Cryptographic assets are gaining significant amount of interest recently, given their rapid increases in value and volatility. This kind of assets experienced a breakout year in 2017.
Currently, there are no accounting standards that specifically address crypto-assets. However, the Australian Accounting Standards Board (AASB) has submitted a discussion paper on “digital currencies” to the International Accounting Standards Board (IASB), and the Accounting Standards Board of Japan (ASBJ) has issued an exposure draft for public comment on accounting for “virtual currencies.” In January 2018, the IASB discussed commodity loans and related transactions during its meeting.
In the Philippines, the Philippine Interpretations Committee (PIC) of the Financial Reporting Standards Council (FRSC) released its Question and Answer (Q&A) 2019-02, Accounting for cyrptographic assets.
Definitions and Background
As defined by IASB in its July 2018 staff paper, Transactions involving commodities and cryptocurrencies, crypto-asset is defined as digital asset class that includes assets recorded on a blockchain, which is a digitised, decentralised, public ledger of all cryptocurrency transactions (Investopedia). Currently per the PIC Q&A, there is no legal definition of cryptographic assets, as there is for securities in various jurisdictions; however, some cryptographic assets can be legally considered securities by local regulators.
The IASB’s staff paper further discussed that crypto-asset could be intended to be used as a medium of exchange (ie cryptocurrencies) or may provide the holder with other rights (ie crypto tokens). As defined by Investopedia, cryptocurrency is a digital or virtual currency that uses cryptography for security. It is not issued by any central authority, rendering it theoretically immune to government interference or manipulation. Examples of cryptocurrencies are Bitcoin, XRP, Ethereum, Bitcoin Cash, EOS, Stellar, Tether, Litecoin, Tron, and Bitcoin SV. Crypto tokens represent a particular fungible and tradable asset or a utility that is often found on a blockchain.
In the PIC Q&A, a crypto token is further set out into three possible subsets. Asset-based token signifies and derives its value from something that does not exist on the blockchain but instead is a representation of ownership of a physical asset (for example, natural resources such as gold or oil). Utility tokens provide users with access to a product or service and derive their value from that right. Utility tokens give holders no ownership in a company’s platform or assets and, although they might be traded between holders, they are not primarily used as a medium of exchange. Security tokens are similar in nature to traditional securities. They can provide an economic stake in a legal entity: sometimes a right to receive cash or another financial asset, which might be discretionary or mandatory; sometimes the ability to vote in company decisions and/or a residual interest in the entity.
The characteristics that are being most relevant for classifying crypto-assets for accounting purposes are the primary purpose and how the crypto-assets derive its inherent value. The PIC Q&A laid down above the primary purpose of each subset. Let’s take a look at its inherent value:
- Crytocurrency – None, derives its value based on supply and demand
- Asset-based token – derives its value based on the underlying asset
- Utility token – from the demand for the issuer’s service or product
- Security token – from the success of the entity, since the holder of the token shares in future profits or receives cash or another financial asset
In its Q&A, PIC clarified that it focuses on cryptographic assets that carry simple features, instead of hybrid tokens as some cypto-assets might exhibit elements of two or more of the identified subclasses. Hybrid tokens require further analysis and judgement is required to determine the applicable accounting treatment. Factors to consider will include the interaction of contractual clauses, their substance and relevance in the context of the overall characteristics of the token.
Initial Coin Offering
The most common method of issuing tokens is via initial coin offerings (ICO). As defined by Investopedia, this is an unregulated means by which funds are raised for a new cryptocurrency venture. It is used by startups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks. In an ICO campaign, a percentage of the cryptocurrency is sold to early backers of the project in exchange for legal tender or other cryptocurrencies, but usually for Bitcoin. These ICO tokens typically do not represent an ownership interest in the entity, but they often provide access to a platform. The population of ICO tokens in an ICO is generally set at a fixed amount.
In the Philippines, the use of cryptocurrencies particularly Bitcoin is becoming popular. At present, certain local companies that deal in Bitcoin and other cryptocurrencies have acquired registrations from the Bangko Sentral ng Pilipinas (BSP) as money changing and remittance entities. Accordingly, these companies are required to comply with the applicable BSP regulations such as the traditional “Know Your Customer” (KYC) and anti-money launder (AML) compliance, among others.
How should a company as a “holder” report crypto-assets in their financial statements?
Per PIC Q&A, the Philippine Financial Reporting Standards (PFRS) does not include specific guidance on the accounting for cryptographic assets and there is no clear industry practice, so the accounting for cryptographic assets could fall into a variety of different standards. Consideration should also be given to the entity’s purpose for holding the cryptographic assets to determine the accounting model.
Cryptocurrencies held by an entity
As Inventory under PAS 2, Inventories
PAS 2 does not require inventories to be in a physical form, but inventory should consist of assets that are held for sale in the ordinary course of business. Inventory accounting might be appropriate if an entity holds cryptocurrencies for sale in the ordinary course of business. An entity that actively trades the cryptocurrencies, purchasing them with a view to their resale in the near future, and generating a profit from fluctuations in the price or traders’ margin, might consider whether the guidance in PAS 2 for commodity broker-traders should be applied. However, if the entity holds cryptocurrencies for investment purposes (that is capital appreciation) over extended periods of time, it would likely not meet the definition of inventory. PAS 2 requires inventories to be measured at lower of cost or net realizable value, unless the holder is a commodity broker-trader, in which case it may be measured at fair value less costs to sell. [PAS 2 par. 3]
As Intangible Asset under PAS 38, Intangible Assets
PAS 38.8 and 38.13 define an asset as a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. Control in this context means that the entity has the power to obtain the future economic benefits that the asset will generate and to restrict the access of others to those benefits. It appears therefore, that cryptocurrencies would meet the definition of an intangible asset as cyptocurrencies are identifiable as can be sold, exchanged or transferred individually; not cash and non-monetary asset; have no physical form. An intangible asset shall be measured initially at cost. After initial recognition, the entity can choose either the cost model or the revaluation model as its accounting policy. If an intangible asset is accounted for using the revaluation model, all the other assets in its class shall also be accounted for using the same model, unless there is no active market for those assets. One must look at the activity in a market for each individual cryptocurrencies to conclude if it meets the definition of “active market”. Therefore, for the largest cryptocurrencies such as Bitcoin and Ethereum, it is likely this definition would be met.
Crypto-assets other than cryptocurrencies held by an entity
With characteristics of asset-backed tokens
It is a means to transact the underlying asset at minimal cost. As a result, the accounting will likely be driven by the nature of the underlying asset and the relevant accounting standard.
With characteristics of utility tokens
Utility tokens usually give the holder a right to future goods or services. These tokens are a prepayment for goods or services. A prepayment for goods or services might meet the definition of an intangible asset and PAS 38 could be applied. Where it does not meet the definition of an intangible asset, it is accounted for similar to other prepaid assets.
With characteristics of security tokens
Security tokens might give the holder a right to cash, based on the platform’s future profits or a residual interest in the net assets. Such rights might be discretionary or mandatory and might be accompanied by the ability to vote to impact decisions relating to the underlying platform. A contractual right to cash or another financial asset may exist in these circumstances, in which case, these security tokens meet the definition of a financial asset subject to PFRS 9.
How should a company as an “issuer” report crypto tokens in their financial statements?
When an ICO is undertaken, the issuing entity receives consideration (for example, cash or another cryptographic asset).
It is possible that an ICO could create a joint arrangement requiring further analysis based on PFRS 11, Joint Arrangements.
Where consideration for the ICO is not in the form of cash but another crypto-asset, the transaction might be an exchange of similar goods or services. An exchange of similar goods might mean that no accounting is needed. Assuming that there is an exchange transaction and the arrangement does not create joint control, the consideration received by the ICO entity is recorded as the debit side of the journal entry. However, the key challenge for issuing entities is determining the accounting for the ICO token issued (that is, the credit side of the journal entry). This will depend on the nature of the ICO token issued, as well as the guidance of the applicable accounting standard. Consideration of the contract terms is needed, to understand the obligations of the issuer.
An issuer of an ICO token should assess whether a token meets the definition of a financial liability in PAS 32. Many ICO tokens will not meet the definition of a financial liability, but there are situations where the terms and conditions might provide for a refund of proceeds up to the point of achieving a particular milestone. There might be situations in which the contract creates a financial liability at least up to the point at which the refund clause falls away. If the ICO token is a financial liability, the accounting would follow the applicable guidance in PFRS 9.
Typically, ICO tokens do not provide the holders with such a residual interest; for example, they do not give the holders rights to residual profits, dividends, or entitlement to proceeds on winding up or liquidation. These ICO tokens might therefore lack the characteristics of an equity instrument. As defined by PAS 32, an equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Revenue transaction/prepayment for future goods and services
PFRS 15 would apply if (1) the receiver of the ICO token is a customer, (2) there is a ‘contract’ for accounting purposes, and (3) the performance obligations associated with the ICO token are not within the scope of other standards.
In many circumstances, issuers might use the consideration received in the ICO to develop a software platform. Hosting and maintaining the specific platform is often an integral part of the ICO’s future business model. The token could provide the holder with access to the platform, which might be operated as part of the entity’s ordinary activities. This might result in the holders meeting the definition of ‘customers’, from the perspective of the ICO entity; accordingly, the proceeds from the ICO could be revenue of the issuing entity, which will likely be initially deferred.
Other relevant guidance
Where none of the above considerations appears to be relevant, the hierarchy in PAS 8 should be considered in determining the appropriate accounting treatment. Even if the arrangement does not give rise to a financial instrument or a promise to deliver goods or services to a customer, there is likely to be a legal or constructive obligation to the subscriber. This might result in the issuer recognizing a provision in accordance with PAS 37, Provisions, Contingent Liabilities and Contingent Assets.
The consensus in this PIC Q&A becomes effective upon approval by the FRSC, thus 13 February 2019.
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About the Author
Paul is a Certified Public Accountant (CPA), a youth and environmental advocate, leader, writer, blogger, filmmaker and an organist. He’s the former Chairperson of the College Editors Guild of the Philippines-Ilocos Chapter. As a writer, he has found focus and interest on reproductive health, deaf rights, youth development. At the age of 14, he has fully embraced the call of leadership by leading student organizations and college publications. He was a recipient of the PGMA Campus Journalism Award. He joined and won national contests and published some articles related to the United Nations Millennium Development Goals in a Spanish paper and website. Some of his articles were also published in leading Philippine news websites and featured in international organizations website.
He launched his career as a CPA in KPMG R.G. Manabat & Co. Paul is currently leading the Data and Analytics Network (and its university arm) of KPMG in the Philippines. He is also the Business Lead for Innovation. He provides trainings to KPMG professionals in the Philippines. He also joined Financial Services Academy for Shared Service Centres (SSC) as a presenter. He is part of the Technical Advisory Group of the Firm's Department of Professional Practice, focusing on data and analytics, audit methodology, accounting standards, root cause analysis, system of quality management, and financial statement quality control review. He represents the Firm as a resource and motivational speaker, arbiter, adjudicator and judge in academic conferences, audit conventions, accounting and audit cups, and audit case study competitions. He sits as a member of Root Cause Analysis team of the Firm. Paul is an Audit Methodology Champion and Workforce of the Future Champion of the Firm. He is also the Firm's System of Quality Management Implementation Manager.
Paul is the Review Master and Head Coach of PREMIERE Review School.
Paul is a member of the Iglesia Ni Cristo (Church Of Christ) and a Church officer in their locale congregation.
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