This article looks to set out current views amongst bitcoin accountants and traditional finance experts around the world with regards to how to treat digital assets when it comes to financial reporting.
Why it’s important to ensure your bitcoin accounting and financial reporting is correct?
This is very simple and can be summarised in a few key bullet points:
- In most jurisdictions the tax treatment follows the accounting treatment. What this means is your taxable profits follow the profits that are recorded in your financial statements. The profits recorded in your financial statements will follow local accounting generally accepted accounting practises, which is important to understand with your Bitcoin accounting too. Thus, if you get the accounting treatment wrong, you could be taxed either too early, too late or even worse, incorrectly!
- Perception from current investors and investors to come; If you are lucky enough to obtain capital from an investor prior to fully trading, your financial statements are a means for to obtain comfort over how the business is doing. As we will explore in more detail below, you do not always need to physically receive cash to show income and a profit. Your income is driven by contractual obligations and if correctly recorded could demonstrate to your investors and potential future investors that the business is successful.
- Financial integrity and creditworthiness of the company; your financial statements give you key information that will allow you to make the correct business decisions. They will help you accurately review the financial performance of your business, which cannot be underestimated!
Before I lead into the consensus around accounting for bitcoin, I would like to take a minute to explain some key terminology…
What is a digital asset?
- A virtual token;
- A virtual financial asset;
- Electronic money;
- A financial instrument
A digital asset can be a digital currency that is encrypted (or secured) using cryptography, which is the use of encryption techniques to secure and verify transactions. The best-known example is of course Bitcoin, which is powered by blockchain or distributed ledger technology, which also needs accounting for.
Bitcoin Accounting principles in the UK and across the world
Accounting principles in the United Kingdom confirm to both Financial Reporting Standard 102 (FRS 102) and perhaps more relevant for this article International Financial Reporting Standards (IFRS) as adopted by the European Union. FRS 102 is specific to the UK, whereas IFRS is generally used across most countries especially in Europe.
IFRS Standards are issued and maintained by the International Accounting Standards Board and were established to create a common ground for countries around the world looking to find a common accounting language!
Although UK Legislation permits the use of reduced disclosure accounts (Micro accounts, accounts with small exemptions etc), reference below will only be made to IFRS.
What is the asset definition under IFRS, do these new “digital assets” fit in with the current conceptual framework as a starting point?
“Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity”
We then need to consider what type of asset it’s and these can be summarised as follows:
- Fixed assets
- Intangible assets
- Financial assets
Whilst considering whether they fall into any of these categories, some people think they do not fall into any. The best way is to break it down and review each category.
Are Bitcoin and Cryptocurrencies considered as cash?
“Money in coins or notes, as distinct from cheques, money orders, or credit.” (https://en.oxforddictionaries.com/definition/cash)
Bitcoin is not backed by the government or state, so they sadly do not fall nicely into this definition. The holder of the Bitcoin cannot demand that he/she are due cash. For the Bitcoin, alt coin or crypto to be converted into a fiat, the holder would need to find a crypto broker and there would be a fee for this service. The value would also depend on several factors and again, there is no certainty surrounding this.
Cash in Hand
However, the definition of “Cash in Hand” as per IFRS could lead people to believe a different conclusion. IAS 32.AG includes the following:
“Currency (cash) is a financial asset because it represents the medium of exchange and is therefore the basis on which all transactions are measured and recognised in financial statements. A deposit of cash with a bank or similar financial institution is a financial asset because it represents the contractual right of the depositor to obtain cash from the institution or to draw a cheque or similar instrument against the balance in favour of a creditor in payment of a financial liability” – IFRS
While still not providing much reassurance, this definition suggests cash could be considered as a medium of exchange. However, this still does not work because as we know the market for accepting cryptocurrency, although it’s increasing, it’s still very limited. Thus, you cannot say that crypto is legal tender.
If it’s not cash, could it be considered as a cash equivalent?
A cash equivalent is considered to be highly liquid investments, cheques not deposited, savings accounts etc. The key here is the level of liquidity being very high.
As we all know, with fiat currencies you have a very high level of certainty with regards to the purchasing power (with the exception of inflation). However, with bitcoin or other digital assets they are regarded as extremely volatile and hence there is a significant risk of changes in value. You could go sleep with it being one rate and wake up with the rate halving- hence the purchasing power could be deemed minimal. Thus, some people believe that this category may not be appropriate due to the level of risk associated with the volatility.
Is Crypto a Financial asset?
If digital assets are not considered to be cash or cash equivalents, do they fall into the category of a Financial asset?
Most of us would agree that the most appropriate way of measuring these coins would be at Fair Value. The reason being, Fair Value would represent the true value of the currency at any given point in time and indeed the value that would be realised by the company, investor or individual.
However, for us to recognise at Fair Value these digital assets would need to fall within the category of a Financial asset.
For us to explore this definition we need to refer to International Accounting Standard 32: Financial Instruments Presentation and apply this to bitcoin:
|Category of Financial asset||Explanation||Yes/No|
|Cash||Bitcoin is not legal tender as we discussed earlier|
|An equity instrument of another entity||Bitcoin does not entitle the holder to any residual interest in the issuer of the Bitcoin|
|contractual right to receive cash or another financial asset from another entity||Bitcoin is created via a process of “mining” or similar independent and not legally binding. There is no contractual right or relationship upon issuing bitcoin.|
Based on the above, bitcoins fail the definition of a Financial Instrument.
So where does that leave us, they are not cash, cash equivalents or financial assets. One would then look to explore intangible assets and inventories.
Are digital assets and cryptocurrencies an Intangible asset?
As cryptocurrencies do not seem to have a tangible form, upon first review it appears they could fall into the category of an Intangible asset.
Per International Accounting standard 38, the definition of an Intangible asset is as follows
“an identifiable non-monetary asset without physical substance”
Bitcoin appears to meet this definition. It’s identifiable, because individual units (or portions) of bitcoin can be sold or exchanged for goods or services. It also has no physical form.
IAS 38 requires an intangible asset to be measured on initial recognition at cost, with subsequent measurement being either to follow the cost model, or the revaluation model. However, the revaluation model can only be utilised if there is an active market for the intangible asset.
Whilst it might be argued that there is an active market for bitcoin, for virtually all other digital assets this is unlikely to be possible. In addition, if an intangible asset is revalued, changes in fair value are recorded in Other Comprehensive Income (OCI) and not profit or loss.
The definition of intangible asset in IAS 38 is mutually exclusive of the cash and cash equivalents (‘non-monetary asset’) definitions. Thus, the classification options appear to be between cash and intangible asset. Based on current IFRS literature and the standard setters’ pronouncements, bitcoin appear to be closer in definition to an intangible asset rather than cash and cash equivalents
However, we do not believe that the accounting treatment under IAS 38 would provide relevant and useful financial information.
Bitcoin Income Statement
If we establish that bitcoin and other alt coins are to be recognised as an intangible asset, one needs to determine whether we can recognise the gain/loss in Income Statement as opposed to the Statement of Other Comprehensive income.
On the one hand a recognition through the Income Statement provides more relevant and useful financial information, and we believe that under the conceptual framework it’s possible depart from IFRS in this situation (Conceptual Framework, OB2 (IFRS, 2017)).
On the other hand, the standard setters specifically distinguish tangible assets used for investment purposes (IAS 40) and other tangible assets (IAS 16, IAS 2), and the difference emphasises the relevance of changes in fair value in understanding the performance of an entity about tangible property held for investment versus tangible assets held for own use or consumption.
Is there a gap under the current IFRSS – Intangible assets that are held for investment purposes?
There are schools of thought here that reject all the above and propose that there should be an entirely new category of asset instead.
In some cases, bitcoin could fall into the category of inventory. Although in many cases, inventory has physical form, this is not required within the definition of inventory in IAS 2. This includes the definition
“Held for sale in the ordinary course of business”
However, for bitcoin to be considered as inventory, the company/individual would need to prove that the cryptocurrencies are being traded frequently enough for the trading to be deemed the entity’s ‘ordinary course of businesses, throughout their Bitcoin accounts. One could refer to Crypto traders and crypto asset management companies in this instance.
IAS 2 requires the measurement of inventories at the lower of cost and net realisable value (IAS 2.9). However, where the ‘ordinary course of business’ test is met, consideration is also required of whether the entity holding the bitcoin is a commodity broker-trader (in this case the commodity being the bitcoin) which would require measuring inventory at fair value less costs to sell. In such a case, IAS 2 would not apply to establish the bitcoin’s measurement accounting policy.
There are opinions regarding the application of accounting standards ,within crypto accounting, by analogy to the previously used IAS 25 Accounting for Investments, where the requirements for other non-financial investments potentially could be used for items such as digital currencies and some commodity transactions. However, when IAS 25 was withdrawn, those requirements were not replaced by a subsequent standard.
In order to determine how to account for an asset (i.e. as either an intangible asset under IAS 38 or inventory under IAS 2) it’s necessary to establish how the asset is used in the ordinary course of the business.
How can Harvex Help you?
We are aware of the many interpretations that currently exist within the bitcoin accounting world. However, this does not mean you cannot receive appropriate, correct accounting advice.
Our many years of accounting for Bitcoin and other Cryptocurrencies allows Harvex to be uniquely positioned to help. After all, we didn’t just jump on the bandwagon at the end of 2017, we’ve been involved from the early days of Bitcoin.
Harvex are experienced and qualified accountants, who by using up-to-date industry relevant decision trees, means we can assess and supply accounting services to all businesses, ensuring that their transactions are correctly recorded in the financial statements. Get in touch for help with your own bitcoin accounting.