Author: Alexander J. Sannella, Ph.D., CPA; Professor of Accounting; Department of Accounting and Information Systems; Rutgers Business School; Newark, New Jersey1
The statements in this document reflect guidance issued as of February 1, 2020.
There is currently no codified guidance for accounting for virtual currencies under US GAAP and IFRS and therefore, practice has varied. In general, it is clear that virtual currencies are assets but the asset classification remains elusive. Most of the published information indicates that virtual currencies are not currency, not investments or financial assets and are generally not classified as inventory. In addition, the purpose of holding the virtual currency will determine the accounting treatment. Is the virtual currency held by an entity on its own behalf, held by an investment company or is it held for sale in the ordinary course of business? The answer to this question will drive the ultimate accounting treatment.
Virtual Currency Held by an Entity on its own Behalf
If an entity is holding a virtual currency on its own behalf, current practice classifies that asset as an indefinite life intangible asset. This means that under US GAAP the asset is held at cost and written down to market if impaired2. This is the cost-impairment model. The impairment test begins with assessing qualitative factors and if based on all available evidence it is determined that it is “more likely than not” that the asset has been impaired, the impairment is recognized as the difference between the fair value and the asset’s carrying value. If the “more likely than not” test is met and the asset is determined to have been impaired, then the asset is written down to market value, with a loss recognized in earnings. Of course, extracting a proper valuation from inactive markets is difficult. There is no ability to write the asset up again if it recovers.
The cost-impairment model is also available under IFRS with the ability to recover any losses but only up to the original carrying value. That is, an unrealized gain can only be recognized to recover an unrealized loss. IFRS also permits the use of a revaluation model when accounting for indefinite life intangible assets. Here the asset can be carried at fair value, if an active market exist and a gain results, it is deferred in other comprehensive income (on the balance sheet) until sold. Losses are recognized in profit and loss immediately. If impairment losses are initially recognized, subsequent gains can be recognized in earnings but only to the extent of the prior loss. Gains in excess of prior losses are recorded in other comprehensive income.
Virtual Currency Held by Investment Companies
Under US GAAP, entities defined as investment companies may invest in or hold virtual currencies as an asset class for purposes of capital appreciation. In this case, the entity would classify the virtual currency as an investment (typically other investments because virtual currencies are not securities or financial assets). The investment company can employ fair value accounting with unrealized gains and losses recognized in earnings. The existence of an active market is critical for these mark-to-market procedures to be implemented.
Virtual Held for Sale in the Ordinary Course of Business
When virtual assets are held for sale in the ordinary course of business, the asset may be classified as inventory under IFRS and then, the lower of cost or net realizable value rule applies. The accounting, in this case, is as the cost-impairment models previously described. However, IFRS allows commodity broker-trader-type entities buying and selling virtual currencies in the normal course of business to utilize the fair value model: this is the implementation of fair value accounting with all unrealized gains and losses recognized in profit and loss. Under US GAAP, virtual currency does not meet the definition of inventory because it is not tangible in nature. Therefore, only the cost-impairment model applies.
1 Written by Alexander J. Sannella, Ph.D., CPA; Professor of Accounting; Department of Accounting and Information Systems; Rutgers Business School; Newark, New Jersey. Professor Sannella can be contacted at [email protected]. The author is writing on his own behalf and none of the statements should be attributed to Rutgers Business School.
2 An asset is considered to be impaired if its carrying value on the balance sheet exceeds its market value, net of disposal costs.