The absence of specific financial reporting guidelines for crypto assets has resulted in a jungle of classifications and measurement methods adopted worldwide. Francesco Venuti, Christopher Hossfeld and Anne Le Manh write that this lack of standardised guidance leaves room for interpretation by companies, potentially leading to misleading or incomparable information for investors.
The European Central Bank recently highlighted the significant risks and volatile nature of crypto assets, as evidenced by the ongoing “crypto winter“, [a period of downward pressure on the crypto market]. The rapid growth of this market raises concerns for companies regarding the accurate reporting of crypto assets in their financial statements. It is also a concern for auditors worried about how to effectively audit them, and investors who must properly interpret the information related to crypto assets provided in companies’ financial statements.
The term “crypto asset” is not universally defined, which leads to frequent ambiguity and confusion when distinguishing it from related terms and products such as “crypto token,” “digital asset,” “DLT asset,” “virtual asset,” “utility token,” “security token” and “cryptocurrency.” Crypto assets can be classified in several ways based on different criteria. From an academic perspective, crypto-assets could be categorised according to their technical characteristics (blockchain-based and non-blockchain-based), functionalities (medium of exchange, providing access to a product or a service…), and regulatory treatment (whether they are considered commodities, securities or currencies).
The International Financial Reporting Standards (IFRS), which is the most international accounting regulation available, currently propose no standards covering crypto-asset accounting in a systematic and comprehensive way. The only guidance, which was published by the IFRS Interpretations Committee (IFRIC) in June 2019, focuses on cryptocurrencies only. According to this, cryptocurrencies are a subcategory of crypto assets with three major defining characteristics:
1. A digital or virtual currency recorded on a distributed ledger that employs cryptography for security;
2. Not issued by a jurisdictional authority or other party; and
3. Which does not give rise to a contract between the holder and another party.
While several options within the IFRS framework could be considered to account for cryptocurrencies – cash, cash equivalents, financial assets (other than cash), intangible assets or inventories -, the IFRIC definition excludes their classification as cash or financial assets.
Indeed, according to the IFRIC definition of cryptocurrencies, it is quite clear that, based on their nature and characteristics, they may not be classified as cash, cash equivalents or other financial assets, due to their high volatility, the fact that they are not readily convertible and the lack of any contractual claim provided to the holder. Consequently, when it comes to accounting for cryptocurrencies, they can only be categorised as either inventories or intangible assets, leading to distinct effects on the financial statements in line with the chosen approach.
Therefore, if a company holds cryptocurrencies for sale purposes in the ordinary course of business, it could meet the conditions required for inventories. For example, consider the case of a broker-trader of cryptocurrencies who acquires bitcoins with the only purpose of generating a short-term profit by reselling them. In this case, cryptocurrencies can be classified as inventory. Therefore, the initial asset recognition will be at the acquisition cost (fair value at acquisition date) and subsequent evaluations will be at the lower cost and net realisable value (same as for “regular” inventories) or at fair value less costs to sell (applicable only to commodity broker-traders). In this latter case, changes in fair value will be recognised in net income. Hence any change in the market value of cryptocurrencies will impact net income.
If the cryptocurrencies are not held for trading, but rather for longer investment purposes, they may not be classified as inventories, and consequently considered as intangible assets. The initial asset recognition is still at acquisition cost. For subsequent evaluations, companies can choose between the cost method and the revaluation method, assuming an active market exists. Using the cost model implies recognising cryptocurrencies at acquisition cost and testing them for impairment at least once a year. Under the revaluation method, cryptocurrencies are fairly valued regularly (multi-year frequency). Fair value gains are not recognised in net income, but in other comprehensive income, while losses below the acquisition cost are recognised in net income.
To date, there have been few studies of companies’ accounting practices for cryptocurrencies. Mei Luo & Shuangchen Yu highlighted looked at the 2020 IFRS financial statements of 40 companies that operate in typical cryptocurrency businesses (such as purchase/investments, mining, trading and asset management in the secondary markets, etc…). They found that 15 of those companies classified cryptocurrencies as intangible assets while the others categorised them as inventories. Their findings indicated that, while the majority of companies adhering to IFRS classify cryptocurrencies as intangible assets and inventories using a fair value method, a small number of IFRS-compliant firms who hold cryptocurrencies for long-term objectives recognise them as intangible assets applying the cost model. Hence, recognising cryptocurrencies as intangible assets measured with the revaluation model (impacting primarily other comprehensive income) appears to be the approach most used among companies adopting IFRS for their financial statements.
In a research paper based on the US context, Anderson et al (2022) convincingly illustrated the presence of considerable managerial discretion when it comes to accounting for cryptocurrency holdings. They observed a shift from fair value accounting to the recognition of crypto-currencies as intangible assets, with this change becoming prominent from 2018 onward.
Even among the companies categorising cryptocurrencies as intangible assets, notable disparities in the valuation assumptions employed have been identified. It would be relevant to conduct this type of study in an IFRS context and to investigate the determinants of the choice of one method or another among the different options compliant with IFRS.
Given that there are no specific accounting standards for either cryptocurrencies or other crypto assets, the current accounting practices exhibit a considerable level of inconsistency and distortion in companies’ financial reporting. These discrepancies pose challenges in accounting choices for companies and auditors, leading to non-comparable financial statements that have negative implications for investors. Regulations seem necessary in the reporting of crypto assets to guide everyone through this jungle, ensure comparability and prevent manipulation by companies.
- This blog post is based on How to account for technological assets such as crypto-currencies? ESCP Impact Paper No.2023-13-EN.
- The post represents the views of its authors, not the position of LSE Business Review or the London School of Economics.
- Featured image provided by Shutterstock
- When you leave a comment, you’re agreeing to our Comment Policy.