Crypto-assets often have very different terms and conditions. The holder needs to evaluate their individual terms and conditions carefully in order to determine which International Financial Reporting Standard (IFRS) applies. Depending on the standard that applies, the holder may also need to assess its business model in determining the appropriate accounting.
Determining ownership of a crypto-asset when it is held by a custodian or a crypto-exchange may present additional challenges and could impact the determination of the appropriate accounting.
In the context of crypto-assets, a financial asset could be: cash, an equity instrument of another entity, a contractual right to cash or other financial assets, or a right to trade financial instruments on potentially favorable terms (e.g., a derivative).
Crypto-assets that entitle the holder to underlying goods or services provided by an identifiable counterparty, despite being contractual, would not meet the definition of financial assets as the future economic benefit is obtained from the receipt of a good or services rather than the right to cash or another financial asset [IAS 32 AG11].
For example, a crypto-asset that entitles the holder to cloud computing services, even if contractual, would not be a financial asset as the future benefit is a service rather than the right to a financial asset.
Holders of such crypto-assets should evaluate the appropriate accounting based on the relevant IFRS standard. The discussion related to prepayments and intangible assets could also be relevant. Whether a contractual right exists for the holder of the crypto-asset to receive underlying goods and services may require a careful examination of the specific facts and circumstances and the enforceability of the contract.
What are the possible classifications of crypto-assets?
- Cash and cash equivalents
- Financial instrument
- Intangible asset
- Undefined self-developed classification (IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors)
The ECB, International Monetary Fund and US Federal Reserve note that money has three different functions, as follows:
- Medium of exchange
- Unit of account
- Store of value
IAS 32 Financial Instruments: Presentation uses cash and currency interchangeably. In practice, currency is synonymous with the money, both physical and electronic, in circulation in a particular jurisdiction.
IAS 32 also notes that ‘cash’ is a financial asset that represents the medium of exchange and is, therefore, the basis on which all transactions are measured and recognised in financial statements [IAS 32 AG3]. Demand deposits generally represent deposits that can be withdrawn on demand, without prior notice or penalty.
Cash, as currently presented in the financial statements, tends to be the physical holdings and demand deposits of fiat currencies issued, or supported, by the governments of various jurisdictions. Fiat currencies have little or no intrinsic value but are generally accepted as a medium of exchange in a jurisdiction because they are supported by government and recognized as legal tender in their respective jurisdictions.
Legal tender status is conferred by law in a jurisdiction and is typically reserved for notes and coins issued by a central bank or an organization authorized by the government. According to the Bank of England, legal tender has a very narrow and technical meaning: the debtor cannot be sued for non-payment if the debtor offers full payment of his or her debt in legal tender. In addition, what is classified as legal tender is typically a matter of law in the specific jurisdiction. Therefore, while a crypto-asset may be accepted for payment by certain entities within a jurisdiction, it does not automatically become legal tender in that jurisdiction.
IAS 32 indicates that cash is the basis on which all transactions are measured and recognized in the financial statements. Currently, it is unlikely that a crypto-asset would be considered a suitable basis for measuring and recognizing items in an entity’s financial statements.
While it is necessary for a crypto-asset to be legal tender before it can potentially be considered cash, the legal tender status by itself may not be sufficient. A holder needs to consider other factors such as whether the crypto-asset represents a medium of exchange and the basis on which the holder recognizes and measures all transactions in its financial statements.
While some governments are reported to be considering issuing their own crypto-assets or supporting a crypto-asset issued by another party, it is unclear at this stage whether those crypto-assets would be legal tender (i.e., they must be accepted as payment for legal extinguishment of a pre-existing debt).
Private issuers of crypto-assets lack the authority to confer legal tender status. Therefore, even if those crypto-assets are used or accepted as a means of payment, they are not considered cash for the purposes of IFRS. To some extent, these crypto-assets are similar to privately issued gift cards which, even if they are accepted by a wide range of merchants, are not considered cash either.
1B Cash Equivalents
IAS 7 defines cash equivalents 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. IAS 7 goes on to indicate that cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes and that an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition.
Cash equivalents is a presentational category and does not dictate the recognition or measurement of the asset. Therefore, a crypto-asset would need to be classified and measured under the applicable accounting standard before it could be considered as a cash equivalent for presentation purposes.
The IFRS Interpretations Committee (formerly the International Financial Reporting Interpretations Committee) confirmed, in 2009, that the amount of cash that will be received must be known at the time of the initial investment in order for an instrument to meet the definition of cash equivalents.
Accordingly, crypto-assets cannot be considered cash equivalents unless they are held for meeting short-term cash commitments, have a short maturity, are subject to an insignificant risk in change of value, and the amount of cash that will be received on maturity is already known when the crypto-asset is initially acquired.
Crypto-assets currently do not meet the definition of cash equivalents because they are generally, among others, not convertible to known amounts of cash, nor are they subject to an insignificant risk of change in value.
2 Financial instruments
– Contractual right
The first part of the definition of a financial instrument requires the existence of a contract or contractual relationship between parties. This is emphasised in the application guidance of IAS 32, which notes assets or liabilities that originate from statutory requirements (e.g., income taxes) are not financial instruments. Similarly, whilst highly liquid, gold bullion is not a financial instrument as it does not convey a contractual right to receive cash or another financial asset.
A contract is defined by IAS 32 as an agreement between two or more parties that has clear economic consequences which the parties have little, if any, discretion to avoid, usually because the agreement is enforceable by law [IAS 32 13]. Contracts may take a variety of forms and need not be in writing.
The use of blockchain or distributed ledger technology does not automatically give rise to a contractual relationship between parties. On the one hand, crypto-assets that entitle the holder to underlying goods, services or financial instruments provided by an identifiable counterparty could meet the definition of a contract. On the other hand, crypto-assets that do not entitle the holder to underlying goods, services or financial instruments and have no identifiable counterparty would not meet the definition of a contract. For example, the individual parties involved in the bitcoin blockchain do not have a contractual relationship with any other participant in the bitcoin blockchain. That is, by virtue of owning a bitcoin, the holder does not have an enforceable claim on bitcoin miners, exchanges, holders or any other party. Such holders need to find a willing buyer in order to realise economic benefits from holding their bitcoin.
Crypto-assets that are not contractual themselves could still be the subject of a contract, for example, a binding agreement to buy bitcoins from a certain counterparty would constitute a contract, even though the bitcoin itself does not represent a contractual relationship. Therefore, agreements entered into ‘off the chain’ to buy or sell crypto-assets could be contracts as defined above.
Holders of crypto-assets need to consider carefully whether the terms and conditions of their crypto-assets give rise to a contract. In the absence of a contract, a crypto-asset is not a financial instrument.
2i Equity instrument
IFRS defines an equity instrument as any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. Hence, a crypto-asset that conveys such rights would, in substance, be an electronic share certificate and as a result a financial asset.
Even if a crypto-asset gave rise to a variable stream of cash flows, that would not automatically mean that it met the definition of an equity instrument. For example, a crypto-asset that entitles the holder to a share of the gross royalty stream on an intangible asset (e.g., an online game) would not be an equity instrument. Additionally, a constructive obligation on the part of the issuer of a crypto-asset does not give rise to a contractual right to a residual interest that qualifies as an equity instrument for the holder. Finally, although the value of a crypto-asset may be correlated to the popularity of an underlying platform on which it is used, that by itself does not represent a contractual right to a residual interest in the net assets of the underlying platform (i.e., it is not an equity instrument).
A crypto-asset is only an equity instrument under IFRS if it embodies a contractual right to a residual interest in the net assets of a particular entity.
Equity instruments held are initially recorded at fair value, without adjusting for transaction fees, and, subsequently, measured as at fair value through profit or loss under IFRS 9. However, the holder of equity instruments that also meet the definition of equity from the perspective of the issue, but are not held for trading, may make an irrevocable election, on initial recognition, to present subsequent fair value changes in other comprehensive income, without recycling. In such a case, the fair value on initial recognition is adjusted for attributable transaction fees.
2ii Another financial asset
A crypto-asset, that is not an equity instrument (see above) or a derivative (see below) would still meet the definition of a financial asset if it is both contractual and embodies a right to receive cash or another financial asset. For example, a crypto-asset that entitles the holder to a cash payment, or the delivery of bonds or shares would meet the definition of a financial asset. In such cases, the crypto-asset would, in effect, be akin to a digital deposit slip, which exposes the holder to the economic risk on the underlying financial asset as well as counterparty risk.
Such a crypto-asset will be subject to the IFRS 9 classification and measurement requirements. All financial assets are initially recorded at fair value plus attributable transaction costs, apart from those subsequently measured at fair value through profit or loss, in which case, the transaction costs should be expensed as incurred.
Subsequent measurement depends on the cash flow characteristics of the asset and the business model in which it is held. Financial assets, aside from equity instruments (discussed above), which fail the solely payment of principal and interest (SPPI) cash flow characteristics test, as well as those held for trading, are measured at fair value through profit or loss. The business model in which they are held drives the measurement of financial assets that do meet the SPPI test. Those in a ‘held to collect’ business model are measured at amortized cost under IFRS 9. While those in a ‘held to collect and sell’ business model are measured at fair value through other comprehensive income, with subsequent recycling to profit or loss on derecognition. IFRS 9, however, allows a holder to designate a financial asset, despite meeting the SPPI cash flow characteristics test, as at fair value through profit or loss, on initial recognition, if doing so reduces or eliminates an accounting mismatch.
IFRS 9 defines a derivative as a financial instrument or other contract within the scope of IFRS 9 with all three of the following characteristics:
- Its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided that, in the case of a non-financial variable, the variable is not specific to a party to the contract (sometimes called the ‘underlying’)
- It requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors
- It is settled at a future date
Therefore, a derivative can originate from either a financial instrument or another contract, provided that contract is in the scope of IFRS 9. These other contracts are discussed below.
Some contractual rights to buy or sell non-financial items that can be settled net in cash, or for which the non-financial items are readily convertible to cash, are accounted for as if they were financial instruments (i.e., a derivative). This does not apply to ‘own-use1’ contracts, unless these are designated as at fair value through profit or loss on initial recognition in accordance with paragraph 2.5 of IFRS 9. The holder of such a right should consider whether it meets all three of the characteristics of a derivative, discussed above, and, if so, account for that right as a derivative.
A contractual right to buy or sell crypto-assets (e.g., a bitcoin forward entered into with an investment bank) could be a derivative even if the crypto-asset itself is not a financial instrument, provided the crypto-asset is readily convertible to cash or the contract can be settled net in cash. This is similar to the accounting for commodity contracts that are held in a trading business model (e.g., forward oil contracts may fall within the scope of IFRS 9, although oil itself is not a financial instrument).
Derivatives are initially recorded at fair value and subsequently measured at fair value through profit or loss, without any deduction for sale or disposal costs. However, for a derivative designated as a hedging instrument in a cash flow hedge, the fair value movements relating to the effective hedge portion are recorded in other comprehensive income until the hedged item affects profit or loss.
An entity will need to evaluate a contractual right to buy or sell crypto-assets that can be settled net or where the underlying crypto-asset is readily convertible into cash, to determine whether the contract is within the scope of IFRS 9 and, therefore, should be accounted for as a derivative.
However, a gross-settled contract to buy or sell a non-financial crypto-asset, which is not traded in an active market, would not be in the scope of IFRS 9 as the crypto-asset would not be readily convertible into cash.
Although this is often assumed, IAS 2 does not require inventory to be tangible. The standard defines inventory as an asset:
- Held for sale in the ordinary course of business;
- In the process of production for such sale; or
- In the form of materials or supplies to be consumed in the production process or in the rendering of services.
Crypto-assets could be held for sale in the ordinary course of business, for example, by a commodity broker-trader. Whether crypto-assets are held for sale in the ordinary course of business would depend on the specific facts and circumstances of the holder. In practice, crypto-assets are generally not used in the production of inventory and, thus, would not be considered materials and supplies to be consumed in the production process.
IAS 2 does not apply to financial instruments (see above). Thus, where a crypto-asset meets the definition of a financial instrument, it should be accounted for as such under IFRS 9 rather than as inventory under IAS 2.
Normally, IAS 2 requires measurement at the lower of cost and net realisable value. However, commodity broker-traders who acquire and sell crypto-assets principally to generate profit from fluctuations in price or broker-traders’ margin have the choice to measure their crypto-asset inventories at fair value less costs to sell.
Cost or lower net realisable value
The costs of purchased crypto-asset inventories would typically comprise the purchase price, irrecoverable taxes and other costs directly attributable to the acquisition of the inventory (e.g., blockchain processing fees). Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the crypto-asset inventories to their present location and condition. The cost of inventory excludes anticipated selling costs as well as storage expenses (e.g., costs of holding a wallet or other crypto-account), unless storage between production stages is necessary in the production process, which is unlikely to apply to crypto-assets.
Net realisable value is defined in IAS 2 as the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated cost necessary to make the sale.
The cost of crypto-assets recorded as inventory may not be recoverable if those crypto-assets have become wholly or partially obsolete (due to a declining interest in the crypto-asset or its application) or if their selling prices have declined. Similarly, the cost of crypto-asset inventory may not be fully recoverable if the estimated costs to sell them have increased.
An entity holding crypto-asset inventory will need to estimate the net realisable value at each reporting period. Where this is below cost, the inventory should be written down to its net realisable value with the write-down being recorded in profit or loss. A previous write-down of inventory is reversed when circumstances have improved, but the reversal is limited to the amount previously written down so that the carrying amount never exceeds the original cost.
Estimating the selling costs for crypto-assets classified as inventory may present challenges for a holder as these selling costs can fluctuate significantly depending on the current demand for processing on the particular blockchain.
This can be illustrated by reference to the bitcoin blockchain, where the average transaction fee in December 2017 was above US$ 55 compared with an average of just below US$ 2 at the time of writing.
As noted above, commodity broker-traders may also measure their commodity inventories at fair value less costs to sell. Broker-traders are those who buy or sell commodities for others or on their own account. When these commodities are principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin, they can be classified as commodity inventory at fair value less costs to sell.
When a broker-trader measures its inventory at fair value less costs to sell, any changes in the recognized amount should be included in profit or loss for the period [IAS 2 3(b)]. A broker-trader holder of a crypto-asset will need to estimate the costs to sell the crypto-asset at each reporting date, taking into consideration the transaction cost on the relevant blockchain and other fees required in order to convert the crypto-asset into cash. These fees could fluctuate significantly from period to period, depending on the current demand for processing on the relevant blockchain.
A prepayment is an asset recorded where an entity has paid for goods or services before delivery of those goods or services [IAS 38 70]. As prepayments entitle an entity to future goods or services rather than a right to cash, financial assets or a right to trade financial instruments on favorable terms, they are not financial assets. However, where a crypto-asset entitles the holder to buy or sell an underlying asset that is readily convertible to cash, the derivative guidance (see above) could be relevant.
A crypto-asset that entitles the holder to a future good is more akin to an electronic voucher. An entity’s intention, and business model, would be relevant in determining the appropriate accounting for such a ‘voucher’. If the entity does not intend to hold on to the crypto-asset in order to take delivery of the underlying good, accounting for it as a prepayment would generally not be appropriate and the intangible asset guidance (see below) should be considered.
There is very limited guidance in IFRS on accounting for prepayments. In practice, prepayments are often recognised at cost and are subject to impairment testing under IAS 36 Impairment of Assets. Given the limited guidance in IFRS, an entity will need to develop an accounting policy and apply it consistently to similar items and across reporting periods.
If the only feasible way of realising the economic benefits of a crypto-asset is by accepting subsequent delivery of the underlying goods or services, the holder could account for it as a prepayment. However, if the holder could also realise economic benefits by trading the crypto-asset, the holder should evaluate its business model. If an entity intends to trade the crypto-asset, it would generally not be appropriate to account for it as a prepayment.
5 Intangible assets
IAS 38 defines an asset as ‘a resource controlled by an entity as a result of past events; and from which future economic benefits are expected to flow to the entity’. Intangible assets form a sub-section of this group and are further defined as ‘an identifiable non-monetary asset without physical substance’ [IAS 38 8 Definitions].
A monetary asset is either money held or an asset to be received in fixed, or determinable, amounts of money. A crypto-asset that does not meet the definition of cash or a financial instrument would generally be a non-monetary asset.
Definition of intangible asset
The IASB considers that the essential characteristics of intangible assets are that they:
- Are controlled by the entity
- Will give rise to future economic benefits for the entity
- Lack physical substance
- Are identifiable
An item with these characteristics is classified as an intangible asset regardless of the reason why an entity holds that asset [IAS 38 BC5].
Control – Control is the power to obtain the future economic benefits of an item while restricting the access of others to those benefits. Control is normally evidenced by legal rights, but IAS 38 is clear that they are not required where the entity is able to control access to the economic benefits in another way. IAS 38 notes that, in the absence of legal rights, the existence of exchange transactions for similar non-contractual items can provide evidence that the entity is nonetheless able to control the future economic benefits expected [IAS 38 16].
Future economic benefits – Many crypto-assets do not provide a contractual right to economic benefits. Instead, economic benefits are likely to result from a future sale, to a willing buyer, or by exchanging the crypto-asset for goods or services.
Lacks physical substance – As crypto-assets are digital representations, they are by nature without physical substance.
Identifiable – In order to be identifiable, an intangible asset needs to be separable (capable of being sold or transferred separately from the holder) or result from contractual or other legal rights. As most crypto-assets can be freely transferred to a willing buyer, they would generally be considered separable. Similarly, crypto-assets that result from contractual rights would generally be considered separable.
Crypto-assets generally meet the relatively wide definition of an intangible asset, as they are identifiable, lack physical substance, are controlled by the holder and give rise to future economic benefits for the holder.
An intangible asset is only recognized if it is probable that future economic benefits will flow to the entity and its cost can be measured reliably. Separately acquired intangible assets will normally be recognized as IAS 38 assumes that the acquisition price reflects the expectation of future economic benefits. Thus, an entity always expects future economic benefits, for these intangibles, even if there is uncertainty about the timing or amount.
Intangible assets are initially measured at cost. The cost of acquiring crypto-assets would typically include the purchase price (after deducting trade discounts and rebates, if any) and the related transaction costs, which could include blockchain processing fees. Where an intangible asset is acquired in exchange for another non-monetary asset, the cost is measured at fair value, unless the transaction lacks commercial substance or the fair value of neither the asset acquired nor the asset given up can be measured reliably. In such instances, the cost of the intangible asset is measured as the carrying amount of the asset given up.
Subsequent measurement requirements
There are two subsequent measurement approaches under IAS 38 that can be applied as an accounting policy choice to each class of intangible asset, namely:
- Cost model
- Revaluation model (subject to criteria as discussed below)
An entity that holds different types of crypto-assets would need to assess whether they constitute different classes of intangible assets as the rights and underlying economics of different crypto-assets vary widely.
– Cost model
Useful life and amortization
Many crypto-assets such as bitcoins do not have an expiry date, and there appears to be no foreseeable limit to the period over which they could be exchanged with a willing counterparty for cash or other goods or services.
A holder will, therefore, need to consider if there is a foreseeable limit to the period over which such a crypto-asset is expected to generate net cash inflows for the entity. If there is no foreseeable limit, such a crypto-asset could be considered to have an indefinite2 useful life and, as a result, no amortization is required. However, indefinite useful life intangible assets need to be tested for impairment at least annually and whenever there is an indication of impairment.
Where there is a foreseeable limit to the period over which a crypto-asset is expected to generate net cash inflows for the holder, a useful life should be estimated and the cost of the crypto-asset, less any residual value, should be amortized on a systematic basis over this useful life. In addition, such a crypto-asset is also subject to IAS 36 impairment testing whenever there is an indication of impairment.
Impairment and impairment reversal
When impairment testing determines that an intangible asset is impaired, the holder is required to write down the carrying amount of the intangible asset to its recoverable amount and to record the write-down in profit or loss for the period.
In later periods, the holder would need to evaluate whether there is an indication that an impairment loss may no longer exist (or that the loss may have decreased) and if so, determine the recoverable amount. IAS 36 allows the holder to record an impairment reversal provided the updated carrying amount does not exceed the asset’s original cost less the amortization that would have been recorded had no previous impairment been recognized.
– Revaluation model
An entity can only apply the revaluation model if the fair value can be determined by reference to an active market, which is defined by IFRS 13 Fair Value Measurement as ‘a market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis’.
There are no provisions in IAS 38 that allow for the fair value of an intangible asset to be determined indirectly [IAS 38 75 and IAS 38 81 – 82], for example, by using valuation techniques and financial models such as those applied to estimate the fair value of intangible assets acquired in a business combination. Consequently, if no observable price in an active market for an identical asset exists (i.e., a Level 1 price under IFRS 13), the holder will need to apply the cost method to crypto-assets held.
In assessing whether an active market exists for a crypto-asset, the holder will need to consider whether there is economic substance to the observable transactions, as many trades on crypto-exchanges are non-cash transactions in which one crypto-asset is exchanged for another and the holder may find it difficult to convert the crypto-asset into cash.
Under the revaluation model, intangible assets are measured at their fair value on the date of revaluation less any subsequent amortization and impairment losses.
The net increase in fair value over the initial cost of the intangible asset is recorded in the revaluation reserve via other comprehensive income. A net decrease below cost is recorded in profit or loss. The cumulative revaluation reserve may be transferred directly to retained earnings upon derecognition, and possibly by transferring the additional amortization on the revalued amount to retained earnings as the asset is used, but IAS 38 does not allow the revaluation reserve to be transferred via profit or loss.
6 Undefined self-developed classification
IAS 8 requires that when an IFRS specifically applies to a transaction, other event or condition, the accounting policy applied to that item should be determined by applying that IFRS and considering any relevant implementation guidance issued by the IASB [IAS 8 7]. For example, if a crypto-asset has been appropriately assessed to be an intangible asset subject to IAS 38, the holder is required to apply IAS 38 in accounting for that crypto-asset. In such cases, it would generally not be appropriate to analogize to another standard such as IAS 40 or the financial instruments literature under IFRS 9.
However, in the absence of a standard that specifically applies to a transaction, event or condition, the accounting hierarchy in IAS 8 allows an entity to use its judgment in developing an accounting policy that results in information that is:
- Relevant to the economic decision-making needs of users
- Reliable, in that the financial statements:
In making this judgment, management is required to consider the following sources in descending order:
The requirements and guidance in IFRS dealing with similar and related issues
Management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources above [IAS 8 12].
Where no other standard applies and an entity develops its own accounting policy for a crypto-asset held under the IAS 8 hierarchy, the entity needs to consider if the guidance in IFRS dealing with similar and related issues and the relevant definitions and recognition criteria in the Conceptual Framework would preclude it from being recognized as an asset. In that case, the cost incurred in obtaining the crypto-asset should be expensed as incurred.