Digital currencies proliferate, and companies are beginning to dabble in doing business there, but accounting guidance provides no explicit direction in how to reflect those activities in financial statements.
Plenty of regulators are buzzing with activity to determine how and in what manner to regulate the mushrooming market for digital currencies, but the Financial Accounting Standards Board has not yet opened a project to consider any rulemaking. The board has assigned some staff members to perform research that might help inform the board on what, if anything, it should do to develop new accounting standards regarding emerging digital currencies.
That has left accounting leaders, like the Big 4 firms, to come to a meeting of the minds on their own about how they will steer the accounting based on rules that already exist.
While over the past few years it has been primarily individual investors taking a crack at digital currencies, now companies are starting to experiment in doing business there as well, says Hee Lee, a partner at EY. Goldman Sachs, for example, recently appointed a vice president as head of digital asset markets as the investment banking firm explores how it might expand its scope to include digital asset offerings.
“A lot of institutions are getting into it, even some of the bigger players, either as investors or as a market maker in some of these instruments,” says Lee. “The pace at which market participants are engaging in this has accelerated significantly.”
Based on information provided via the bitcoin platform, which is the largest and best known digital currency, more than 100,000 companies have identified themselves as willing to accept bitcoin for payment, says Bob Uhl, a partner at Deloitte & Touche. Few, however, are holding amounts of bitcoin that would likely be regarded as material for most companies. Companies that accept bitcoin for payment often immediately convert it to cash, he says.
“Not a lot of people agree with that particular guidance. A lot of people believe given the volatility of the instrument, maybe fair value is the right measurement attribute.”
Hee Lee, Partner, EY
As they consider the financial reporting implications of doing business in digital currencies, they need to cobble through accounting guidance that doesn’t entirely fit with this emerging category of assets.
Companies reflect assets on corporate balance sheets based on the nature of the asset, whether it is cash or cash equivalents, other financial assets, inventory, physical property, or even intangible assets, like customer lists or trademarks. Those assets are defined in Generally Accepted Accounting Principles (GAAP) to make it clear how they should be accounted for in financial statements. Digital currencies do not clearly land in any of the defined buckets, accounting leaders say.
“It’s not a legal currency, so it’s not cash,” says Uhl. “It’s not a cash equivalent because it’s not convertible to a fixed, known amount in cash.” Digital currencies also do not meet the definition of other types of financial instruments or financial assets because they are not tied to contractual rights or obligations with other known parties.
Digital currencies also generally are not inventory or other physical assets because they are not tangible, says Uhl. An exception would be for investment companies, which can potentially make the case that digital currencies amount to an investment that is bought and sold for profit, given their business model.
For other companies, however, that leaves only one category where digital currencies potentially fit under GAAP—intangible assets—and even there, some analysis is in order. Ultimately, the asset class within GAAP where digital currencies best fit is “indefinite lived intangible assets,” says Uhl.
Under GAAP, intangible assets with an indefinite life are accounted for at cost, unless there’s a triggering event that would suggest impairment, or a decline in value. GAAP requires entities to check for impairment at least annually and to mark down the value if warranted, but it makes no provision for the value to rise again in the future.
Once such an asset is impaired and marked down, it can never increase in value—at least not in the value that is booked and reported under GAAP in financial statements. That’s not what happens to digital currencies in the marketplace, however, where their values rise and fall like any other traded security or commodity. “Nobody is really happy with that accounting, but that’s pretty much the agreement amongst all the firms,” says Uhl.
Lee concurs. “There’s a consensus now that while it may not be exact GAAP, intangible assets is where people are looking to in terms of guidance,” he says. “Having said that, not a lot of people agree with that particular guidance. A lot of people believe given the volatility of the instrument, maybe fair value is the right measurement attribute.”
Fair value is the measurement method for many financial assets, especially those that companies hold for sale. Readily observable market values give companies plenty of evidence of what those securities are worth, so they are marked up and down each period. Changes in those values are reported through the income statement.
Investment companies that are trading in digital currencies might be able to measure those currencies at fair value, but companies that are not specifically in the investment business are left with reporting falling values, not rising values, under the indefinite-lived intangible asset model.
The answers for companies following International Financial Reporting Standards are similar to the conclusions firms are developing in the United States, says Markus Veith, partner in charge at Grant Thornton. The International Accounting Standards Board also has not written explicit rules on how to account for digital currencies, but its staff has recommended the board consider issuing guidance. “We are seeing it being looked at very similarly,” says Veith.
It would be a good thing for companies if both FASB and IASB were to issue guidance that is aligned, says Veith. “We don’t expect any significant differences, but you never know until you know,” he says.
It remains to be seen whether FASB will consider amending accounting standards to allow for the emergence of this new asset class that is still making its presence known in capital markets. Uhl considers it a bit of a “chicken and egg” problem. Companies may hesitate to make more material investments until they have better accounting answers, but standard setters are not seeing material amounts that would suggest guidance should be a priority.