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Digital assets: what are the accounting issues?

Author: ICAEW Insights

Published: 23 Aug 2022

ICAEW’s Head of Tech Policy, Esther Mallowah, explores the challenges surrounding accounting for digital assets and provides highlights of a recent panel discussion on the subject.

Accounting for digital assets was originally predicted to be one of the next big accounting issues at the ICAEW Information for Better Markets (IFBM) 2021 Conference. The conference examined accounting issues that could fall into the ‘too difficult box’ and the challenges with addressing these in accounting standards. The dialogue from the IFBM conference prompted ICAEW’s hosting of a follow-up panel session at the virtual Annual Meeting of the American Accounting Association (AAA) earlier this month.

In its simplest and broadest sense, anything that exists in digital form that can be used to realise value is a digital asset. That includes audio files, videos, logos, databases, software and websites, all of which have been around from as far back as the 1950s.

Technological advancement in the 1990s facilitated the development of company websites and digital equivalents of physical assets such as paper documents, photographs, and cash, and enabled the dematerialisation of financial instruments such as share certificates.

Most recently, advancements in cryptography, distributed ledger technologies (DLTs), and smart contracts have broadened the ways in which digital assets can be created, used and transferred. This has led to the newest wave of digital assets including crypto assets such as cryptocurrencies, non-fungible tokens (NFTs), central bank digital currencies (CBDCs), asset-backed tokens and tokenised real estate.

Although this history lesson shows that digital assets are not a new phenomenon, it is only now that debates surrounding the challenges of accounting for digital assets seem to be gaining traction, reflecting their growing complexity.

And those debates seem set to increase as the scope and nature of digital assets continues to broaden thanks to further developments and growing innovation in technologies such as augmented/virtual reality, artificial intelligence, Web 3.0, quantum computing and 5G.

While the term digital assets is often used to refer to the subset of digital assets backed by DLTs, eg, crypto assets, it is important to remember that the scope is much broader and encompasses both older digital assets as well as any future digital assets.

What are the accounting challenges?

Digital assets can offer business benefits by making transactions and processes cheaper, faster, and more efficient and inclusive. In the past, they have been classified as intangible assets for accounting purposes and measured at cost less accumulated amortisation and impairment losses. However, experience has shown that this is not always an accurate representation.

The broad and ever-changing scope of digital assets and the variety of use cases, even for individual assets, makes them complicated. For example, bitcoin was originally intended to be used as a form of exchange, similar to cash. And while it can be used that way, it is most often held as a speculative investment.

Depending on how the assets are used, the appropriate accounting treatment will vary. In addition, there is often a lack of clarity on the rights and obligations associated with different types of digital assets, which again makes accounting for them tricky.

Digital assets can also have a material impact on financial stability. Their value can fluctuate significantly in a short period of time as was seen with the sharp drop in the prices of Bitcoin, Tether and Luna earlier this year. The effects can be far reaching, going beyond individual assets to wider markets and causing significant financial harm to individuals.

Further, regulation on digital assets is limited, with a patchwork of existing and proposed regulations covering particular elements of specific digital assets. The EU Markets in crypto assets (MiCA) proposal and the 5th Anti Money Laundering Directive, as well as the UK Financial Services and Markets Bill and the US crypto bill all focus on specific elements of crypto assets.

Accounting’s response on what standard should be set

I was one of the panellists at the recent AAA panel session alongside Financial Accounting and Standards Board (FASB) board member Christine Botosan and Craig Smith, Technical Manager, International Accounting Standards Board (IASB).

The panel discussed whether standard setters should get ahead of regulators in defining how to account for digital assets. Christine’s view was that this carries the risk of being interpreted as accounting’s endorsement of digital assets which may influence the market. The panel agreed that the better approach would be for standard setting bodies to stay on top of current developments and be prepared to respond appropriately.

Given the broad scope of digital assets, panellists proposed that the sensible approach would be to focus on specific subsets of digital assets as they become more prevalent.

Financial Accounting Standards Board (FASB) approach

In May this year, FASB voted to add a project to its technical agenda to address accounting for certain digital assets and commodities, as a result of feedback to an Invitation to Comment on its Agenda Prioritisation. Although the exact scope is yet to be determined, it is expected to focus specifically on the use of crypto assets as cash.

Use of cryptocurrency is not yet pervasive, Christine Botosan remarked, with the bulk of bitcoin cryptocurrency held by a handful of companies, and the expectation is that the majority of accountants are not accounting for or auditing material amounts of crypto assets.

Cryptocurrency has previously been accounted for as an indefinite-lived intangible asset valued at cost minus impairment or using specialised industry guidance. However, as cryptocurrencies release their future cash flow through exchange, overwhelming feedback has been to account for it at fair value. This was noted to be a sensible approach, but one that only works where there is an existing market.

International Accounting Standards Board (IASB) approach

The IASB has taken a slightly different approach. In 2019, the board committee discussed how IFRS Standards apply to holdings of cryptocurrencies. It took the decision not to add an associated project to its standard-setting agenda, as the view was that existing standards provided sufficient guidance.

It concluded that cryptocurrency meets the IAS 38 definition of an intangible asset and where it is held for sale in the course of ordinary business, it falls under IAS 2 Inventories. These standards provide accounting guidance including measuring value and routes to fair value assessment. The process to determine applicability of standards for cryptocurrencies can be used for other crypto assets and digital assets.

The IASB is continuing to monitor the area of crypto assets and has a project looking at intangible assets including the scope of IAS38 and what should/shouldn’t be covered. This will include reviewing whether cryptocurrency should be in the scope of IAS 38.

Despite the difference in approaches, the IASB and FASB agreed that to determine the right accounting treatment, accountants must consider the substance and financial impact of use of digital assets. The two bodies are in continued dialogue on how to account for cryptocurrency and other digital assets and will continue to work together on addressing the challenge.

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