Why bitcoin may prompt companies to write down losses or book zero profit growth even in a rally

  • In Business
  • 2021-03-18 09:30:00Z
  • By South China Morning Post

There is currently no specific accounting standard that deals with cryptocurrency investments, but the volatility of digital assets such as bitcoin, whose price has rallied 10 times over the past 12 months after dropping over 80 per cent in 2019, has raised questions about how their value will be treated by corporate investors.

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Unlike property investments or bank deposits where investors can track yields, cryptocurrencies offer no yield and price drivers are unclear.


A Meitu employee shows the features of the app in Xiamen, southeast China's Fujian province. Meitu became the first Hong Kong-listed company to invest its cash reserves into bitcoin. Photo: Xinhua alt=A Meitu employee shows the features of the app in Xiamen, southeast China's Fujian province. Meitu became the first Hong Kong-listed company to invest its cash reserves into bitcoin. Photo: Xinhua>

There is no rule barring listed companies in Hong Kong from diversifying their investments into digital assets. However, where an issuer acquires cryptocurrencies or other digital assets, its directors have a duty to ensure such acquisition is in the interests of the issuer as a whole, an HKEX spokesman wrote in response to email inquiries from the Post.

What disclosure standards should listed companies follow regarding their cryptocurrency investment?

For example, a "disclosable transaction" is applicable as soon as one of the five percentage ratio tests, such as asset ratio test, or consideration ratio test, hits 5 per cent. If a transaction hits 25 per cent in such a test it qualifies as a "major transaction", requiring it to publish an announcement and seek shareholders' approval.

In addition, a company must also disclose in its annual reports a breakdown of its "significant investments" - defined as any investment with a value of 5 per cent or more of the issuer's total assets as of the year-end. This also applies to digital assets and cryptocurrencies.

Such disclosure should present the fair value of these investments, the performance of each investment and the related investment strategy.

Fair value is the price that is received on selling an asset or paid to transfer a liability in an orderly transaction between market participants.

How is cryptocurrency booked in a listed company's financial statements?

Depending on the purpose and use by companies, cryptocurrencies can be booked as "inventory" under accounting standard IAS 2.

For companies that are not broker-traders, they could measure bitcoin at the net realisable value - estimated selling price less the estimated cost necessary to make the sale.

Where this value drops below cost, the company would then have to write it down in its profit and loss statement. But if bitcoin bounces back, it can then write-back the amount, but only up to the amount that it had previously written down.

What about companies that only hold cryptocurrencies as a long-term investment?

Bitcoin and other digital currencies can also meet the definition of "intangible assets" under accounting standard IAS 38.

"Intangible assets" are initially measured at cost, which typically includes the purchase price and other related transaction costs, such as the blockchain processing fees.

Under a "cost model", bitcoin and other digital assets are not affected by amortisation expenses. But these assets will need to be tested for impairment.

Companies are required to write down the impaired amount in their profit and loss statement. They can also realise gains from an increase in value as net profit at the date they sell bitcoin.

But under another measurement model based on taking data from an active market, if there is an appreciation in bitcoin over its initial cost, such gain is recorded in the revaluation reserve.

If the company ultimately sells the bitcoin and profits from it, it can then transfer these gains to its retained earnings.

Retained earnings represent the portion of a firm's profits that are not distributed as shareholders' dividends, and are a key component of a firm's shareholder equity.

This also means that if bitcoin's value jumps 10 times, investors will not benefit from an immediate dividend payout under this model.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2021 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2021. South China Morning Post Publishers Ltd. All rights reserved.


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