Inside Finance | Fall 2021
Analyzing Two Accounting Approaches for Cryptocurrencies
In the absence of comprehensive guidance for cryptocurrencies, companies that hold them on their balance sheets are looking for the best method to account for them.
Nancy Miller, CPA
Controller - UOP, Honeywell International Inc.
Cryptocurrencies have so far managed to dodge comprehensive regulation and
straightforward accounting approaches despite their expanding uses and growing
popularity among investors and companies alike, which has created unique challenges for
corporate finance professionals—especially those trying to account for their presence on
an organization’s balance sheet. Let’s take a look at what accounting approaches work—
and which don’t—for cryptocurrencies.
A quick refresher on cryptocurrencies: They’re a purely digital medium of exchange
powered by blockchain technology. This technology means that cryptocurrencies aren’t
housed in any particular system but are spread across a decentralized network of
computers that record and verify transactions and continually update the respective
blockchain. There are thousands of cryptocurrencies today, of which Bitcoin is believed to
be the first and remains the most popular.
Explanations for why cryptocurrencies have become so popular vary. Some proponents
believe they’re the currency of the future, while others think the decentralized blockchain
technology behind cryptocurrencies makes them more secure. Others like cryptocurrencies
as investment vehicles and hope they continue to rise in value. Yet others gravitate toward
them because they eliminate the need for central banks and other financial institutions and
allow parties to transact without intermediaries.
So, what’s the accounting issue? Well, there’s no authoritative or universal guidance
currently on accounting for cryptocurrency. Here are two of the most intuitive methods for
accounting for cryptocurrencies so far, along with my analysis of whether or not these
methods hold up.
Fair Value Accounting
The first thought for many of us would be to use fair value accounting. However, there are
many ways in which cryptocurrencies don’t meet the definition of a class of asset that can
be accounted for at fair value.
Cryptocurrencies won’t meet the definition of cash or cash equivalents since they aren’t
considered legal tender and aren’t backed by sovereign governments. In addition,
cryptocurrencies don’t have maturity dates and have consistently experienced significant
price volatility. Cryptocurrencies can’t be considered financial instruments or assets as
they’re not cash nor an ownership interest in an entity and they don’t represent a contractual
right to receive cash or another financial instrument.
Finally, while cryptocurrencies may be held for sale in the ordinary course of business, they
aren’t a tangible asset and therefore may not meet the definition of inventory. For all these
reasons, using fair value accounting for cryptocurrencies can be challenging.
Currently, the consensus seems to be that cryptocurrencies can be accounted for as intangible assets since they’re assets that lack physical substance. An indefinite-lived intangible asset is initially carried at the value determined in accordance with ASC 350 and isn’t subject to amortization but should be tested for impairment annually, or more frequently if events or changes in circumstances indicate it’s more likely than not that the asset is impaired. Ultimately, this means that the value can be reduced on the balance sheet due to the decline in price, but there’s no way to recover that value as U.S. GAAP doesn’t allow for reversal of impairments.
While treating cryptocurrencies as intangible assets may make sense on the surface, the concern around this approach is that it might not accurately reflect the economic value. Cryptocurrencies can be used to purchase goods or services or be held as an investment. Absent the ability to mark up the value of its cryptocurrency holdings, if a company believes fair value to be more reflective of the economics of its investment, it has the flexibility to provide disclosures that it believes are meaningful to its stakeholders (being mindful of non-GAAP measures when preparing these types of disclosures). Companies should provide stakeholders with detailed information about their cryptocurrency holdings, such as the underlying purpose, given exchange, purchase price, and quantity. With this information, stakeholders can arrive at an approximate determination of the valuation of the company’s holdings or return on their investments.
But what happens when companies use cryptocurrencies for business transactions, such as paying vendors? A more complex accounting treatment is required for these transactions as the intangible asset is now being used as a tangible asset. This muddies the usefulness of financial reporting using the intangible asset method.
The issues currently arising are complex, but there are paths forward. Ultimately, I believe the simplest approach in the short term is to consider accounting for cryptocurrencies as financial assets at fair value rather than as intangible assets. Under fair value accounting, companies can recognize losses and gains in value immediately, and while it may create more volatility in the financial statements, it will provide the most useful information to stakeholders.
This column was co-authored with John Hepp, Ph.D., clinical assistant professor of accountancy in the University of Illinois Gies College of Business.