Accounting for cryptocurrency under IFRS and US GAAP

Cryptocurrencies continue to generate a significant amount of interest from both private investors and large corporations due to their rapid increase in value and expanded institutional adoption. As activity in cryptographic assets increases, it has attracted regulatory scrutiny across multiple jurisdictions. And the appearance of such assets in company’s financial statements requires financial services to carefully analyze, develop accounting methods and present them in reporting.

In this article, we discuss special aspects of accounting for cryptocurrencies, such as Bitcoin, in reporting under IFRS and US GAAP. To understand the specifics of cryptocurrencies in relation to accounting, it is useful to know a few basic definitions, which we provide below.

Fiat is a form of money that is issued by the government and declared as legal tender (e.g. US dollar, euro).

Cryptoassets is the asset with all the following characteristics [Holdings of cryptocurrencies (ifrs.org)]:

a)       digital or virtual currency recorded on a distributed ledger that uses cryptography for security.

b)      not issued by a jurisdictional authority or other party.

c)       does not give rise to a contract between the holder and another party.

A cryptographic asset is a fairly broad concept; it can be issued for various purposes and, depending on this, have different inherent value for the holder (investor). For example, there are:

• Cryptocurrencies - designed to function as a medium of exchange. They have no intrinsic value; they are valuable as a means of payment. This is a kind of analogue of fiat money, and we will discuss its accounting further in the article.
• Asset-backed tokens – – cryptographic analogues of traditional “physical” assets, they are backed by real-life liquid assets. These can be goods and services (for example, oil or gold).
• Utility tokens – provide the holder with access to a software service or blockchain platform service. They do not promise any benefits or give ownership rights to property or other assets of the company.
• Security tokens - represent a certain share of ownership of a financial instrument or part of a company (right to shares, dividends, share of profits, etc.). Such tokens are traded on exchanges, their turnover occurs in accordance with the legal norms of financial regulators in various countries.

The above classification is a starting point for analyzing the essence of cryptographic assets, but is not closed. Many cryptographic assets have hybrid features. Depending on the specific features of the cryptographic asset, the inherent value and targets of its holder, IFRS accounting may be regulated by various standards, such as IFRS 9 Financial Instruments, IAS 2 Inventories, IAS 38 Intangible assets" and others.

In this article, we consider the accounting of cryptocurrency used as a medium of exchange or investment, for example, Bitcoins, by the company holding these assets (trading cryptocurrency is not the main activity of the company).

If we express the key features of cryptographic assets in another words, their main features are:

1. records of cryptocurrency is provided by a decentralized payment system that operates automatically;
2. cryptocurrency does not have an issuer that would guarantee the reliability of its issue and further circulation,
3. in fact, cryptocurrency is impersonal: it is impossible to determine who is the owner of the cryptocurrency, since this system assumes complete anonymity.

As we told above, the main purpose of cryptocurrency is as a medium of exchange. Therefore, it would be logical to assume that the accounting and presentation of cryptocurrency should be similar to cash. IFRS does not clearly define the terms “cash” or “currency”. The definition of currency is found in IAS 32 “Financial Instruments: Presentation”, which states that it is a financial asset that represents a medium of exchange and is therefore the basis on which all transactions are measured and recognised in financial statements[2].

However, cryptocurrencies do not share some common features of cash and currency, in particular:

• cryptocurrencies are not legal tender and in most cases are not issued or supported by any government or state;
• and cryptocurrencies are currently unable to set prices for goods and services directly. Cryptocurrencies may be accepted to settle some transactions, but they are not directly involved in setting prices for goods or services in the economy. Therefore, cryptocurrencies cannot be the basis (metric) for measurement of transactions in financial statements.

Due to these features, cryptocurrencies cannot be treated as part of the company’s cash, and the question arises of how to classify them in the financial statements.

The next logical assumption is to treat cryptocurrency as a financial asset accounted for in accordance with IFRS 9 “Financial Instruments”. However, ownership of cryptocurrency does not generally give the holder a contractual right to receive cash or another financial asset, and cryptocurrency does not arise from a contractual relationship. By this criterion, a cryptocurrency does not meet the definition of a financial instrument under IAS 32[3]. Therefore, the provisions of IFRS 9 are also not applicable for accounting for cryptocurrency.

The applicable accounting standard for cryptocurrency at the moment is IAS 38 “Intangible Assets”.

According to IAS 38, an intangible asset is a resource:

• controlled by the entity (that is, the entity has the right to obtain the economic benefits that the asset will generate and to limit the access of third parties to those benefits) as a result of past events and from which future economic benefits are expected to flow to the entity[4];
• it is identifiable because it can be sold, exchanged or transferred individually[5];
• it is a non-monetary asset that has no physical form[6].

IAS 38 provides two models of accounting for intangible assets:

1. Аt cost. In this model, after initial recognition, the intangible asset must be carried at cost less accumulated amortization and impairment losses[7].
2. At revalued amount. After initial recognition, an the intangible asset shall be carried at a revalued amount, being its fair value at the date of the revaluation less any accumulated amortization[8] and accumulated impairment losses. Fair value shall be measured by reference to an active market[9].

[2] para AG3 IAS 32

[3] para 11 IAS 32

[4] para 13 IAS 38

[5] para 12(a) IAS 38

[6] para 8 IAS 38

[7] para 74 IAS 38

[8] based on the nature of cryptocurrencies, they are intangible assets with an indefinite useful life in accordance with para 88 of IAS 38 and, accordingly, are not depreciated

[9] para 75 IAS 38

The model of accounting for intangible assets is the choice of the company and is stated in its accounting policy.

If revaluation model is used:

• If an intangible asset’s carrying amount is increased as a result of a revaluation, the increase shall be recognised in other comprehensive income and accumulated in equity under the heading of revaluation surplus. However, the increase shall be recognised in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognised in profit or loss[10].
• If an intangible asset’s carrying amount is decreased as a result of a revaluation, the decrease shall be recognised in profit or loss. However, the decrease shall be recognised in other comprehensive income to the extent of any credit balance in the revaluation surplus in respect of that asset. The decrease recognised in other comprehensive income reduces the amount accumulated in equity under the heading of revaluation surplus[11].

[10] para 85 IAS 38

[11] para 86 IAS 38

Briefly comparing the two possible accounting models, both have their deficiencies. From the investor’s point of view, cryptocurrency is a liquid investment, the change in value of which directly affects the financial results of the company. However, based on current accounting provisions, the financial statements will reflect:

· under the cost model: an increase in fair value on the balance sheet and profit from an increase in cryptocurrency quotes will not be recorded. The decrease in value and loss from the fall of the cryptocurrency will be shown.

·         under the revaluation model the situation is slightly better: an increase in the value of the cryptoasset will be reflected in the balance sheet, but such an increase will not affect the profit for the period and will be recorded in other comprehensive income and equity. So the investor will not directly see this profit in the financial statements. But the decrease in value will be shown as a loss.

Unfortunately, this issue has not yet been resolved in IFRS; after the publication of the IFRS Interpretations Committee Decision in 2019[Holdings of cryptocurrencies (ifrs.org)], no changes to the standards were made.

In US GAAP, the situation on accounting for cryptocurrency at the time of its emergence could be said to be even worse. If we shorten the sequence of interpretations of the scope of which standard cryptocurrency falls under, then we can say that the logic roughly corresponds to IFRS and it falls in the scope of ASC 350 Intangible assets - Goodwill and others.

The standard provides for mandatory periodic revaluation of all intangible assets, but as a result, the value of intangible assets can only be reduced (there is an analogy with the cost model in IFRS). But, unlike IFRS, a previously recognized decrease in value cannot be reversed in subsequent periods.

Thus, according to the current US GAAP rules, the market value of cryptocurrency could diverge greatly from that reflected in the financial statements and not provide the real state of affairs in the company.

As an example, we can analyze financial statements of Tesla Inc. for 2022[10-K (sec.gov)]. In it, bitcoins are presented on the balance sheet as a separate type of assets “Digital assets” as part of non-current assets. The statement of cash flows shows purchases and sales of crypto assets as part of investing activities. Losses from the impairment of bitcoins and profits from their conversion are included in other expenses. The disclosures indicate that digital assets are considered indefinite-lived intangible assets under applicable accounting rules. It is management's view that, as with any investment and consistent with how the company manages fiat-based cash and cash-equivalent accounts, it may increase or decrease the holdings of digital assets at any time based on the needs of the business and its view of market and environmental conditions. And, in addition, the company discloses that in 2022, losses were recorded from the impairment of bitcoins, however, when converting part of the cryptocurrency, the company made a profit.

Another example of a very large cryptocurrency holder is Microstrategy Inc. The company invested $250 million in Bitcoin in 2020, explaining this by lower cash yields, a weaker dollar and other global macroeconomic factors. In subsequent years, it continued to make large purchases and partial sales of them. Bitcoin trading is not the company's main activity. But if you look at its balance sheet at the end of 2022[Microstrategy Inc (MSTR) 10K Annual Reports & 10Q SEC Filings (last10k.com)], more than 75 percent ($1.8 billion) of its assets are bitcoins, and its biggest loss is also impairment on them. The accounting rules under current US GAAP requirements are the same as for Tesla, i.e. digital assets are recognized as non-current assets and are revalued only if their value decreases. Given the materiality of cryptocurrency to a company's financial statements, more detailed disclosures are provided, but the accounting rules remain the same.

However, FASB has been working to develop new cryptocurrency accounting rules since 2022. As of September 2023, the final version of the update to the standard on accounting for intangible assets is being prepared, to which a chapter on accounting and disclosure of information about cryptographic assets will be added[Accounting for and Disclosure of Crypto Assets (formerly known as Accounting for and Disclosure of Digital Assets) (fasb.org)].

Under the proposed update to the standard, cryptocurrencies will be measured at fair value, with changes in value recognized in net income in each reporting period. The new rules are expected to become effective for reporting periods beginning on December 15, 2024, with early adoption permitted.

So we expect that US GAAP will soon make cryptocurrency accounting and disclosures transparent and it will provide more useful information for investors. The practice of using US GAAP rules in IFRS, in the absence of sufficient guidance in them, is quite common. Therefore, it can also be expected that US GAAP cryptocurrency accounting methods will have an impact on companies reporting under IFRS.