Cryptocurrencies: New Asset, New Accounting Puzzle
As more and more companies accept cryptocurrencies as payment, U.S. GAAP has yet to catch up. So how should companies account for them?
There’s no question that cryptocurrency is rapidly gaining acceptance in the corporate world. Among the many large companies that accept it as a form of payment are Microsoft, PayPal and Expedia. Even government entities have jumped on the bandwagon. Earlier this year, Florida announced that residents of Seminole County would be able to pay their property taxes in bitcoin.
But as these new monies (also known as virtual or digital currencies) make inroads, they also present a challenging question for accounting and finance management: What type of asset is cryptocurrency? The answer is critical as it drives where on the balance sheet the asset is recorded as well as its subsequent measurement.
Unfortunately, U.S. GAAP has not caught up with the market’s acceptance of the new currencies. In the absence of U.S. GAAP language specific to the accounting for crypotocrrencies, companies can use the asset definitions in the Financial Accounting Standards Board (FASB) Codification to determine how to best classify and account for cryptocurrency. This article offers some suggestions for how companies could apply those definitions.
Rise of the Cryptocurrency Ecosystem
Most people are familiar with cryptocurrency through news stories about bitcoin, which launched in 2008. Since that time, more than 1,500 new cryptocurrencies have been developed and are actively exchanged on currently unregulated and online markets. As of June 30, the fair value of those cryptocurrencies was in excess of US$400 billion, with merchants of all sizes welcoming the digital payments. Bitcoin alone is accepted by more than 100,000 merchants.
The focus of this article is on the accounting for transactional cryptocurrencies, which includes bitcoin, litecoin and ether, among others. These are substitutes for fiat currencies, which distinguishes them from functional cryptocurrencies that are beyond the scope of this article.
Asset Definition in U.S. GAAPWithout specific guidance from U.S. GAAP, companies holding cryptocurrency need to decide which accounting model best fits these assets. One starting point is the definitions in the Master Glossary to the FASB Codification. Based on our review of select SEC filings, the accounting and disclosure for cryptocurrency by public companies is inconsistent and lacking in specificity, if addressed at all.
Asset Definitions – What Does the FASB Codification Have to Say?
We believe the following asset definitions from the Master Glossary are likely most useful in determining what accounting model to apply to cryptocurrencies:
- Cash – Currency on hand and demand deposits with banks or other financial institutions. May also be a legal form of tender backed by a government or state. Cash also includes other kinds of accounts that have the general characteristics of demand deposits.
- Cash equivalents – Short-term, highly liquid investments that are (a) readily convertible to known amounts of cash and (b) so near their maturity that they present insignificant risk of changes in value.
- Commodity – The Master Glossary also previously defined “commodity” as “a product whose units are interchangeable, are traded on an active market where customers are not readily identifiable and are immediately marketable at quote prices.” Although that definition has been superseded, it is noted here and may still be worthwhile to consider.
- Inventory – Tangible personal property that is (a) held for sale in the ordinary course of business, (b) in process of production for such sale, or (c) to be consumed in the production of goods or services.
- Financial Asset – Cash, evidence of an ownership interest in an entity, or a contract that conveys to one entity a right to either (a) receive cash or another financial instrument from a second entity or (b) exchange other financial instruments on potentially favorable terms with the second entity.
- Intangible Assets – Assets (not including financial assets) that lack physical substance.
It is open for debate whether any of the above definitions would be an appropriate match for the economics of cryptocurrency.
How Does Cryptocurrency Match Up Against Asset Definitions Under U.S. GAAP?
- Is it cash or a cash equivalent? When accepted as a form of payment, cryptocurrency can in fact seem like cash. But it does not contain the characteristics of “cash” because it is not a legal form of tender backed by a government or state. Cryptocurrency also does not appear to qualify as a “cash equivalent” because it does not have a maturity date and its value is subject to significant volatility.
- Is it a financial asset? Cryptocurrency does not represent an ownership interest in an entity, nor does it represent a contract that entitles the holder to receive cash or another financial instrument, and therefore it does not appear to qualify as a financial asset. However, as discussed further below, one could argue that classifying cryptocurrency as a financial asset would be more consistent with the economics of holding cryptocurrencies.
- Is it inventory? Probably not. For most companies, cryptocurrency most likely would not satisfy that definition because it is not tangible personal property and likely is not held for sale in the ordinary course of business.
- Is it a commodity? It would be difficult to conclude that cryptocurrency clearly qualifies as a commodity because it is not a tangible asset. However, this classification has some appeal when you consider that cryptocurrency units (i.e., coins) are interchangeable, are traded on a market (exchanges) where customers are not readily identifiable and are immediately marketable at quoted prices, though this classification may present certain challenges with subsequent measurement, as discussed below.
- Is it an intangible asset? Cryptocurrency has the characteristics of an indefinite-lived intangible asset since it is not a financial asset and lacks physical substance. But this definition presents challenges, particularly associated with the recognition of impairment. It also ignores the fact that, in most cases, cryptocurrency has a readily determinable market price, unlike most other intangible assets.
Consequences and Challenges of Classification
Classifying cryptocurrency as a financial asset and recognizing subsequent changes in market value in earnings appears most consistent with the economics of holding cryptocurrencies (i.e., cryptocurrency has a quoted market price and, in many cases, is actively traded, making it similar to equity securities); however, this classification is difficult to support based on the current definition of a financial asset.
Additionally, whether a cryptocurrency is classified as a commodity or an intangible asset, subsequent measurement challenges may exist:
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- As a commodity, it may not be possible to recognize subsequent changes in the price of cryptocurrency in earnings as they occur, except for declines in the price. Under U.S. GAAP, a company may, only in exceptional circumstances, measure a commodity at an amount in excess of cost. That guidance applies when the units are interchangeable, are immediately marketable at quoted prices, and the cost of a unit is difficult to obtain. Cryptocurrencies likely meet the first two conditions, but would not appear to meet the third condition because a company would know the cost of each unit it purchased or received in exchange for goods or services or perhaps the dollar amount of cash it paid in a recent purchase of bitcoin.
- As an intangible asset, a company would be required to consider, at least annually, whether the asset is impaired. The criteria provided for performing a qualitative assessment of impairment in ASC 350-30-35 are more applicable to intangible assets that do not have quoted market prices.
If, because of a decline in the price of a cryptocurrency, the company concludes the asset is in fact impaired, it would be required to write-down the carrying amount of the asset to its current fair value. This model effectively would result in recording cryptocurrency at the lower of cost or market in subsequent periods.
Neither a cost nor a lower of cost or market model for subsequent measurement of a cryptocurrency seems wholly appropriate given the fact that many cryptocurrencies are actively traded with readily determinable market prices, like equity securities. In the case of cryptocurrencies with readily determinable market prices, using the accounting model for financial assets may provide users with better information than following a cost or lower of cost or market model; however, classification of cryptocurrency as a financial asset is not yet addressed or supported by existing U.S. GAAP.
Need for FASB Guidance Soon
Significant judgment is required to determine the asset classification to be applied to cryptocurrency because of the absence of specifically applicable guidance. Given the increased use of cryptocurrency and the diversity in practice that has and will continue to result from this lack of guidance, accounting for cryptocurrency is an emerging issue the FASB should address, either directly or through the Emerging Issues Task Force.
Senior Managing Director