What you need to know about accounting for Bitcoins – PART 2

Part 1 of this article gave an understanding of what Bitcoin is. From all the research and analysis of this financial reporting “nightmare”, an in-depth analysis is needed. Whilst most accountants are still pondering on what exactly are bitcoins and trying to understand the technicalities behind them, most potential investors are already asking questions which affect the accounting profession:

  1. Is there an International Financial Reporting Standard (IFRS) which guides on accounting of bit coins?
  2. If there is no guidance, should the International Accounting Standards Board develop one?
  3. If there is no guidance, what are accountants doing now?
  4. How will auditors verify the occurrence of a digital currency transactions, verify existence and valuation of the Bitcoins etc.?

What are the possible financial reporting implication of cryptocurrencies?

Despite the accelerated usage of the Bitcoins, there is unfortunately no specific guidance from the International Accounting Standards Board with regards to financial reporting for cryptocurrencies. Lack of guidance however does not stop transactions taking place and neither does it exonerate accountants from reporting on the transaction.

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors provides guidance where there is no existing standard or interpretation which applies to a specific transaction, other event or condition. It emphasizes the need for management to exercise its judgement in developing an accounting policy that results in information that is relevant and reliable to the economic decision-making needs of users. In making such a judgement, one must first consult the requirements and guidance in another International Financial Reporting Standard dealing with a similar issue or guidance which may have been issued by another standard setting body. Currently, there are no similar transactions covered by IFRS and no such guidance has been formally drafted to date by any financial reporting body.

In circumstances where no such guidance exists, one can also try to apply the definitions of elements in the Conceptual Framework and the recognition criteria in same to account for the transaction. Our analysis in this paper will therefore be based on the Conceptual Framework.

A reporting entity should report business transactions and events must be reported as an asset, liability, income, expense or equity in the statement of financial position and or as income or expense in the profit and loss account. Are Bitcoins therefore assets, liabilities, equity or income or expenses?

When an entity incurs a cost, the cost can either be capitalized as an asset, or it should be expensed. For one to obtain Bitcoins, an initial investment (cost) must be incurred, thus Bitcoins should be tested for qualification as either an asset or as an expense.

An asset is as a resource controlled by the entity because of past events and from which future economic benefits are expected to flow to the entity. The idea of an asset is the ability of an entity to use that resource obtained to ultimately create future economic benefits for itself and the entity is able to limit any other party from accessing the same benefit from the same resource. In our opinion, costs incurred to hold digital currency would meet this definition as an entity would either buy, “mine” or receive a digital currency unit as payment (i.e. past event) and would be able to control that digital currency unit as it would be able to decide when to sell it or use it as a medium of exchange (i.e. resource controlled). Each bitcoin has its own encrypted identification number, thus no two parties can have rights to the same coin, which puts ultimate control on one owner. Finally, if an entity sells or otherwise exchanges a digital currency for some other goods or services, the economic benefit is expected to flow to that entity. Bitcoins are therefore definitely assets to holders.

The financial reporting  treatment of assets however differ depending on the asset category. Assets are classified based on their nature and how each entity recovers its investment in the asset which includes: Inventory, Property Plant and Equipment, Financial Assets, Intangible Assets, Investment Property and Biological Assets

When considering the applicable asset category, we would need to take into account the following

  1. Frequency of trading for the applicable company
  2. Volatility or Risk of Change in Value; Bitcoin has moved from no value in 2009. In 2013, the price soared from less than $15 to more than $1,000 over the course of the year and in December 2017 it got to $13 800
  3. Regularization in the applicable jurisdiction
  4. Physical Substance
  5. Rights
  6. Convertibility
  7. Unit of Account (Goods or Services being purchased using bitcoin are priced in e.g. USD or Rand)
  8. Link to macroeconomics e.g. Interest rates

It is important to note that on 25 May 2016 the Japanese government passed a bill to regulate Bitcoin exchanges. They also passed a set of bills recognizing virtual currencies like bitcoin to contain asset-like-values that can be used to make payments and be transferred digitally but some jurisdictions like Zimbabwe and India are still skeptical and have issued warning cautioning users. Some companies in the USA and South Africa are accepting bitcoin to pay for goods or services using Bitcoin wallet software typically installed on a computer or mobile device e.g. United States of America. This would also need to be considered when assessing the asset category.

Due to the depth and analysis surrounding bitcoins, an in-depth analysis of each asset category is needed and the resulting valuation. This assessment will be made in Part 3 of this paper.