One of the banes of holding digital assets is accounting for it in your financial statements. As governments are still grappling to precisely determine the character and classifications of various digital assets, the methods of accounting under US GAAP and IFRS are equally muddled, requiring the application of rules and standards that were not designed for such assets. Ill-suited accounting standards present challenges to the increasing number of businesses (and their investors) who hold cryptocurrency and other defi investments, as such companies struggle to accurately represent the value of their digital assets in their financial statements whilst following current accounting rules. Currently, many market participants believe the existing GAAP and IFRS frameworks do not provide decision-useful information to users of financial statements.
There is no precise definition of a digital asset. For purposes of this discussion, we will refer to digital assets in two forms: (1) assets that are digital and which do not entail any corresponding legal or proprietary rights in another asset (think Bitcoin); and (2) digital assets that do reference a legal or proprietary interest in another asset (think fiat-backed stablecoins like USDC).
Assets and liabilities are classified further to help you (and your investors) monitor your financial position. Both are broken down into “current” and “non-current” to show how soon they can be turned into cash (assets) or must be repaid (liabilities). In sum, the classifications represent how quickly assets can be converted to cash, whether they are tangible or intangible, how a business uses them, as well as how soon liabilities must be repaid.
For accounting purposes, you would generally expect to classify such assets as cash or cash equivalents, inventory, financial instruments, or intangible assets.
No type of cryptocurrency to date can be treated as cash or cash equivalents under US GAAP or IFRS for accounting purposes, as none represent a definitive contract that enables the tokens to be readily converted to cash. Nor can any ensure an insignificant risk to changes in value.
With respect to classification as inventory, positions held for investment or trading purposes by investment companies and broker-dealers are generally marked to market under US GAAP. Beyond that, US GAAP presently all but precludes treating digital assets as inventory, as inventory generally must be tangible. However, under IFRS, inventory is not restricted to physical goods.
Accordingly, digital assets can be treated as inventory in IFRS accounting, as appropriate. Under IFRS, this would allow for digital assets to be accounted for at fair value, less cost of sale, for broker-dealers, whereas they would be measured at the lower of cost and net realizable value when held for sale in the ordinary course of business.
Native digital assets, like Bitcoin, do not generally meet the definitions of financial assets under US GAAP or IFRS, as they do not represent a right to receive cash or another financial instrument. However, an asset-referencing digital asset, like stablecoins, may meet the definition of a financial instrument because it is redeemable for cash.
As most digital assets do not qualify as cash, inventory, or financial instruments under US GAAP or IFRS, they are generally treated as intangible assets.
Currently, US GAAP requires intangible assets to be accounted for at cost, with impairment losses recognized if fair value falls below cost. Conversely, an increase in the fair value of the asset cannot be recognized until it is sold. The fact that companies following US GAAP can reflect downward, but not upward, changes in the fair value of their digital asset could be misleading to users of their financial statements, as it may not translate into realistic current asset values.
Furthermore, US GAAP permits different accounting methodologies, such as LIFO or FIFO, which can impact the timing of gain/loss recognition and result in variable presentations of revenue from one business to another.
For IFRS, intangible assets can be accounted for at cost or according to the revaluation method. The cost method is substantially similar to the requirements of US GAAP, where the revaluation approach allows such assets to be initially measured at cost and subsequently measured at fair value less accumulated amortization and impairment losses, if applicable.
Revaluing intangible assets may not always be an option, as active markets for them are uncommon. However, the revaluation model can often be used for exchange-traded cryptocurrencies.
It is essential that businesses and investors of all types are able to clearly reflect the value of their assets on their balance sheets. Generally, accounting for digital assets at fair value would provide users of financial statements with more relevant and current information as to their fair value and liabilities at the time of the financial statements, as opposed to historical data based on a cost-less impairment model. The cost-less impairment models under US GAAP and IFRS prevent current accounting from reflecting the true nature and value of these assets.
Digital assets should have the option to be measured at fair value, just like financial assets and liabilities, and it would also enable businesses to mitigate volatility in earnings resulting from differing methods of measuring assets and liabilities.
At present, the most practical approach would be for US GAAP and IFRS to require all digital assets with readily determinable fair values to be accounted for at fair value unless fair value cannot be readily determined. For assets without a readily determinable fair value, only then would businesses have to apply the cost less impairment model as noted above.
The growth in the digital assets market has been driven by an increasing range and variety of market participants. As more and more companies across the globe continue to offer new products and services linked to digital assets, the need to accurately represent their value in financial statements becomes all the more critical to businesses and their shareholders. Presently, accounting for such assets according to US GAAP or IFRS can result in asymmetric valuations, causing financial reporting results between the two standards to vary significantly - in addition to causing an appreciable deviation between current asset values as opposed to how such values must be represented in financial statements.
The Financial Accounting Standards Board (FASB), the body responsible for establishing US GAAP reporting standards, has recently indicated that special guidance aimed solely at fungible tokens may be on the way. Specifically, this would allow assets such as Bitcoin and Ethereum, which are deemed to be intangible assets, to be measured at fair value, and allow increases and decreases in value to be recognized in income for each reporting period. This significant departure from the current requirements of accounting for fungible tokens at cost and recognizing impairment losses if the value falls below cost is a critical step towards presenting a proposal for public comment. So stay tuned!