When an ICO is undertaken, the issuing entity receives consideration. The form of the consideration varies (for example, cash or another cryptographic asset) and, for accounting purposes, it is key to understand the economics and characteristics of the transaction.
It is possible that an ICO could create a joint arrangement requiring further analysis based on IFRS 11, ‘Joint Arrangements’. The fact that the subscribers provide the majority of the funding might suggest that the arrangement is a collaboration between the ICO entity and the subscriber. However, the subscribers are typically passive, which suggests that the arrangement might not provide the parties with joint control. Some issuers might grant veto rights over the future direction of the project to subscribers, typically, these are protective in nature and in most cases will not create joint control.
Where consideration for the ICO is not in the form of cash but another cryptographic asset, the transaction might be an exchange of similar goods or services. An exchange of similar goods might mean that no accounting is needed. However, we believe that it is unlikely that an ICO will be an exchange of ‘similar goods or services’, because no two cryptographic assets are generally alike.
Assuming that there is an exchange transaction and the arrangement does not create joint control, the consideration received by the ICO entity is recorded as the debit side of the journal entry. Depending on the form of the consideration, this might involve the thought process explained in section 2.2 and 2.3 above.
However, the key challenge for issuing entities is determining the accounting for the ICO token issued (that is, the credit side of the journal entry). This will depend on the nature of the ICO token issued, as well as the guidance of the applicable accounting standard.
The following figure provides a possible analysis framework of accounting models to consider when determining the nature of, and accounting for, the issued ICO token. Consideration of the contract terms is needed, to understand the obligations of the issuer.
An issuer of an ICO token should assess whether a token meets the definition of a financial liability. Specifically, an entity would consider the definition in IAS 32, which states that a financial liability is:
- a contractual obligation
- to deliver cash or another financial asset to another entity or
- to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity or
- a certain contract that will or might be settled in the entity's own equity instruments, such as those that violate the principle stated in paragraph 11 of IAS 32 (commonly known as the ‘fixed-for-fixed’ principle)
If the ICO token is a financial liability, the accounting would follow the applicable guidance in IFRS 9.
Many ICO tokens will not meet the definition of a financial liability, but there are situations where the terms and conditions might provide for a refund of proceeds up to the point of achieving a particular milestone. There might be situations in which the contract creates a financial liability at least up to the point at which the refund clause falls away.
An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities (IAS 32 para 11). Typically, ICO tokens do not provide the holders with such a residual interest; for example, they do not give the holders rights to residual profits, dividends, or entitlement to proceeds on winding up or liquidation. These ICO tokens might therefore lack the characteristics of an equity instrument. Careful consideration is needed to assess whether the rights to the cash flows only relate to a specific project or whether, in substance, they provide rights to residual cash flows of the ICO entity.
Revenue transaction/prepayment for future goods and services
The issuing entity should consider whether the ICO token issued is in substance a contract with a customer that should be accounted for under IFRS 15.
IFRS 15 would apply if (1) the receiver of the ICO token is a customer, (2) there is a ‘contract’ for accounting purposes, and (3) the performance obligations associated with the ICO token are not within the scope of other standards.
Appendix A to IFRS 15 defines a customer as “a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration”.
To determine whether a contract with a customer exists, an entity should consider whether the whitepaper, purchase agreement and/or other accompanying documents create ‘enforceable rights or obligations’ (IFRS 15 App A). To be a contract with a customer for the purposes of IFRS 15, such rights should be legally enforceable. This assessment might be challenging where the documentation provided by the issuer is not well defined. Entities should further evaluate all of the criteria in paragraph 9 of IFRS 15, to determine if a contract with a customer exists.
PwC observations: Whitepapers are not the same as a standard legal contract or other offering documents such as a prospectus or offerig memorandum. Entities should carefully examine the whitepaper or similar document, to make sure that there are, in fact, legally enforceable rights. Clauses that disclaim any legal obligation by the issuer require further investigation. In some situations, additional legal advice might be needed.
In many circumstances, issuers might use the consideration received in the ICO to develop a software platform. Hosting and maintaining the specific platform is often an integral part of the ICO’s future business model. The token could provide the holder with access to the platform which might be operated as part of the entity’s ordinary activities.
This might result in the holders meeting the definition of ‘customers’, from the perspective of the ICO entity; accordingly, the proceeds from the ICO could be revenue of the issuing entity, which will likely be initially deferred.
Determining the performance obligations, how they are satisfied and the period over which to recognise revenue will be judgemental and will depend on the specific facts and circumstances of the ICO offering.
Consider other relevant guidance
Where none of the above considerations appear to be relevant, the hierarchy in IAS 8 should be considered in determining the appropriate accounting treatment. We believe that it is unlikely that issuers will receive consideration without taking on an obligation to the subscribers. Even if the arrangement does not give rise to a financial instrument or a promise to deliver goods or services to a customer, there is likely to be a legal or constructive obligation to the subscriber. This might result in the issuer recognising a provision in accordance with IAS 37.