According to a crypto research agency CREBACO, Indian crypto investments by October, 2021 had increased to over US $10 billion, with 105 million Indians, i.e., approximately 7.90% of India’s total population, owning cryptocurrency. Currently, numerous cryptocurrencies, crypto coins and crypto tokens are in circulation. Some cryptocurrencies such as Bitcoin are also used as an alternative to money, though its main use is as investment in an asset class. At the time of writing, over 12,000 different cryptocurrencies, crypto coins and crypto tokens were traded or listed on various crypto exchanges across the globe.
This article discusses the accounting by holders of crypto assets under Ind AS. A question arises that if crypto assets are not legal tenders, then would they fulfil the definition of asset in the first place. In accordance with the Conceptual Framework for Financial Reporting under Ind AS issued by the ICAI ‘An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.’ The crypto assets are capable of producing economic benefits because they can be sold at a price and the economic benefits can be realised. Therefore, they would meet the definition of an asset under the Conceptual Framework.
The IFRS Interpretation Committee (IC) in its Agenda decision titled Holdings of Cryptocurrencies in June, 2019 defined a cryptocurrency as a crypto asset with all of the following characteristics: ‘(a) a digital or virtual currency recorded on a distributed ledger that uses cryptography for security, (b) not issued by a jurisdictional authority or other party, and (c) does not give rise to a contract between the holder and another party’. Bitcoin, for example, would meet this definition. Cryptocurrencies represent a subset of crypto assets. The terms and applications of the crypto assets vary widely and could change over time. The terms and conditions and the purpose for which they are held by the holders will determine the accounting consequences.
Some crypto assets entitle the holder to an underlying good or service from an identifiable counter-party. For example, some crypto assets entitle the holder to a fixed weight of gold from a custodian bank. In those cases, the holder can obtain economic benefits by redeeming the crypto asset for the underlying. While not money as such, these crypto assets share many characteristics with representative money. Other crypto assets (e.g., Bitcoin) do not entitle the holder to an underlying good or service and have no identifiable counter-party. The holder of such a crypto asset has to find a willing buyer who will accept the crypto asset in exchange for cash, goods or services to realise any economic benefits from the crypto asset.
An entity can directly hold its crypto assets in its own ‘wallet’ or may hold it indirectly. For example, an entity holding an economic interest in crypto assets in the shared wallet of a crypto asset exchange may have an indirect holding of the crypto assets through a claim on the exchange. In this case, in addition to the underlying crypto asset volatility, the holder would also be exposed to counter-party performance risk (i.e., the possibility that the exchange is not holding sufficient crypto assets to cover all customer claims). The holder would need to analyse carefully, among other things, its claim on the crypto exchange to evaluate the nature of the assets held to determine the appropriate accounting treatment.
CAN CRYPTOCURRENCY OR CRYPTO ASSET BE CLASSIFIED AS CASH?
Ind AS 32 indicates that cash represents the medium of exchange and is, therefore, the basis on which all transactions are measured and recognised in the financial statements. The description of cash in Ind AS 32 suggests that cash is expected to be used as a medium of exchange (i.e., used in exchange for goods or services) and as the monetary unit in pricing goods or services to such an extent that it would be the basis on which all transactions are measured and recognised in financial statements (i.e., it could act as the functional currency of an entity). Currently, it is unlikely that any crypto asset would be considered a suitable basis for measuring and recognising all the items in an entity’s financial statements.
At present, crypto assets are not used as a medium of exchange except for Bitcoins to a very limited extent; however, the acceptance of a crypto asset by a merchant is not mandated in most jurisdictions. While some governments are reported to be considering issuing their own crypto assets or supporting a crypto asset issued by another party, at the time of writing El Salvador is the only country that has passed legislation that treats Bitcoin as legal tender (alongside US dollars).
The price of crypto assets is highly volatile when compared to a basket of fiat currencies. Hence, no major Governments or economic actors have stored their wealth in crypto assets. Crypto assets continue to remain a speculative investment. If, in the future, a crypto asset attains such a high level of acceptance and stability that it exhibits the characteristics of cash, a holder would need to consider whether that crypto asset represents a medium of exchange and unit of account to such an extent that it could act as the basis on which the holder recognises and measures all transactions in its financial statements (i.e., it could act as the functional currency of an entity). In 2019, the IFRS Interpretation Committee (IC) confirmed that crypto assets currently do not meet the definition of cash equivalents because they are generally, among other things, not convertible to known amounts of cash, nor are they subject to an insignificant risk of change in value.
CAN CRYPTO ASSETS QUALIFY AS FINANCIAL INSTRUMENTS?
Ind AS 32 defines a financial instrument as any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. The first part of the definition of a financial instrument requires the existence of a contract or contractual relationship between parties. A contract is defined by Ind AS 32 as an agreement between two or more parties that has clear economic consequences which the parties have little, if any, discretion to avoid, usually because the agreement is enforceable by law.
Crypto assets generally do not entitle the holder to underlying goods, services or financial instruments and have no identifiable counter-party and consequently would not meet the definition of a contract and qualify as a financial instrument. For example, the individual parties involved in the Bitcoin blockchain do not have a contractual relationship with any other participant in the Bitcoin blockchain. That is, by virtue of owning a Bitcoin, the holder does not have an enforceable claim on Bitcoin miners, exchanges, holders, or any other party. Such holders need to find a willing buyer to realise economic benefits from holding their Bitcoin.
WILL CRYPTO ASSET QUALIFY AS EQUITY INSTRUMENT?
Ind AS defines an equity instrument as any contract that evidences a residual interest in the assets of an entity after deducting all its liabilities. Although the value of a crypto asset may correlate to the popularity of an underlying platform on which it is used, that, by itself, does not represent a contractual right to a residual interest in the net assets of the platform. Therefore, a crypto asset will not qualify as an equity instrument.
WILL CRYPTO ASSET QUALIFY AS A DERIVATIVE INSTRUMENT?
Ind AS 109 defines a derivative as a financial instrument or other contract within the scope of Ind AS 109 with all three of the following characteristics:
* Its value changes in response to the change in an ‘underlying’ that is not specific to a party to the contract;
* It requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors;
* It is settled at a future date.
Crypto assets that are not contractual themselves could still be the subject of a contract, for example, a binding agreement to buy Bitcoin from a certain counter-party would constitute a contract, even though the Bitcoin itself does not represent a contractual relationship. Therefore, agreements entered ‘off the chain’ to buy or sell crypto assets would qualify as contracts.
Some contractual rights to buy or sell non-financial items that can be settled net in cash, or for which the non-financial items are readily convertible to cash, are accounted for as if they were financial instruments (i.e., a derivative). A contractual right to buy or sell crypto assets (e.g., a Bitcoin forward entered with an investment bank) could be a derivative even if the crypto asset itself is not a financial instrument, provided the crypto asset is readily convertible to cash or the contract can be settled net in cash. This is like the accounting for commodity contracts that are held in a trading business model (e.g., forward silver contracts may fall within the scope of Ind AS 109, although silver itself is not a financial instrument).
WILL CRYPTO ASSET QUALIFY AS INVENTORY?
Although it is often assumed to be the case, Ind AS 102 does not require inventory to be tangible. The standard defines inventory as an asset:
* Held for sale in the ordinary course of business;
* In the process of production for such sale; or
* In the form of materials or supplies to be consumed in the production process or in the rendering of services.
In practice, crypto assets are generally not used in the production of inventory and, thus, would not be considered materials and supplies to be consumed in the production process. Therefore, to this extent crypto assets do not qualify as an item of inventory.
Crypto assets could also be held for sale in the ordinary course of business, for example, by a commodity broker-trader, in which case it would qualify as an item of inventory. Whether crypto assets are held for sale in the ordinary course of business would depend on the specific facts and circumstances of the holder. Normally, Ind AS 102 requires measurement at the lower of cost and net realisable value. However, commodity broker-traders who acquire and sell crypto assets principally to generate profit from fluctuations in price or broker-traders’ margin have the choice to measure their crypto asset inventories at fair value less costs to sell with any change in fair value less costs to sell being recognised in profit or loss in the period of the change.
WILL CRYPTO ASSET QUALIFY AS INTANGIBLE ASSETS?
Ind AS 38 defines 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’. Ind AS 38 describes four essential features of an intangible asset:
Control – Control is the power to obtain the future economic benefits of an item while restricting the access of others to those benefits. Control is normally evidenced by legal rights, but Ind AS 38 is clear that they are not required where the entity is able to control access to the economic benefits in another way. Ind AS 38 notes that, in the absence of legal rights, the existence of exchange transactions for similar non-contractual items can provide evidence that the entity is nonetheless able to control the future economic benefits expected.
Future economic benefits – Many crypto assets do not provide a contractual right to economic benefits. Instead, economic benefits are likely to result from a future sale, to a willing buyer, or by exchanging the crypto asset for goods or services.
Lacks physical substance – As crypto assets are digital representations, they are by nature without physical substance.
Identifiable – In order to be identifiable, an intangible asset needs to be separable (capable of being sold or transferred separately from the holder) or result from contractual or other legal rights. As most crypto assets can be freely transferred to a willing buyer, they would generally be considered separable.
Crypto assets generally meet the relatively wide definition of an intangible asset as they are identifiable, lack physical substance, are controlled by the holder, and give rise to future economic benefits for the holder. The IFRS Interpretation Committee (IC) confirmed in 2019 that crypto assets would generally qualify as an intangible asset, subject to consideration of detailed facts and circumstances.
CONCLUSION
The accounting of cryptocurrency by holders in most cases would qualify as an intangible asset. However, given the numerous versions of cryptocurrency and other innovations, such as an exchange traded fund of crypto, the accounting conclusion may not be fairly straight forward. One will have to carefully analyse the features and the terms and conditions of the crypto to determine the accounting conclusion. Besides, the accounting would be different for a trader of crypto as against an investor in crypto.
