Dominium explains how to properly account for cryptocurrency token sale fundraising from an IFRS perspective.
2017 will forever be known as the start of the ICO craze, when entrepreneurs and start-ups raced to raise over $5.6 billion in funds, many of which lacked any standardised accounting method for the funds once they were raised.
Unfortunately for both the investors and the projects themselves, not properly accounting for funds has the potential to present serious future legal problems.
The good news is that accounting for today’s growing number of cryptocurrencies isn’t impossible. In fact, we’ve found that accounting approaches for cryptocurrencies may well fit within the existing International Financial Reporting Standards (IFRS) framework.
As an international property management organisation that solves regulatory and accounting issues on a daily basis, Dominium has thoroughly analysed how to properly account for cryptocurrency funds raised in token sales.
Here’s a brief yet important look at cryptocurrency accounting from an (IFRS) perspective, based on a published report from Grant Thornton, one of the world’s largest professional networks.
Before accounting for funds raised in token sales, one must first clearly define the funds themselves.
Grant Thornton defines a cryptocurrency asa digital or “virtual” money, which uses cryptography in its transactions, to control the creation of additional currency units, and to verify the transfer of assets.
Comparison of accounting approaches for cryptocurrency asset holdings
To determine the best approach for accounting for cryptocurrency funds, we must first determine which IFRS standard is most suitable for the currency class.
The IFRS report outlines six major standards and categories that might be used to account for cryptocurrencies.
Cash and Equivalents – IAS 7
Although cryptocurrencies are considered to be digital “cash” by many, the fact that they are not backed by a central government or bank, means they are not classified as legal tender.
IAS 7 ‘Statement of Cash Flows’ defines cash simply as “cash on hand and demand deposits.”
However, another accounting standard, IAS 37, further defines “cash” as a “financial asset because it represents the medium of exchange.”
A great majority of today’s digital currencies cannot readily be exchanged for goods and services, something that cash implies. For this reason, cryptocurrencies cannot be considered cash.
‘Cash equivalents’ under IAS 7 are considered instruments that are “almost as good as cash” in that they are “cash-like in nature.”
Furthermore, cash equivalents are defined as “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value.”
Most of today’s 1,600+ cryptocurrencies are considered volatile, and for these reasons we believe that they fail to meet this classification.
Financial Assets at Fair Value Through Profit or Loss
Another potential approach to accounting for cryptocurrencies is to classify them as financial assets at Fair Value Through Profit or Loss.
However, cryptocurrencies first must pass the test of being a financial instrument.
IAS 32 defines financial instruments as:
- An equity instrument of another entity
- A contractual right to receive cash or financial assets from another entity OR to exchange financial assets or liabilities under conditions favourable to another entity
- A contract that will or may be settled in the entity’s own equity instruments
We have already determined that cryptocurrencies do not meet the definition of being cash. They also cannot be considered equity instruments or contracts to be settled in equity instruments. Furthermore, cryptocurrencies are not a contractual right to receive cash or assets.
For these reasons, cryptocurrencies fail to meet the definition of being a financial asset under current international accounting standards.
Investment property – IAS 40
Can cryptocurrencies be considered investment property?
Investment property is defined under IAS 40 as: “property (land or a building – or part of a building – or both) held … to earn rentals or for capital appreciation…”
Cryptocurrencies, while some may be considered to have capital appreciation, are not physical assets that represent property.
There are several remaining accounting approaches that one might find possible to use for cryptocurrencies.
- Plant and equipment
- Intangible assets
Because cryptocurrencies cannot be considered physical assets, we can soundly rule out the possibility of classifying them as property or plant and equipment.
Let’s take a look at intangible assets and inventories.
Intangible assets – IAS 38
IAS 38 defines intangible assets as “an identifiable non-monetary asset without physical substance.”
This classification appears to fit cryptocurrencies more closely. But first we must be certain that cryptocurrencies are identifiable, non-monetary, and without physical substance.
IAS 38 defines identifiableas being either:
…separable, capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so;
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.
Because cryptocurrencies can be traded and exchanged in peer-to-peer transactions, we can determine that they are indeed identifiable.
IAS 38 defines monetary assets as “money held and assets to be received in fixed or determinable amounts of money.”
Cryptocurrency valuations fluctuate due to volatility in supply and demand in today’s markets, which means they do not fit the definition of being a monetary asset. Therefore, they are non-monetary in nature.
Without physical substance
Cryptocurrencies are digital, and therefore without physical substance
Of all classifications examined, intangible assets represent the clear and most logical category for cryptocurrencies to be classified under.
Let’s take a look at how we can account for intangible assets under today’s international accounting standards.
Accounting approaches under IAS 38
There are two separate accounting approaches under IAS 38; cost and revaluation.
The cost approach measures intangible assets at cost at first recognition and subsequently at cost minus accumulated amortization and impairment losses.
What is cost?
Cost is defined as:
The amount of cash or cash equivalents paid, or the fair value of other consideration given to acquire an asset at the time of its acquisition or construction, or, when applicable, the amount attributed to that asset when initially recognized in accordance of the specific requirements of other IFRSs, recognised in profit or loss to the extent e.g., IFRS 2 Share-based Payment.
An alternative approach to accounting for intangible assets under IAS 38 is by Revaluation, given that they are traded in an “active market.”
Like the cost model, intangible assets are measured at initial recognition and subsequently measured at fair value minus amortization and impairment losses.
IAS 38 dictates that revaluation increases must be recognized in other comprehensive income and accumulated equity under the heading of revaluation surplus.
Revaluation increases are recognized in profit and loss to the extent that it reverses a revaluation decrease of the same asset.
Revaluation decrease is also recognized in profit and loss. Decreases are recognized in income to the extent of any credit balances in the revaluation surpluses.
Amortisation and Impairment
IAS 38 requires intangible assets to be assessed based on whether the useful life of an asset is finite or indefinite.
The definition of an indefinite asset is one that has no limited period to which the asset is expected to generate net cash flows.
Most cryptocurrencies are considered to be a store of value over an indefinite time, which means we can consider them as indefinite intangible assets under IAS 38.
Intangible assets with indefinite life are not amortised but they must be tested for impairment by comparing their carrying vlue annually, and also whenever there is any other indication of impairment.
‘Impairment of assets’ under IAS 36 states that impairment losses be immediately recognized in profit or loss, with the exception that the asset is carried at a revalued amount.
Impairment losses are treated as a revaluation decrease. We’ve also found that the same standard requires that reversals of impairment losses be treated as a revaluation increase.
Inventories – IAS 2
Accounting for some cryptocurrencies may also be possible under the IAS 2 ‘Inventories’ classification.
Although we believe most cryptocurrencies fit the definition of being intangible assets, there is stipulation under IAS 38 that assets held for sale in the course of business are outside the scope of IAS 38 and should be considered to be accounted for under IAS 2.
Measurement of inventories under IAS 2 is at the lower value of cost and net realized value. This standard also states that it does not apply to the measurement of inventories held by commodity broker-traders.
Commodity broker-traders are required to measure their inventories at fair value minus their costs to sell being recognised in profit or loss within the period of change.
The measurement exception of commodity broker-traders presents a grey area. Are cryptocurrencies considered physical assets to be traded by commodity broker-traders for profit from price fluctuations?
The lack of a further definition means that in some distinct cases, cryptocurrencies may possibly be accounted for as an inventory under IAS 2.
There is no clear and specific framework for accounting for cryptocurrencies.
However, we find that in many circumstances, funds raised from ICOs and token sale events most closely fit under accounting standard 38 (IAS 38) as Intangible Assets.
However, in very limited cases cryptocurrencies may also be accounted for as Inventories under IAS 2with the provision that they are traded as commodities in nature with the intention of profiting from future price fluctuations.
As always, we encourage every blockchain project to do their own due diligence to determine which accounting standard best fits their circumstances and to also to consider additional disclosures to comply IAS 38 and IAS 2.