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Journal number 1 ∘ Nino Lomidze
Accounting for Cryptocurrencies in Compliance with International Financial Reporting Standards (IFRS): Challenges and Prospects

Increased corporate interests in holding cryptocurrencies have put forward a discussion on their accounting and presentation in financial statements in compliance with IFRS.  In June 2019, IFRS Interpretations Committee (IFRS IC) published its agenda decision, which represents the official position of the International Accounting Standard Board (IASB) with regard to accounting for cryptocurrency holdings. IFRS IC concluded that a cryptocurrency should not be considered as cash or another type of financial asset. Cryptocurrencies meet the definition of intangible assets and inventory. Therefore, they should be accounted for under IAS 38 unless they are held for sale in the ordinary course of business, in which case, IAS 2 would apply.

The article analyzes the existing regulatory framework for accounting cryptocurrencies in terms of providing useful information for users of financial statements. It provides ground and sets a stage for critical reasoning and discussion of contradictory views regarding the fact that the given standards (IAS 38, IAS 2), which were developed a long time ago for the assets with completely different content, do not provide fair accounting and measurement of a new economic phenomenon – cryptocurrency, which was created  on a technological basis. Even though a cryptocurrency is not considered as a financial instrument, it is often an integral part of a present-day enterprise investment portfolio. Additionally, more and more companies are agreeing to accept cryptocurrencies as alternative means of payment.

The paper emphasizes the fact that accounting for cryptocurrencies should be based on the actual business model and economic content of their holdings, which will provide users of a financial statement with high-quality and useful information in this regard.

Keywords: Cryptocurrency, digital currency accounting, IFRS IC, intangible asset, commodity broker trader, financial instrument, cash, faithful representation, fair value measurement, accounting policy.

JEL Codes: G23, M40, M48





Introduction

 

In 1976, the Nobel laureate Friedrich August von Hayek (F.A. Hayek, 1899-1992), an Austrian economist and philosopher, published a book entitled “Denationalization of Money”. The main ideology of the paper was that the author viewed money in the context of commercial goods, the creation of which was to be carried out by individuals in a competitive market environment. Hayek believed that the price level stability can be achieved only by removing from national governments their monopoly of money creation and allowing private entities to issue currencies with their own  trademarks (Gvasalia 2014.1). The emergence of cryptocurrencies is a manifestation of the Nobel Laureate's views and the vision of the Austrian School of Economics in general. It is known that throughout the twentieth century, libertarians fought against the monopoly of central banks in the issue of money emission and supportedthe transition to private money (Chikobava, Kakulia 2018. 2).

And, that time has come. The rapid growth of internet users and the development of digital technologies have greatly contributed to the creation of thousands of virtual currencies*, of which Bitcoin (BTC) takes the leading position.  The invention of Bitcoin was publicly announced in late 2008 by Satoshi Nakamoto, an anonymous person (possibly a group) whose identity is still unknown. Since 2009, a decentralized, peer-to-peer (P2P) Bitcoin network has been launched based on blockchain technology**, which has no central administrator and, the network participants are able to conduct financial transactions directly with each other, without any third party, so-called trusted intermediaries. Furthermore,   payments between the network participants are made only in Bitcoin, the value of which is not tied to any asset or official currency, but is determined on the basis of demand-supply in the free market (Chkoidze, Tomaradze 2014. 4).

Bitcoin is the main, but not the only cryptocurrency for which corporate interest is growing more and more. Recently, the American investment banks and hedge funds have become interested in virtual currencies, which may serve to hedge the inflationary risks posed by printing large quantities of US dollars by the US government in order to manage the COVID  Pandemic. Bitcoin is represented on the balance sheets of such corporations as MicroStrategy, Tesla, Galaxy Digital Holdings, Voyager Digital LTD., Square Inc, etc.  (https://www.buybitcoinworldwide.com/treasuries/#public).

The enhanced interest of companies in cryptocurrencies and the growing number of transactions implemented in the digital currencies has put on the agenda the issue of their recording and presenting in the financial statement in accordance with the International Financial Reporting Standards (IFRS). After several years of discussions and debates, in June 2019 the IFRS IC finalized its agenda decision and published the document, “Holdings of Cryptocurrencies”.  

The purpose of this paper is to analyze the official regulatory framework for cryptocurrency accounting, to assess the correctness and appropriateness of the current models of classification and presentation of the digital currencies in the financial statements. Based on reviewing different types of sources, develop a viewpoint for the challenges associated with the preparation of reliable financial statements and therefore providing useful information for decision-makers.   

 

Current Regulatory Framework for Cryptocurrency Accounting

 

A conceptual framework defines an asset as an economic resource controlled by the entity as a result of a past event from which future economic benefits are expected to flow to the entity.  Cryptocurrency meets this definition, but it is not a traditional asset. Cryptocurrency is a completely new economic phenomenon that is actually designed for functioning as an alternative means of payment (Nakamoto, 2008.1). However, it is not issued and supported by central institutions, which in turn complicates and makes questionable the issue related to proper classification, accounting and measurement of cryptocurrency.

Until June 2019, there was no single regulatory framework for accounting the digital currency in accordance with IFRS. Therefore, cryptocurrency holding companies had to develop their own accounting policies. The topic of digital currencies was identified as a potentially new project for the IASB in 2015 through the Board’s working plan consultation process. The Board decided not to act immediately but to continue to monitor developments. In December 2016, the Accounting Standards Advisory Forum (ASAF) presented for discussions an extensive document prepared by the Australian Accounting Standards Board (AASB) that actually laid the foundation for working in this direction. The paper discusses the possible classification of digital currencies in different types of assets; there is analyzed the relevant standards, and highlighted some of the inconsistencies and “Gaps”, which in the opinion of the authors, were manifested in the existing IFRS in relation to digital currencies (we will return to the issue in the next chapter).

In July 2018, the IASB addressed the IFRS Interpretations Committee to discuss and present its view on the issue of accounting of cryptocurrencies in accordance with IFRS from the position of a cryptocurrency holder. In November 2018, the Board reviewed the technical analysis prepared by the IFRSIC, agreed with the presented vision and asked the Committee to consider publishing an agenda decision on how entities apply existing IFRS standards in holdings of cryptocurrencies

In March 2019, the Interpretations Committee issued its tentative agenda decision for public discussion, to which comments were made and views (both for and against) were presented by regulators around the world, leading auditing and consulting companies, major international corporations, and crypto developers. 

In June 2019, the Committee published a final decision – the document entitled "Holding of Cryptocurrencies". The scope of this decision applies to cryptocurrencies that meet the following characteristics:

  1. A digital or virtual currency recorded on a distributive ledger that uses cryptography for security;

  2. Not issued by a jurisdictional authority or other party; 

  3. Does not give rise to a contract between its holder and any another party. 

According to the decision made by the Committee, the holdings of cryptocurrency should not be considered as the possession of cash or another type of financial asset, since digital currency does not meet the definitions of such assets. In particular, according to the Standard, a financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity (IAS 32. p.11). Possession of cryptocurrencies (whatever form a company may take it) is not implemented on a contractual basis. Therefore, it is not a financial asset. As for the monetary classification of the digital currencies, IFRSIC notes: Cash (Currency) is a financial asset because it represents the medium of exchange, monetary unit in pricing goods or services and the basis on which all transactions are measured and recognized in financial statements (IAS 32 AG.3). According to the explanations made by the IFRSIC, some virtual currencies may be used to purchase specific goods or services, but not to the extent that they are considered as widely used means of exchange and as a unit of  accounting for generalization of operations in the financial statements. 

By the  IFRSIC agenda decision, it is advisable to use IAS 38 – “Intangible Assets” or IAS 2 “Inventories” for accounting for the holdings of cryptocurrencies.  The document clarifies that if an enterprise owns digital currencies for the purpose of their subsequent sale in the ordinary course of business, such the asset should be classified as an inventory and placed within the scope of IAS 2. The Committee also observed that an entity may act as a broker-trader of cryptocurrencies. In this case, the company considers the requirements in paragraph 3(b) of IAS 2 for commodity broker-traders, who measure their inventories at fair value less costs to sale.  According to IAS 2. p.5, broker-traders are those who buy or sell commodities for others or their own account. The inventories referred to in paragraph 3(b) are principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin.     

According to IFRSIC, if  cryptocurrency is not considered in the category of inventories, then it is an intangible asset insofar as it meets its definition. The Committee observed digital currency to be an identifiable, non-monetary asset without physical form. Identifiability is indicated by the fact that it is possible to separate, sell, transfer or exchange cryptocurrency from an enterprise. In the part of measuring as a non-monetary asset, an emphasis is made on the content of IAS 21. p.16, which states that the essential feature of monetary items is the right to receive a fixed or determinable amount of money (or the obligation to deliver) that digital currencies do not have. Here some examples of non-monetary assets, including intangible assets are provided. Thus, by the decision of the Committee the cryptocurrencies are better to account in accordance with IAS 38, which provides two models of measurement of the intangible assets: (1) Cost Model, according to which cryptocurrency should be measured in the balance sheet at cost less accumulated amortization and accumulated impairment loss. It is noteworthy that a digital currency is an asset with an indefinite useful life, to which no amortization is accrued, although for which an annual impairment test is required (IAS 36, p. 10. a). Impairment loss should be recognized immediately in the profit or loss. If an indicator of reversal of currency impairment (price increase) is detected, the loss recognized in previous years should be offset, albeit at the amount of the carrying amount that would have been obtained if no impairment loss had been recorded in the previous year. (2) Revaluation model can only be used for cryptocurrencies for wich an active market exists. Under this model, a difference caused by fair value increases is recognized in other comprehensive income and accumulated in the equity as revaluation surplus (reserve).  In case of impairment of the asset, the credit balance on the revaluation reserve should be reduced first and only the difference should be written off the profit or loss. Compensation for impairment loss is recognized in the profit or loss statement in the income statement, while the residual revaluation reserve increases with the remaining amount (if any) along with other comprehensive income. 

The decision of IFRSIC taken 4 years later of the release of this issue, is the official position of the IASB regarding the accounting for cryptocurrencies.



Challenges Associated with the Presentation of High-Quality Financial Statements

 

The main essence of preparing high-quality financial statements is to make financial information useful to decision-makers. Information is useful if it presents the content of the economic event fairly and, is not limited to providing information only about the legal form of the transaction. Faithful representation varies with reporting entities and depends on their actual business model along with the economic reality of the underlying transaction.  Mining*** of cryptocurrencies shall, therefore, follow different accounting principles other than receiving payments in cryptocurrencies or investing in cryptocurrencies (Prochazka, 2018. 5/164).

It will not be easy to characterize the cryptocurrencies-related business model, in which case the use of IAS 38 would be adequate. The fact that digital currency meets the definition of an intangible asset is not a sufficient precondition for accounting cryptocurrencies within the scope of IAS 38. The standard was established in 1998 for those intangible assets owned by an entity for long-term operational use. Cryptocurrency is an absolutely new economic phenomenon “born” as a result of technological achievements, which is often a part of the investment portfolio for traditional companies. Thus, we are dealing with investments made in intangible assets that cannot be covered by IAS 38 and therefore cannot provide useful information for users of financial statements. Just on the existence of this “gap” points out an extensive document of the AASB  published in 2016:  “Digital currency - A Case for standard setting activity”. In this paper, the most adequate measurement model for cryptocurrencies is considered to be the fair value model, reflecting the change in profit or loss, rather than the revaluation model proposed by  IAS 38, which reflects the change in other comprehensive income. In this regard, an interesting parallel is made between the different approaches to measuring long-term tangible assets under IAS 40 and IAS 16 (FVTPL vs FVTOCI)****.  The authors believe that it does not matter whether the asset is tangible or not. If the purpose of their holding is similar, the accounting approach should be the same.

How adequate is the use of IAS 2 for cryptocurrencies? In this regard, it seems to be advisable to consider the standard approach on the one hand, from the position of an ordinary enterprise that estimates inventory at its lowest price in the financial statements, between cost and net realizable value, and on the other hand, from the commodity broker-trader’s perspective, measures inventory using a fair value method less cost to sale and recognize the difference in profit and loss  (IAS 2. p.3b). The most adequate model in terms of submitting highly reliable  financial statements and providing useful information to users is the method offered as an exception to commodity brokers for measuring the inventory. However, there is a kind of inconsistency in this regard as well. In particular, cryptocurrency represents the asset without physical form, so, its identification as a “commodity” is to some extent incompatible (IFRS Viewpoint 9, 2018.9). Nonetheless,  International Financial Reporting Standards do not provide a specific definition of “commodity” and there is no factual limitation for inclusion of digital assets in this category - the commodity which is traded on the world financial markets, mainly represented by physical assets   (https://www.businessinsider.com/what-are-commodities).

It is not advisable to use IAS 2 in relation to cryptocurrencies beyond the commodity brokers. The standard is designed for a “classic” type of inventory, which is intended for sale and is not based on any type of investment interest. Assessment of cryptocurrency at the lowest cost fails to provide a fair reflection of a contextual meaning of this type of asset and gives misleading information to the users. Given this, it is unclear to us, apart from commodity brokers, what category of enterprises the Committee was referring to when it determined that their inventories should be measured by “standard” on a lower cost and net realizable value. It should be emphasized that this particular issue is not widely reviewed and discussed either in the working meetings of official bodies or in the reports of leading audit companies.

Thus, the use of IAS 38 and IAS 2 (except in the case of a commodity broker) for accounting and measuring the assets that are highly volatile and serve for the short or long-term investment interests, is not appropriate.  An interesting opinion is expressed in the AASB study regarding IAS 25*****,  which the authors consider an all-inclusive standard that addressed the accounting for investments. IAS 25 defined an investment as an asset held by an enterprise for the accretion of wealth through distribution (such as interest, dividends and rentals), for capital appreciation or other benefits to the investing enterprise such as those obtained through trading relationships. However, IAS 25 was superseded as a result of issuing IAS 39 – “Financial Instruments: Recognition and Measurement”,  and IAS 40 – “Investment Property” and consequently, left a “gap” that would have addressed the accounting for investments in intangible assets and commodity held for investment purposes. 

According to the decision of IFRSIC,  cryptocurrency is not cash/currency, neither any other type of financial asset because it does not meet the definition of the relevant standard (IAS 32.11). In parallel with this assessment, the digital currencies clearly show their economic essence and appear as an investment tool on the one hand,  and as an alternative means of payment on the other hand, which more and more companies agree to accept (https://99bitcoins.com/bitcoin/who-accepts/).

Even though digital currency does not meet the definition of a financial instrument, its possession (“purchase and hold”) for investment purposes is substantially comparable to trading in a financial instrument. From this point of view, it is relevant to consider the measurement models proposed in IFRS 9. From applicable models, amortized cost cannot be employed, as cryptocurrencies do not have any maturity date. Only FVTPL or FVTOCI models can be applied and shall be
applied as a relevant source of useful information for the users of financial
statements (Prochazka, 2018. 8/167).  In particular, if a company invests  in digital currencies to sell them in the short term, it is advisable to use a fair value model that reflects the change in profit or loss. As for the long-term investment perspective, the fair value model reflects the change in other comprehensive income. It is true that digital currency does not provide the generation of contractual cash flows, but the logic of this particular author's reasoning can be explained by assessing the company’s model of cryptocurrency holdings management.  Namely, if the company has a speculative / trading interest in virtual currencies, then it would be reasonable that the change in fair value should affect the current period's profit or loss. And, if the company owns cryptocurrency for the purpose of increasing the value of its capital in the long run, then it is better not to include the current price change in the calculation of profit or loss.

The use of the fair value models is associated with certain risks and difficulties. On the one hand, due to the high volatility of the digital currencies, the financial condition and results of a company can suddenly change significantly, as a result, the information provided to users can no longer be useful to make the right conclusions. To avoid such risks, it is necessary to discuss widely in the explanatory notes and consider all possible scenarios that could have a material impact on the Company's financial position.

On the other hand, the measurement of fair value of cryptocurrencies is a challenge.  The crypto-industry is in its developing stage and some digital currencies are relatively less actively traded and have fewer usage cases. The mere existence of a market or exchange is  not sufficient to meet the definition of an active market. An assessment is needed to evaluate whether the frequency and volume of transactions of that market are sufficient to provide pricing information on an ongoing basis for a specific cryptocurrency. (Deloitte, 2018. 14).

The more companies are involved in the crypto-industry and agree to accept digital currency as an alternative means of payment, the more relevant it becomes to discuss the definition of “Money” on the one hand, and the regulator's decision that cryptocurrency is not cash on the other hand. In this regard, an interesting opinion was expressed by the  Securities and Exchange Commission of Brazil (CVM******), which noted that in their view, the IAS 32. AG.3 definition relates not to cash in general, but to the concept of a functional currency, since it is focusing on the use of currency as a means of set prices for the goods and services on one hand, and as an instrument of generalization of transactions in the financial statements, on the other hand.  In addition, the functional (working) currency is the currency of the primary economic environment in which the entity operates (IAS 21.p.8). Based on this reasoning, the CVM considers it appropriate to consider cryptocurrency as a foreign currency, which according to the definition of the Standard is a currency other than the functional currency of the entity.  (IAS 21.p.8). This approach is shared by other respondents and they believe that the definition of money provided in the existing IFRS is quite limiting and may need to be updated (EFRAG DP, 2020. 57).

Another and we think the most important issue that makes it problematic to recognize cryptocurrency as cash is the status of the so-called “Legal Tender”. Granting this status is considered in the legal context. The jurisdiction/state itself decides what is the legal means of payment in its territory, in other words, what is the money that the supplier of goods and services cannot refuse to accept. Thus, a company may accept digital currency as an alternative means of payment, but this does not automatically give the currency the status of a “Legal Tender” (EY, 2021.10).

El Salvador is the only country in the world that, since September 2021, has recognized bitcoin as a legal tender along with the US dollar. This means the following: Any company (including international brands) operating in the territory of El Salvador is obliged to accept bitcoin as the official currency. This is a clearly challenging issue for regulators, including the International Accounting Standards Board. "If the scale of bitcoin transactions has grown so much that people have started buying coffee in cryptocurrency, then obviously we will have to reconsider the definition of “Cash” and make adequate changes” - said the IASB representative on the webinary (https://www.youtube.com/watch?v=4i0s5Y9sjKQ&t=3552s) organized by European Financial Reporting Advisory Group (EFRAG).

 

Conclusion

 

In reviewing the preliminary version of the IFRSIC agenda decision, a number of national standard-setting organizations (Japan, Korea, Canada, Italy) and professional associations have taken a critical stance on the proposed model of cryptocurrency accounting. Criticism was shared by members of the Board and the Interpretation Committee themselves, who supported the idea of developing ​​a new standard by the Board or making amendments in the existing standards. Nevertheless, the final decision has not been changed. The impression remains that such a decision was motivated more by the IASB’s need to  defend its dominant position in the regulatory rather than appropriately respond to its constituents expectations (Ramassa,  Leoni, 2021.21)  

The existing regulatory framework of accounting for cryptocurrencies fails to ensure presentation of high-quality financial statements and the provision of useful information to the users. There are several reasons for making such an assessment:

  • The decision made by IFRSIC does not cover all possible models of holdings of cryptocurrencies. The document says nothing on how to record the digital currency received as a result of the sale of goods and services, which is an alternative means of payment for a number of companies.

  • The classification of cryptocurrencies is developed only with compatibility at the definition level. The fact that a digital currency meets the definition of an intangible asset should not be a sufficient condition for its consideration within the scopes of  IAS 38. The standard, created in 1998 for intangible assets that an enterprise owns for long-term operational use,  fails to provide relevant accounting for the digital currency, a new technology-driven economic phenomenon held by companies primarily for investment purposes. As a matter of fact, we are dealing with investments in intangible assets, which cannot be covered by IAS 38.

  • We also consider it unreasonable to use IAS 2 towards cryptocurrencies, in particular – for measuring the inventory with the lowest cost or net realizable value model. As for the case of a commodity broker-trader who estimates inventory at fair value less costs to sell - we think this is the most logical and substantively justified method in terms of providing useful information to users. However, even in this case, we are dealing with an investment in a "commodity", which is not within the scope of IAS 2.

 Even though under the existing regulatory framework, cryptocurrency is considered neither cash nor any other type of financial asset, it clearly presents its economic essence and appears as an investment instrument on the one hand, and as an alternative means of payment on the other hand. Measurement of the digital currency in the financial statements should be based upon the actual business model of holding the said assets. If we consider the issue from the position of an investor, we can consider an interesting analogy the fair value models offered by IFRS  9 (FVTPL, FVTOCI) considering that the asset is for short-term trading (FVTPL) or  the entity decides to keep it for a long term as a store of value. (FVTOCI).

A real factor creating barriers to classification cryptocurrency as “cash”- is its current status. As long as cryptocurrencies are not issued by central institutions, they do not represent an official means of payment. The Republic of El Salvador is by far the sole state in the world that has given bitcoin the  “Legal Tender” status recognized it as the official currency along with the US Dollar. This phenomenon is noteworthy for standard-setting and regulatory bodies, but their future actions in revising the definition of “cash” depend on the frequency and volume of use of digital currency as a means of payment. As for the consideration of cryptocurrency in the context of “foreign currency”, we think this issue too is directly related to the scale of operational transactions in digital currencies.

While interest in the crypto-industry is growing and it is not limited to cryptocurrencies only,   the position of the IASB  - not to support the commencement of works for drafting a new standard, is understandable to us.  However,  in view of the above findings, we think it would be more appropriate not to publish the IFRSIC agenda decision and let companies deal with cryptocurrency transactions by their own accounting policy elaborated in accordance with IAS 8. P.10.    

Such an approach would ensure the accumulation of more knowledge and experience, a deeper understanding of the issue and further development of a regulatory framework on the basis of which the prepared information would be useful to the users of financial statements. 

 

References:

  • Gvasalia G. (2014). Cryptocurrency and its Future in the Global Economy. Tbilisi: “Audit, Accounting, Finance”.  # 3. (171).  (In Georgian).

  • Chikobava M., Kakulia N. (2018). Modern Genesis of Cryptocurrencies. Publishing House Paata Gugushvili Institute of Economics. Tbilisi.  (In Georgian).

  • Chkoidze N., Tomaradze G. (2014). Virtual/Cryptographic Currency and its Features. Regulation of Virtual Currencies (on the example of BITCOIN). Economics and Banking, V.2 2, # 3. (In Georgian).  http://lawjournal.ge/wp-content/uploads/2020/03/2-2019-37-43.pdf

  • Bhatia N. (2021). Layered Money: From Gold and Dollars to Bitcoin and Central Bank Digital Currencies. ISBN 978-1-7361105-1-5. 

  • Nakamoto S. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System.  https://bitcoin.org/bitcoin.pdf 

  • European Central Bank (2015). Virtual Currency Schemes – A Further Analysis.  https://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemesen.pdf 

  • Venter H. (2016). Digital Currency – A Case for Standard Setting Activity. A Perspective by the Australian Accounting Standards Board (AASB).

https://www.aasb.gov.au/admin/file/content102/c3/AASB_ASAF_DigitalCurrency.pdf

     https://www.iasplus.com/en/publications/global/thinking-allowed/2018/thinking-allowed-cryptocurrency-financial-reporting-implications 

      https://www.ifrs.org/   materials (last viewed: 03.02.2022)