12.2 Accounting for digital assets
6 min read•august 19, 2024
Digital assets are reshaping the financial landscape, presenting new challenges for accountants. From cryptocurrencies to tokens, these digital representations of value require careful consideration in financial reporting. Understanding their unique characteristics is crucial for accurate accounting and disclosure.
Accounting for digital assets involves complex issues like , , and impairment testing. With limited specific guidance under IFRS and US GAAP, companies must apply judgment in determining appropriate treatments. Proper classification, valuation, and risk management are essential for transparent financial reporting.
Definition of digital assets
- Digital assets are digital representations of value that can be digitally traded, transferred, or used for payment, encompassing cryptocurrencies, tokens, and other digital financial instruments
- Exist on distributed ledger technology (DLT) platforms like blockchain, enabling secure peer-to-peer transactions without intermediaries (banks)
- Gaining prominence in global financial markets, with increasing investment and adoption by individuals, companies, and institutional investors
Types of digital assets
Cryptocurrencies vs tokens
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- Cryptocurrencies are native digital currencies of blockchain networks (Bitcoin, Ether) used as a medium of exchange, store of value, or unit of account
- Tokens represent digital assets built on existing blockchain platforms (Ethereum), often used to raise capital for projects or represent ownership rights, utilities, or assets
- Key distinction: cryptocurrencies have their own blockchain, while tokens are created and managed on existing blockchain networks
Fungible vs non-fungible tokens
- Fungible tokens are interchangeable and divisible, with each token having equal value and utility (stablecoins like USDC)
- are unique, indivisible, and non-interchangeable, representing ownership of specific digital assets (artwork, collectibles, gaming items)
- NFTs are stored on blockchain with metadata linking to the associated digital asset, enabling verifiable ownership and transferability
Accounting standards for digital assets
IFRS guidance on digital assets
- IFRS Interpretations Committee clarified that IAS 2 Inventories applies to cryptocurrencies held for sale in ordinary course of business
- IAS 38 Intangible Assets applies to cryptocurrencies held for other purposes, as they meet the definition of an intangible asset
- Lack of specific guidance for other types of digital assets, requiring judgment in determining appropriate accounting treatment
US GAAP treatment of digital assets
- No specific guidance under US GAAP, with companies applying existing standards based on the nature and use of the digital asset
- Cryptocurrencies often accounted for as indefinite-lived intangible assets under ASC 350, with impairment testing required
- Some companies classify digital assets as inventory if held for sale in the ordinary course of business, applying lower of cost or market approach
Initial recognition of digital assets
Cost basis for acquired digital assets
- Digital assets acquired through purchase are initially recognized at cost, which includes the purchase price and any directly attributable transaction costs (fees)
- Digital assets obtained through mining or staking are recognized at fair value on the acquisition date, with a corresponding increase in revenue or other income
Fair value measurement challenges
- Determining fair value for digital assets can be complex due to market , lack of standardized pricing, and varying liquidity across exchanges
- Companies may use quoted prices from principal markets, or valuation techniques (discounted cash flow) if no active market exists
- Judgment required in selecting appropriate valuation inputs and assumptions, considering risks and market conditions
Subsequent measurement of digital assets
Revaluation models for digital assets
- Companies may elect to apply a revaluation model under IAS 38, recognizing digital assets at fair value if an active market exists
- Revaluation gains recognized in other comprehensive income and accumulated in equity (revaluation surplus), while revaluation losses recognized in profit or loss
- US GAAP does not permit revaluation of intangible assets, requiring cost model with impairment testing
Impairment testing of digital assets
- Digital assets subject to impairment testing whenever events or changes in circumstances indicate the carrying amount may not be recoverable
- Impairment loss recognized if carrying amount exceeds the recoverable amount (higher of fair value less costs of disposal and value in use)
- Volatility in digital asset prices can trigger frequent impairment assessments, requiring robust processes and documentation
Presentation in financial statements
Classification as intangible assets
- Digital assets meeting the definition of an intangible asset are presented separately on the balance sheet or disclosed in the notes
- Classification as current or non-current based on expected realization or use within the normal operating cycle
- Separate presentation enhances transparency and comparability for users of financial statements
Disclosure requirements for digital assets
- Companies should disclose the nature, carrying amount, and accounting policies for digital assets
- Disclosure of significant judgments and estimates, such as valuation techniques and inputs, impairment assessments, and risk exposures
- Transparency in enables users to understand the impact of digital assets on financial performance and position
Derecognition of digital assets
Accounting for sales of digital assets
- Digital assets derecognized when the company transfers control to the buyer, typically at the time of the transaction on the blockchain
- Gain or loss on sale recognized in profit or loss, calculated as the difference between the proceeds and the carrying amount
- Proceeds measured at the fair value of the consideration received or receivable, considering any variable consideration or constraints
Disposal and write-off of digital assets
- Digital assets may be disposed of through sale, exchange, or abandonment, with the carrying amount derecognized and any gain or loss recognized in profit or loss
- Write-off required when digital assets become worthless or are lost due to theft, fraud, or other circumstances
- Adequate internal controls and documentation necessary to support the derecognition and write-off of digital assets
Risks and internal controls
Custody and safeguarding of digital assets
- Digital assets are susceptible to theft, loss, or unauthorized access, requiring robust custody and safeguarding measures
- Companies may use self-custody (private keys) or third-party custodial services to secure digital assets
- Internal controls over private key management, access controls, and segregation of duties are critical to mitigate risks
Cybersecurity risks for digital assets
- Digital assets are vulnerable to hacking, malware, and other cyber threats, which can result in financial losses and reputational damage
- Companies should implement strong cybersecurity measures, such as multi-factor authentication, encryption, and regular security audits
- Incident response plans and insurance coverage can help mitigate the impact of cybersecurity breaches
Taxation of digital assets
Income tax implications
- Gains or losses on the sale or exchange of digital assets are generally subject to income tax, with the specific treatment depending on the jurisdiction and the nature of the transaction
- Digital assets held as investments may be subject to capital gains tax, while those used for business purposes may be treated as ordinary income or expense
- Companies should carefully track and document digital asset transactions for income tax reporting purposes
Value-added tax considerations
- The application of value-added tax (VAT) or goods and services tax (GST) to digital asset transactions varies across jurisdictions
- Some countries treat digital assets as a form of property or asset, subject to VAT/GST on sale or exchange, while others consider them a form of currency exempt from VAT/GST
- Companies should monitor the evolving VAT/GST landscape and comply with the relevant rules in each jurisdiction
Auditing digital asset transactions
Verification of ownership and existence
- Auditors should verify the ownership and existence of digital assets by examining blockchain transactions, wallet addresses, and private key controls
- Confirmation of digital asset balances with third-party custodians or through independent blockchain analysis tools
- Evaluation of the company's processes for securing and managing digital assets, including access controls and segregation of duties
Assessing valuation and impairment
- Auditors should assess the reasonableness of the valuation techniques and inputs used by the company to measure digital assets at fair value
- Review of the company's impairment testing methodology, assumptions, and documentation to ensure compliance with the applicable accounting standards
- Consideration of the inherent risks and uncertainties associated with digital assets, such as market volatility, regulatory changes, and technological advancements, in evaluating the appropriateness of valuation and impairment conclusions
Key Terms to Review (17)
Audit trail: An audit trail is a documented record that provides evidence of the sequence of activities that have affected a specific operation, procedure, or event in a financial context. It serves as a critical tool for ensuring transparency and accountability, allowing stakeholders to track the flow of transactions and validate their authenticity. In an increasingly complex financial landscape, maintaining a clear audit trail is essential for compliance with standards, especially when dealing with digital assets and harmonizing non-financial reporting.
Balance Sheet Presentation: Balance sheet presentation refers to the way assets, liabilities, and equity are organized and displayed on a company's balance sheet, providing a snapshot of its financial position at a specific point in time. This presentation can vary significantly between accounting frameworks, particularly in terms of classification and ordering of items, which influences how stakeholders interpret the financial health of a business.
Blockchain audit: A blockchain audit is a systematic examination of blockchain transactions and records to ensure their accuracy, integrity, and compliance with relevant regulations. This process helps verify the authenticity of data stored on a blockchain, which is critical in accounting for digital assets, as it enhances transparency and accountability while reducing the risk of fraud.
Cryptocurrency: Cryptocurrency is a form of digital or virtual currency that uses cryptography for security and operates on decentralized technology, primarily blockchain. It allows for secure and anonymous transactions without the need for traditional banking systems. This innovative form of currency has transformed the way value is exchanged and has become a significant part of discussions around digital assets.
Disclosures: Disclosures refer to the information that organizations provide to stakeholders regarding their financial performance, risks, and other critical aspects of their operations. These disclosures are essential for maintaining transparency and accountability, enabling stakeholders to make informed decisions based on a company's financial health and business practices.
Fair Value Measurement: Fair value measurement is the process of estimating the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This concept plays a crucial role in financial reporting, affecting how assets and liabilities are valued on financial statements and guiding various accounting practices across different jurisdictions.
Financial Accounting Standards Board (FASB): The Financial Accounting Standards Board (FASB) is an independent organization responsible for establishing and improving financial accounting and reporting standards in the United States. FASB plays a critical role in ensuring transparency, consistency, and comparability in financial statements, which is essential for investors and stakeholders to make informed decisions.
Fincen guidance: FinCEN guidance refers to the directives issued by the Financial Crimes Enforcement Network, which is a bureau of the U.S. Department of the Treasury. This guidance provides clarification on how existing laws and regulations apply to digital assets and cryptocurrencies, ensuring compliance with anti-money laundering (AML) and counter-terrorism financing (CTF) regulations. It helps organizations understand their responsibilities in reporting suspicious activity and maintaining proper records related to digital transactions.
IFRS 13: IFRS 13 is an International Financial Reporting Standard that provides a framework for measuring fair value and requires disclosures about fair value measurements. It aims to enhance consistency and comparability in fair value measurements across entities and jurisdictions, which is crucial in financial reporting, especially when valuing assets like cryptocurrencies and digital assets that can fluctuate significantly.
Initial Recognition: Initial recognition refers to the process of recording an asset or liability in the financial statements when it is first acquired or incurred. This process is crucial because it establishes the basis for subsequent measurement and affects how the entity presents its financial position. Accurate initial recognition ensures that the financial statements reflect the true economic reality at the time of transaction, impacting various accounting aspects such as valuation, disclosure, and compliance with relevant standards.
International Accounting Standards Board (IASB): The International Accounting Standards Board (IASB) is an independent organization responsible for developing and maintaining international financial reporting standards (IFRS) to ensure transparency, accountability, and efficiency in financial markets globally. The IASB plays a vital role in fostering consistency in accounting practices across different countries, which helps businesses and investors make informed decisions.
Market Capitalization: Market capitalization refers to the total market value of a company's outstanding shares of stock, calculated by multiplying the current share price by the total number of shares. This figure provides an important measure of a company's size and performance in the financial markets, influencing investment decisions and strategies. In the context of cryptocurrency accounting and digital asset accounting, market capitalization helps investors gauge the relative value of different cryptocurrencies and digital assets in a rapidly evolving market.
Non-fungible tokens (NFTs): Non-fungible tokens (NFTs) are unique digital assets that represent ownership of a specific item or piece of content, verified using blockchain technology. Unlike cryptocurrencies, which are fungible and can be exchanged for one another, NFTs are distinct and cannot be replaced with something identical, making them suitable for representing ownership of digital art, collectibles, and other forms of creative work.
Regulatory uncertainty: Regulatory uncertainty refers to the lack of clarity and predictability regarding regulations that impact businesses and industries. This uncertainty can arise from fluctuating laws, inconsistent enforcement, or changes in government policy, which makes it difficult for companies to plan and make informed decisions. In the context of digital assets, regulatory uncertainty can greatly affect market behavior, investment decisions, and overall industry development.
SEC Regulations: SEC regulations are rules and guidelines set forth by the U.S. Securities and Exchange Commission, designed to protect investors, maintain fair and efficient markets, and facilitate capital formation. These regulations impact various aspects of financial reporting and corporate governance, including how companies disclose financial information, report earnings, and manage their assets.
Subsequent Measurement: Subsequent measurement refers to the process of valuing an asset or liability after its initial recognition, according to specific accounting standards. This concept is essential as it impacts how entities report their financial position over time, ensuring that financial statements reflect the most accurate and relevant information for stakeholders.
Volatility: Volatility refers to the degree of variation in the price of an asset over time, indicating how much the price can change in a short period. It’s a key feature in the financial markets, especially for assets like cryptocurrencies and digital assets, where rapid price swings are common. Understanding volatility is crucial as it affects risk assessment, investment strategies, and financial reporting for these types of assets.