December 4, 2019 – The Securities and Exchange Commission (SEC) has adopted the Philippine Interpretation Committee’s (PIC) Accounting Pronouncement for cryptographic assets in a circular published this November 2019.
In this article, we summarized some of the key points discussed in the PIC’s “Accounting for Cryptographic Assets” consensus with references at the end of the article. This is a subject I am not entirely familiar so I asked Atty. Rafael Padilla about it. He said the PIC provides guidance on how the Philippine Accounting Standards (PAS) and Philippine Financial Reporting Standards (PFRS) should be interpreted. “SEC adopting their interpretation on PIC Q&A No. 2019-02 practically means that Certified Public Accountants can rely and be guided by such interpretations when performing accounting and audit services for cryptoasset businesses.”
Classifying Cryptographic Assets for Accounting Purposes
According to the PIC, there are 2 characteristics of cryptographic assets that are relevant for accounting purposes:
- The primary purpose of the cryptographic asset
- How the cryptographic asset derives its inherent value
Four Possible Subsets of Cryptographic Assets
Based on the characteristics detailed above, the PIC proposes the following 4 specific subsets
- Purpose: Cryptocurrencies like Bitcoin operate independently of a central bank and are intended to function as a medium of exchange.
- Inherent Value: None – because its value is based on supply and demand.
2. Asset-backed Token
- Purpose: Signifies and derives its value from something that does not exist in the blockchain but instead is a representation of ownership of a physical asset (such as gold, or oil)
- Inherent Value: Derives its value based on the underlying asset.
3. Utility Token
- Purpose: Provides users with access to a product or service. The utility token will not give its holder any ownership to the company that issues the tokens. Although they are traded, they are not primarily used as a medium of exchange.
- Inherent Value: Derived from the demand for the issuer’s service or product.
4. Security Token
- Purpose: Similar to traditional securities, they can provide an economic stake in a legal entity; sometimes a right to receive cash or another financial asset, which might be discretionary or mandatory; sometimes the ability to vote in company decisions and/or residual interest in the entity.
- Inherent Value: Derived from the success of the entity, since the holder of the token shares in the future profits or receives cash or another financial asset.
How should companies report cryptocurrency in their financial statements?
The PIC sought to create a guideline on
- How a company as a “holder” must report the following cryptographic assets in their financial statements?
- Cryptocurrencies held by an entity
- Cryptographic assets other than cryptocurrencies
- How should a company as an “issuer” report crypto tokens in their financial statements?
Because there is no clear industry practice, the accounting for cryptographic assets could fall into a variety of different standards.
For Accounting for Cryptocurrencies Held By An Entity
1. Cryptocurrencies can be treated as inventory
Under PAS 2 (Philippine Accounting Standards), “Inventories”, inventories do not need to be in physical form, but can consist of assets that are held for sale in the ordinary course of business. This kind of accounting (inventory accounting) is appropriate for entities that hold cryptocurrencies for sale in the ordinary course of business.
If the entity holds crypto for the purpose of investment and is waiting for the value to appreciate over a period of time, then it will not meet the definition of inventory.
2. Cryptocurrencies can be treated as Intangible Asset under PAS 38
Cryptocurrencies can also meet the definition of an intangible asset – those assets with no physical form but can be sold, exchanged, or transferred individually, and is expected to have future economic benefits for the entity.
For Accounting for Cryptographic Assets Other Than Cryptocurrencies Held By An Entity
This will include security tokens, asset-backed tokens, utility tokens (referred below as crypto tokens). (Also, remember the classification of cryptographic assets described earlier in the article).
- For asset-backed tokens, the accounting will be driven by the nature of the underlying asset and the relevant accounting standard.
- For utility tokens, it can meet the definition of accounting for intangible assets.
- For security tokens – accounting for financial assets
- For crypto tokens with hybrid characteristics, further analysis must be required to determine the applicable accounting treatment.
Accounting For Crypto Tokens By the Issuer
This is a bit tricky. PIC said that if an Initial Coin Offering (ICO) is undertaken, the issuing entity will receive consideration that varies (cash? another cryptographic asset?). For accounting, the economics and characteristics of the transaction must first be understood.
- If the ICO token meets the definition of a financial liability, apply guidance in PFRS 9
- If the ICO token meets the definition of an equity instrument, apply guidance in PAS 32
- If the ICO token is a prepayment for goods and services from a contract with a customer, apply PFRS 15
- If the ICO Token does not meet any of the above, consider other relevant guidance
PFRS (Philippine Financial Reporting Standards) and PAS (Philippine Accounting Standards) can be found here.
In the last part “consider other relevant guidance”, the hierarchy in PAS 8 ”
Accounting Policies, Changes in Accounting Estimates and Errors” will be considered. PIC believes that it is unlikely for the issuers to receive consideration without taking on an obligation to the subscribers. Meaning there is always a legal or constructive obligation to the people who subscribe to the tokens.
This article is published on BitPinas: PH SEC Adopts PIC Guidance in Accounting for Cryptoassets
- PIC Consensus on Accounting for Cryptographic Assets
- SEC Memorandum Circular No. 22, Series of 2019 which approved and adopted Philippine Interpretation Committee’s Q&A No.2019-02
- Functions of the Philippine Interpretations Committee