Cryptocurrency may be a relatively “new” investment for investment funds, but it highlights an old issue as it relates to why U.S. GAAP is a preferable basis of accounting for investment companies as opposed to IFRS. Investment companies (e.g. hedge funds) more commonly hold investments in cryptocurrency than other types of entities and therefore, these types of entities are the first to be exposed to the necessary analysis on how to account for these investments.
In our Investment Management Industry Fundamentals online and live-classroom training course, we highlight the unique transactions of this industry, and the special accounting and reporting for the industry. It is generally considered that funds would prefer to account for its investments at fair value through P&L as this provides investors and users of the financial statements with the most relevant information. However, when comparing U.S. GAAP to IFRS in this course, we often see that this may not always be the result. Cryptocurrency accounting highlights one of these fundamental differences between U.S. GAAP and IFRS for investment funds.
Accounting for cryptocurrency under IFRS
IFRS does not provide industry-specific accounting for investment entities and therefore, proper analysis of all IFRSs is necessary to determine the proper accounting for cryptocurrency.
My colleague, Christine Leese, posted a blog last week focusing on a recent IFRIC agenda decision related to cryptocurrency published in their June 2019 meeting. The IFRIC determined that under IFRS, a cyptocurrency does not meet the definition of a financial asset, namely that cyptocurrency was NOT cash. In order to be cash, crypto-assets should 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”. As a result, they concluded that CURRENTLY, cyptocurrency does not meet this definition (leaving the door open to be considered cash in the future when it becomes more commonly used in business).
As a result, cryptocurrency is viewed as an intangible asset under IAS 38 Intangible Assets, unless it is held to be sold in its ordinary course of business, in which case IAS 2 Inventories would apply.
Intangible assets under IAS 38:
Intangible assets under IAS 38 are generally measured at cost. Depending on whether the intangible asset has a finite or indefinite life, the cost is subject to amortization and impairment or just an annual impairment test. There is, however, a revaluation approach if an active market exists for the asset. However, increases in value due to revaluations are recognized through OCI (not earnings), whereas decreases below cost due to revaluations are recognized in earnings.
Inventory under IAS 2:
Inventory is generally measured at the lower of cost or net realizable value under IAS 2. However, there is a measurement exception for broker-dealers of commodities where fair value (less cost to sell) may be used for measurement. However, IAS 2.5 clearly limits this exception to inventory that is “principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin.” This likely will be a tough hurdle to reach for an investment fund.
As result of the IFRIC guidance, the ability to hold a medium to long-term investment in cryptocurrency at fair value through the P&L is unlikely under IFRS.
Accounting for cryptocurrency under U.S. GAAP
Unlike IFRS, U.S. GAAP provides industry-specific guidance for many industries including investment companies. Therefore, an investment company (as defined by ASC 946, where this specialized guidance is provided) does not have to perform nearly as complex an analysis as under IFRS.
Under ASC 946, investments (whether financial or non-financial, tangible or intangible) are measured at fair value through P&L. This measurement approach enables the financial statements to determine a current net asset value (and NAV per share) for an investment fund at each reporting date, which is the most relevant information for an investor or user of the financial statements.
In a recent Investment Company Annual Update training I was providing to a client, I asked one of the firm’s leaders in crypto-assets how he was advising his clients to address the recent IFRIC guidance regarding accounting for cryptocurrency. His response… “I tell them to move to U.S. GAAP!”
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