With rapid changes in technology and business environment, holdings of cryptocurrencies allow businesses and individuals to transact directly to each other without any intermediary such as banks or financial institutions. Accordingly, it appears practical issues on how to account for such assets given the fact that there is no accounting standard currently provide direct guidance, therefore, accountants should refer to existing accounting standards and access which FRS should be adopted to account for cryptocurrencies.
What accounting standards might be used to account for cryptocurrencies?
With no reference to the GAAP, the preparer of the financial statements will need to consider carefully which FRS should be adopted and to appropriately account for cryptocurrencies. Followings are the key considerations to determine how cryptocurrencies should be accounted for:
- Are cryptocurrencies cash? (FRS 7)
- Are cryptocurrencies financial instruments? (FRS109)
- Are cryptocurrencies inventories? (FRS 2)
- Are cryptocurrencies intangible assets? (FRS 38)
Consideration as cash
It appears that cryptocurrency should be accounted for as cash in accordance with FRS 7 because it is a form of digital money.
FRS 7 defines:
“Cash on hand and demand deposits and short term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value.”
Despite there is an increase in the usage of cryptocurrency as payment for goods or services, digital currencies are not yet widely accepted as a medium of exchange in the current business environment, simply because they are not legal tender which backed by any government. Entities have the option to accept digital currencies as a form of payment, but there is no requirement to do so. With this shortfall, cryptocurrency always cannot readily be exchanged for any good or service.
As cryptocurrencies are listed on respective exchange and they are subject to high price volatility, it fails to meet the requirement as “insignificant risk of changes in value”. Therefore, digital currencies do not meet the definition of cash and cash equivalents in accordance with FRS 7.
Consideration as a financial instrument
Cryptocurrency might also be considered as a financial asset at fair value through profit or loss (FVTPL) in accordance with FRS 109. A Financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
As digital currency does not represent cash, an equity interest in an entity, or a contract establishing a right or obligation to deliver or receive cash or another financial instrument. In addition, they are not a debt security, nor equity security (although a digital asset could be in the form of an equity security) because it does not represent an ownership interest in an entity. Therefore, cryptocurrency should not be accounted for as a financial asset.
Consideration as inventory
FRS 2 defines inventories as assets:
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.
Depending on the business model of the entity, it might be appropriate to account for digital currency as inventories in accordance with FRS 2 when the entity holds cryptocurrencies for sale in the ordinary course of business and then it should be stated at the lower of cost and net realization value. However, for entity acting as broker/trader of cryptocurrencies, it should be valued at fair value less costs to sell.
Consideration as intangible asset
FRS 38 defines the intangible asset as:
An identifiable non-monetary asset without physical substance. Such an asset is identifiable when:
- it is separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or
- it arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations
Digital currencies appear to meet the definition as an intangible asset as an identifiable non-monetary asset without physical substance. Since cryptocurrencies can be sold on a cryptocurrency exchange, they are identifiable as they can be separated from the entity. In addition, FRS 21 also states that an essential feature of a non-monetary asset is the absence of a right to receive (or an obligation to deliver) a fixed or determinable number of units of currency.
Thus, cryptocurrency meets the definition of an intangible asset in FRS 38 can be separated from the holder and sold or transferred individually and, in accordance with FRS 21, it does not give the holder a right to receive a fixed or determinable number of units of currency. Given the characteristics of the cryptocurrency as an intangible asset, it should be accounted for and classified as an intangible asset in accordance with FRS 38.