Developments in accounting for digital assets: a lost opportunity?
Accounting standards for digital assets need to go further than just cryptocurrencies, writes UNSW Business School's Andrew Jackson
Recent years have seen significant growth in the number and type of digital assets that have been developed and traded. This is in line with ongoing structural transformations in technology and reflects preferences by investors and consumers. While standard-setters continue to debate the best way forward, different forms of crypto-asset classes continue to emerge.
A digital asset is anything that is stored digitally and is uniquely identifiable that organisations can use to realise value. More formally, the European Financial Reporting Advisory Group (EFRAG) defined a crypto-asset as “a digital representation of the value of contractual right stored on some type of distributed ledger technology network (e.g. blockchain) and authenticated through cryptography.”
International accounting regulations and cryptocurrencies
At present, there is a lack of substantial guidance provided by accounting standards for the treatment of digital assets. In June 2019, the International Financial Reporting Standards Interpretations Committee (IFRS IC) issued an agenda decision clarifying the appropriate IFRS-based accounting treatment for cryptocurrencies. They concluded that cryptocurrencies should be accounted for under IAS38 (Intangibles) unless they are also held for sale in the ordinary course of business, in which case IAS2 (Inventories) would apply.
EFRAG then called for submission around three possible options for policy recommendations: (i) allow companies the current discretion to set their own policies; (ii) to make amendments or clarifications to existing standards; or (iii) require standard setters to develop a new accounting standard to address digital assets and liabilities.
On 29 April 2022, EFRAG released its report. Their findings indicate that the majority of respondents in comment letters or via survey supported amending existing standards, with a new standard being the second preference. The policy recommendation put forward by EFRAG was consistent with the feedback received, using a two-step approach. As a first step of amending and clarifying existing IFRS requirements, EFRAG recommended addressing the accounting requirements for holders of crypto-assets by amending IAS 38 to allow for fair value through profit and loss for crypto-assets or other intangibles within the scope of that Standard and develop disclosure requirements for issuers.
Read more: What will Australian regulation mean for cryptocurrency?
As a second step, EFRAG considered it important to also address issuer accounting in more detail and determine the appropriate accounting requirements for issuers, given the challenges that arise from the ambiguity on the nature of rights and obligations associated with the issuance of the novel and fast-moving crypto transactions.
Digital assets and financial instruments
This, however, represents a lost opportunity. A major fallacy in the IFRS IC agenda decision is that they only consider cryptocurrencies. Cryptocurrencies only represent one subset of digital assets, which also include utility tokens, security tokens, asset-backed tokens, non-fungible tokens (NFTs) and stable coins. While EFRAG is correct in that cryptocurrencies do not meet the definition of a financial instrument, these other digital assets do, specifically as derivatives. Other developments, such as El Salvador making Bitcoin legal tender in September 2021, and companies such as Wikipedia, Microsoft and Tesla accepting payment in cryptocurrencies challenge the position that these are not cash.
The recommendations from EFRAG and the lack of inclusion of digital assets on the five-year work agenda of the IASB represent a lost opportunity. As technology continues to advance, new classes of digital assets are likely to emerge, as will the expectation of companies needing to accommodate digital assets into their operations. Without clear guidance, the relevance, comparability and understandability of financial reports are likely to be lacking. Interestingly, it is for the reason that technology is advancing so rapidly that EFRAG rejected the need for the development of a new stand-alone standard on the issue.
In the absence of a desire to draft a new standard dedicated to digital assets, there are opportunities to amend existing standards to more adequately capture the nature and purpose of holding digital assets. The nature and purpose of holding digital assets appear to be more consistent with that of a financial instrument, and except for cryptocurrencies would appear to already meet the definition of a derivative. Here, the standard setters have the ability to extend the definition of derivatives to specifically include cryptocurrencies. Such a treatment would then have the added advantage of already having the accounting rules around hedging addressed. The trader-broker exception within IAS2 could still be applied to the case of firms involved in the mining and selling of cryptocurrencies.
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It is important that the accounting around digital assets is adequately addressed before practices emerge contrary to the purpose of holding these instruments. The Australian Accounting Standards Board has the opportunity to take a world-leading position to ensure the appropriate treatment is put into place, and to pressure the IASB to follow suit.
Associate Professor Andrew Jackson teaches postgraduate financial accounting and financial statement analysis. His research focuses on earnings co-movements and decomposing earnings into market, industry and firm idiosyncratic components. The AASB Research Centre, in collaboration with CPA Australia and Associate Professor Jackson, is seeking input from preparers, users, and auditors on matters pertaining to the accounting and reporting of digital assets. For more information please visit The AASB Research Centre.