The rapid evolution of crypto assets

During the last couple of years, crypto assets have evolved and new players continue to appear in this space, while others - like the Libra from Facebook - appear to have vanished before their debut.

The volatility of value has been a constant feature of cryptocurrencies, which entices many people, but may concern more conservative investors.

For example, using Bitcoin, the most popular crypto asset in the market, while in December 2017 the price hit records of approx. US$19k, it fell to US$11k by the end of January 2018 ; and more recently, if you had invested on 5 Bitcoins on 8 September 2020 you would have paid US$51k, and by 15 September 2021 your investment market value would be US$236k (or a pre-tax gain of US$185k or 362%).

The volume of transactions in cryptocurrencies has increased significantly and the Crypto assets’ eco-system is now much more diverse, including cryptocurrency derivatives such as Futures, options and micro-Futures.  

Regulatory bodies are showing a more proactive approach in trying to regulate the transactions of these assets. The development of a clear and strong regulatory environment is essential for crypto assets to overcome the biggest challenge they face, namely ‘Trust’.

Within this context, below are some examples of regulatory developments around the globe:

AUSTRALIA

On 30 June 2021 the Australian Securities Investments Commission (ASIC) released a Consultation paper (“CP 343”) on crypto-asset based ETPs and other investment products, seeking feedback on proposals about exchange-traded products (ETPs) and other investment products that provide retail investors with exposure to crypto-assets. According to ASIC "The proposals set out good practices for market operators and product issuers regarding crypto-asset ETPs and other investment vehicles that provide retail investors with exposure to crypto-assets".

Submissions on CP 343 were received by 27 July 2021 and ASIC has communicated their intention to publish its final information on good practices shortly.

USA

For a few years, the Securities Exchange Commission (SEC) has been discussing how to regulate the crypto markets. In late 2018, the SEC increased its oversight of cryptocurrencies, including the creation of a Cyber Unit to prevent and enforce misconduct related to Initial Coin Offerings (“ICO”) and Blockchain technology. However, this process of regulation seems far from clear when earlier this month the SEC’s chairman warned that new regulations are needed on cryptocurrencies and digital assets in order to protect U.S. national security.

CANADA 

In March 2021, the Canadian Securities Administrators (“the CSA”) issued a notice to outline their observations based on the first annual filings by reporting issuers (other than investment funds) that engage materially with crypto assets via mining and/or the holding/trading.

Since then, the Securities legislation in Canada requires reporting issuers to disclose the material risks affecting their business and, where practicable, the financial impacts of such risks. Importantly, it specified that for crypto assets reporting issuers, the controls adopted to guard against the risk of loss and/or theft associated with holding such crypto assets is a material risk important for investors.

CHINA

China has maintained a very strong regulatory restriction against private cryptocurrencies. Recently, the regulations on crypto in China have been strengthened. After the forced closure of local cryptocurrency exchanges back in 2017, the regulations appear to have been upgraded and seem to be targeting cryptocurrency mining activities. 

The accounting framework for crypto has achieved some clarity since June 2019, when the IFRS Interpretations Committee (IFRIC) discussed how IFRS Standards apply to holdings of cryptocurrencies.

During these discussions the IFRIC only considered cryptocurrencies with the following characteristics:

• a digital or virtual currency recorded on a distributed ledger that uses cryptography for security;
• not issued by a jurisdictional authority or other parties; and
• does not give rise to a contract between the holder and another party.

As a result of these discussions, the IFRIC concluded that:

• Cryptocurrency, when they are held for sale in the ordinary course of business, should be accounted for in accordance with IAS 2 Inventories (IAS 2) - AASB 102 Inventories in Australia. 

  Therefore, crypto-assets deemed to be Inventory, except for entities acting as a broker-trader as explain below, should be accounted for and subsequently measured at the lower of their cost and their net realisable value.

  In practise, this results in entities having to recognise immediately any losses due to a decrease in the fair value of a crypto asset, while only recognising any gains at the point when the asset is sold. 

  It is noted that the term ‘Ordinary Course of Business' is not defined by IFRS. We provide the following definition as guidance: Ordinary Course of Business means actions taken by the entity that are consistent with the past usual day-to-day customs and practices of the entity in the ordinary course of operations of the business during the period.

• Entities acting as broker-trader of cryptocurrencies should consider the requirements in paragraph 3(b) of IAS 2 for commodity broker-traders who measure their inventories at fair value less costs to sell.
• When IAS 2 is not applicable, entities should apply IAS 38 Intangible Assets (IAS 38) - AASB 138 Intangible Assets in Australia - to account for cryptocurrencies, as these assets meet the definition of an intangible asset (“IA)” in accordance with IAS 38.
  Under IAS 38, in addition to meeting the definition on an IA, entities are required to demonstrate this IA meets the recognition criteria outlined in this standard:
• An intangible asset shall be recognised if, and only if:
  (a) it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
  (b) the cost of the asset can be measured reliably.”

Note below a summary of the potential accounting treatment of crypto assets as IA:

ACQUIRED

Initial Recognition: At Cost

Subsequent Measurement:

Measured at either:

• the Cost model: at its cost less any accumulated amortisation and any accumulated impairment losses, or
• under the Revaluation model: its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses.

For the purpose of the Revaluation model, IAS 38 requires the fair value to be determined by reference to an active market. Generally, most IAs do not have an active market for them, and therefore are measured using the Cost model; however, in our view, widely traded crypto assets such as Bitcoin meet this definition in the accounting standards:

An active market is “A market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis.”

INTERNALLY GENERATED

Initial Recognition: No intangible asset arising from research (or from the research phase of an internal project) shall be recognised. Rather this expenditure on research (or on the research phase of an internal project) shall be recognised as an expense when it is incurred.

Subsequent Measurement: N/A

Initial Recognition:

• At cost or expenditure in development phase, as long as this meets the onerous recognition criteria outlined in IAS 38 for Development phase. This is potentially applicable for entities that are mining digital assets

As above, either using the Cost or the Revaluation model.

ACQUIRED IN A BUSINESS COMBINATION

Initial Recognition: Acquired in a business combination At its fair value at the acquisition date. As above, either using the Cost (deemed its fair value at the acquisition date) or the Revaluation model.

Subsequent Measurement: As above, either using the Cost (deemed its fair value at the acquisition date) or the Revaluation model.

Further, the IFRIC confirmed that cryptocurrency is neither a financial asset nor cash.

The above conclusions of the IFRIC mean good news to many accountants because the above-mentioned accounting treatments are consistent with the treatment adopted for most entities we have been working on in this space.  

However, as the eco-system in crypto evolves other questions may arise, such as: how to account for government-backed digital currency (refers to the recent announcements from El Salvador which has become the first country in the world to accept Bitcoin as legal tender, while a few other countries suggested may introduce crypto assets as tender) or for any potential privately- backed digital assets.  

In addition, the IFRIC noted the following disclosure requirements in the context of holdings of cryptocurrencies:

• Entities should provide the disclosures required by paragraphs 36–39 of IAS 2 for cryptocurrencies held for sale in the ordinary course of business.

• Entities should provide the disclosures required by paragraphs 118–128 of IAS 38 for holdings of cryptocurrencies to which it applies IAS 38.
• Disclosures in paragraphs 91–99 of IFRS 13 Fair Value are applicable for entities measuring cryptocurrency at fair value.
• Applying paragraph 122 of IAS 1, an entity discloses judgements that its management has made regarding its accounting for holdings of cryptocurrencies if those are part of the judgements that had the most significant effect on the amounts recognised in the financial statements.
• Paragraph 21 of IAS 10 Events after the Reporting Period requires an entity to disclose details of any material non-adjusting events, including information about the nature of the event and an estimate of its financial effect (or a statement that such an estimate cannot be made).

For example, an entity holding cryptocurrencies would consider whether changes in the fair value of those holdings after the reporting period are of such significance that non-disclosure could influence the economic decisions that users of financial statements make on the basis of the financial statements.

While the regulatory and accounting framework of digital assets continues to evolve and mature, we would like to highlight some key areas of consideration:

ENTITIES HOLDING CRYPTO-ASSETS SHOULD DEVELOP A FORMAL ACCOUNTING POLICY FOR RECOGNITION AND MEASUREMENT OF THESE ASSETS.

THIS PROCESS SHOULD GIVE CONSIDERATION TO THE FOLLOWING POINTS:

• The nature of the entity’s business and its intention to hold crypto assets (for example; is the entity holding digital assets as a speculative investment? Are the investments in crypto assets made with the purpose of diversification of long-term investments? Does the business operate as a broker-trader and is holding crypto assets for sale in the ordinary course of business?
• The overall financial reporting framework applicable to the entity: does the entity prepare General Purpose Financial Report (GPFR) meeting IFRSs, US GAAPs, or apply another accounting framework?
• In connection with the above point, entities should determine the applicable disclosure requirements.
• Understanding the functionality of the entity management and accounting system, including an understanding of any limitations. Is there a need to upgrade and enhance these systems?

REVIEW YOUR RISK MANAGEMENT FRAMEWORK AND INTERNAL CONTROLS. AS A MINIMUM THIS SHOULD INCLUDE THE FOLLOWING:

• Understanding of the key risk areas in the context of holding and trading crypto assets.
• Reviewing the effectiveness of internal controls, including assessing the effectiveness of the ownership safeguarding of crypto assets.
• Enhancing the IT General Control Area (ITCGC), including change management controls, anti-viral protection, authentication controls, IT and Information Security Incident Handling, etc.
• Establishing and continue monitoring Cyber Security Controls.
• Developing specific policies and processes to mitigate fraud risk.
• Developing internal controls to ensure crypto assets are accounted for in accordance with the accounting policies adopted by the entity. 

ENHANCE YOUR REGULATORY, COMPLIANCE AND ETHICAL POLICIES AND PROCEDURES BY:

• Evaluating the effectiveness of your system for ensuring compliance with laws and regulations (e.g. if the entity is acting as a broker-trader of cryptocurrencies, is it AUSTRAC regulated?)
• Review (or establish) the code of conduct/ethics.
• Develop a whistleblowing policy and the related processes.

If you have any questions regarding the accounting treatments of your assets or require assistance to develop or enhance your risk management framework and internal controls, please contact your nearest RSM office.