST – except for commodity broker-traders where FAIR VALUE LESS COST-TO-SELL (THROUGH PROFIT OR LOSS) is more appropriate.

Disclosure
Refer to PAS 38’s Disclosure section – unless you’re holding the crypto for sale in the ordinary course of business in which case you need to consider the requirements of PAS 2’s Disclosure section. Notwithstanding the purpose of holding a crypto, PAS 1’s requirements and principles should be observed.

NEXT STEPS

EY, along with the other Big Four Firms, strongly believe that dealing with crypto-asset accounting requires a detailed understanding of both the blockchain and relevant accounting concepts. Each individual situation will require a unique approach, tailored with the appropriate professional advice.

The world is still on a wait-and-see, but we can always start preparing. The relevant question is, how are you positioning yourself?

Next articles: VALUATION OF CRYPTO (IFRS 13)… TAXATION ON CRYPTOAUDITING CRYPTO


Disclaimer: Opinions expressed in this article are that of the author and information provided are for general conceptual guidance for public information and are not substitute for expert advice. Contact support@philcpa.org for more information and if you want to avail professional services. Find us on Facebook!



Founder and President/CEO at akawnTHINK | Financial Coach | Mentor at EY UK Foundation's Smart Futures Programme | EY London Digital Ambassador

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