How Are Cryptocurrencies Classified In GAAP Financials?

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More businesses are beginning to accept cryptocurrencies, including stablecoins, as a form of payment in addition to more traditional methods such as cash and credit card. Properly accounting for these transactions in GAAP financial statements is an emerging area as this trend continues.

The Financial Accounting Standards Board (FASB) is the IRS of the accounting world. The FASB is responsible for creating Generally Accepted Accounting Principles (GAAP). As of the date of posting, there are still no cryptocurrency specific GAAP rules.

In the absence of these crypto specific rules set by the FASB, a few months ago, a working group formed by the American Institute of CPAs (AICPA) came up with a Digital asset practitioner guide addressing how to classify cryptocurrencies in GAAP financial statements, specifically, on the balance sheet.

In case you aren’t an accountant, the balance sheet of a company shows its financial position at a specific point in time. This is where the company lists their fixed assets (cash, equipment, land, etc.) and liabilities (amounts owed to outsiders, loans, etc.) and equity (composition of the ownership). What’s reported on the balance sheet reflects the financial picture of the entity so it has a direct impact on company valuation.

How Cryptocurrencies Are Classified On Financials

According to the white paper issued by the AICPA, crypto assets can not be classified as “cash or cash equivalents” on GAAP financial statements because they are not backed by a sovereign government or considered legal tender. They cannot be classified as a financial instrument or a financial asset because they are not cash (see above why) and do not represent any contractual right to receive cash or another financial instrument. Additionally, since cryptocurrencies are intangible, they do not clearly meet the definition of inventory and cannot be labeled as inventory on the balance sheet either. 

Cryptocurrency As An Intangible Asset

After going through the process of elimination as explained above, we are left with only one category to classify cryptocurrencies under intangible assets with an indefinite life. This is how companies like Square are currently classifying crypto assets in the GAAP financials

Practical Mismatches With Intangible Asset Treatment

There are a few problems with classifying cryptocurrencies as intangible assets with indefinite life. Practically speaking, this accounting treatment does not align with the reality. Cryptocurrencies like bitcoin are liquid and work extremely similar to cash. The purpose of GAAP financial statements is to paint an accurate, unbiased picture of the underlying entity’s financial situation. By treating crypto assets as intangible assets, GAAP financials fails to communicate the high liquidity of crypto assets. 

Second, once an item is classified as an indefinite life intangible asset, it should be tested for impairment. This means, if the value of the crypto asset has gone down at the end of the reporting period, the business gets to write off that amount as an impairment loss (not to be confused with tax losses) on the income statement. However, if the value goes back up (which is pretty common due to high volatility), the business does NOT get to mark up the value of the asset. Therefore, the current GAAP accounting practice only leads understatement of crypto assets and prohibits the business from showing the true value of its crypto assets under possession on financial statements.

One thing to note is that, the majority of the small businesses are not required to issue financial statements that comply with GAAP standards. These businesses use either cash or tax basis accounting methods to prepare financial statements which often offer more flexibility when it comes to the classifications of crypto assets. In the next post, we will go through how a small business that deals with cryptocurrencies could treat them in financial statements.

Author: Shehan Chandrasekera

Read more at: https://www.forbes.com/sites/shehanchandrasekera/2020/05/21/how-are-cryptocurrencies-classified-in-gaap-financials/#38b4f2c165b2

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