As mentioned in Part 2 of this series of articles, this part aims to discuss the issues around the class of asset that Bitcoins fall under. In Part 2, we had reached a conclusion that bitcoins are accounted for as assets in the financial records of the holder. This article expands on the type of asset it should be recognised under, thus PPE, Inventory, Intangible Assets, Investment Properties or Financial Assets.
Are they Inventory? – Inventories are current assets that are held for resale purposes or in other words, held for trade purpose in the entity’s ordinary course of business. Bitcoins may not be traded frequently enough such that trading activity would be an entity’s ‘ordinary’ course of business. Bitcoins would fail the definition of inventory unless this test is met. This class, therefore, will not apply to most entities.
Are they Financial Assets? – A financial asset is a form of a financial instrument. A financial asset is defined as a contract that results in the holder holding a financial asset and the issuer holding a financial liability or equity. One of the key factors for an asset to be considered a financial asset is a contractual relationship. Bitcoins arise as a result of ‘mining’, and not as a result of a contractual relationship. Therefore, there is no contractual relationship, and consequently, not a financial instrument. One may, however, argue that Bitcoins can still qualify to be a financial asset through the cash criteria.
Are they Cash and Cash Equivalents? – Although it may seem fairly obvious to some that Bitcoins should be treated the same as any other physical currency, it is imperative to note that most countries – especially in Africa – have not legalised the usage of Bitcoins as a mode of exchange. The most important, implicit, aspect of ‘cash’, for accounting purposes is the central bank support and designation as legal tender and as a widespread medium of exchange. Bitcoins are not issued or backed by any government or state. Given its limited application as well at the moment, there are relatively very few vendors who would currently accept a Cryptocurrency as payment. It is therefore highly likely that the Cryptocurrency cannot be accepted to be cash in most economies. This position might, however, change as digital currencies gain acceptance in future.
Cash equivalents are “short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value”. It would seem that a digital currency would fail the definition of a “cash equivalent” as a result of the significant volatility in the price (the price is currently $11,300 as at 23 January 2018, after reaching $20,000 in December 2017, from $1 a few years ago).
Intangible Assets? – An intangible asset is an identifiable asset without any physical substance. Identifiable simply means the asset is either capable of being separated or divided from the entity and sold, transferred, licenced, rented or exchanged; or it arises from a contractual or legal right.
Though Bitcoins are in digital form, each one has a unique code, thus can be identified separately and can be sold or be transferred to another party. Since Bitcoins only exist in digital form; they, therefore, can never have any physical substance. and the units can be traded and exchanged, they seem to meet the definition of an intangible asset.
Holders of Bitcoins will, therefore, have two alternatives of measurement being the cost model and the revaluation model in other comprehensive income.
The cost model, however, appears not to be the most appropriate given the fluctuations in the value of Bitcoins. Bitcoins value may increase, yet the cost model does not allow an increase of value to reflect market perception. The cost model may therefore not fairly represent the actual value of the instruments.
Furthermore, the cost model is not ideal to deal with items held for speculative or investment purposes or for items with cash-like features, as it fails to adequately capture either of the objectives.
In our opinion, to faithfully represent the economic nature and substance of Bitcoins, the Fair Value model seems, therefore, to be the most appropriate measurement model under the circumstances. Fair value would depict the current digital currency value for currency held for transactional purposes, and would also depict the fair value at reporting date of coins held for their appreciation in investment value. Furthermore, all changes in fair value (up or down) will be presented in the statement of profit or loss.
New guidance may, however, be required to be developed to avoid diversity in practice and provide meaningful information. Until we have new guidance, disclosure is key to explaining how Bitcoins are classified and measured.