The world is constantly evolving, and one of the latest big changes is the introduction of cryptocurrency to the wider world. Cryptocurrency was first created in 2009, but it spent a lot of time lingering in the background, slowly growing. Now, most people have probably heard of cryptocurrency (at least in passing), especially since El Salvador announced it would be made legal tender. Cryptocurrencies are becoming more of a popular concept, with some big companies like Tesla and MicroStrategy switching some of their cash reserves for cryptocurrencies. This opened up a door – after all, almost any business could use or trade in cryptocurrencies, and could even make a nice amount of money doing so. But if you do decide to dip your toe into the crypto world, there are a few things you need to think about. Today we will cover just one of them – how to handle cryptocurrency when it ends up on your balance sheet.
What is cryptocurrency?
While the numerous cryptocurrencies are only now really gaining in popularity, they have actually been around for a long time. But many people still have not heard of them, or what they mean. So, let’s start at the beginning – the official definition of a cryptocurrency is:
‘A digital asset designed to work as a medium of exchange wherein individual coin ownership records are stored in a ledger existing in a form of a computerized database using strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership.’
In other words, cryptocurrency is a form of digital payment, that can be exchanged for goods and services online, or be converted into real world money. They act a bit like tokens from an arcade – you use real money to buy them, and then you can spend the tokens online on the goods and services you want. If you have any left over, or if you earned more tokens, you can exchange them for cash.
In recent years, many companies have created and issued their own forms of cryptocurrency, designed to be traded specifically for the goods or services their company provides. With that in mind, it’s not really surprising that there are over 10,000 different cryptocurrencies on the open market and available for public trade. However, you will probably never hear of a lot of them. The most commonly used cryptos by far are called Bitcoin, Ethereum and Litecoin.
One of the big advantages of cryptocurrency over normal cash is the security. Cryptocurrencies are built on a technology called ‘blockchain’, which is decentralised technology spread across many different computers, using each one to manage, track and record every transaction. This method means that cryptocurrencies are actually one of the most secure forms of payment out there. But there is a catch – cryptocurrencies are still quite volatile, which means the cash value can rise and fall drastically at the drop of a hat.
How do you account for cryptocurrency?
Another thing that can cause a bit of confusion for businesses wanting to invest in cryptocurrency is how to account for it. The main problem is that the current guidance and rules for accounting under UK GAAP (Generally Accepted Accounting Practice), do not address cryptocurrencies or anything similar, so businesses are left to decide for themselves where their cryptocurrencies fit into existing asset classes. When you look through the options, there are 4 possible categories, but only one of them really fits the bill.
Cash: Under the UK’s Financial Reporting Standard (or FRS 102), there is a very strict definition for what cash is and how it should be accounted for. According to FRS 102, cash is: ‘Cash on hand and demand deposits and short term highly liquid investments that are readily convertible to known amounts of cash, and that are subject to an insignificant risk of changes in value.’ So cryptocurrencies fall short of the mark here, since they are not a legal tender backed by any government. They are highly volatile, as we mentioned earlier, and with a low liquidity into fiat currency and a small number of outlets accepting them as payment. So cash is not the right accounting class for cryptocurrency.
Financial instrument: FRS 102 gives us nice clear guidance about financial instruments as well, and why cryptocurrency doesn’t fit into this category either. A financial instrument is a contract that gives rise to a financial asset of one entity, and a financial liability or equity instrument of another. So while you can convert cryptocurrencies into cash, the holder of the cryptocurrency does not have the right to cash just because they hold the cryptocurrency. And since it also does not result in any equity instruments, it does not meet any of the criteria here.
Inventories: It is debatable whether cryptocurrencies could be considered inventories because an inventory is defined as an asset that is held for sale in the ordinary course of business. So technically, any business that simply buys and sells cryptocurrency and nothing more could account for them this way. This would mean they hold the assets at the lower cost and estimated selling price, using the ‘first in, first out’ or ‘weighted average’ formulas in their accounts. If this is needed, we recommend working with an accountant to ensure no mistakes are made.
Intangible assets: This is the most fitting option for cryptocurrencies at the moment. According to FRS 102, an intangible asset needs to be:
‘An identifiable, non-monetary asset without physical substance. Such an asset is identifiable when:
- It is separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, asset or liability; or
- It arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.’
Since cryptocurrencies tick all these boxes, this is the best route for any business looking to work in cryptocurrencies should use when trying to account for it.
Cryptocurrency is still a developing technology, but it is one that is gaining in popularity, particularly in business circles. But the main issues these businesses face is because cryptocurrency is so new, there really isn’t any guidance about how to account for it. So, for now, all we can do is use the current accounting standards to find the best fit and wait for the guidance to catch up with the digital world.
In the meantime, if you are considering investing in cryptocurrency, the recommendation is to do your research, ensure you understand how cryptocurrency works, and to find an accountant who also understands the crypto market. When working with cryptocurrencies your accountant will be a lifeline, giving you advice on how to best handle the process, and to account for cryptocurrencies properly. At Purple Lime, we love working with new technologies, and are excited by all the challenges that cryptocurrencies will bring. If you would like to know more, or see how we can help you, please get in touch to book your free consultation by emailing firstname.lastname@example.org, or calling us on 01249 691360.