Consolidation of Entities using Digital Assets

gm curious accountants 👋

In the dynamic world of cryptocurrency, it's common for companies to operate across multiple jurisdictions, often with a holding company based in a tax haven. However, when it comes to preparing consolidated financial statements, especially for the first time, the process can be daunting—particularly for those with digital assets on their balance sheet. 

This raises many questions: What are the key considerations in consolidation? How can you ensure it's done correctly? Let's explore the intricacies of consolidation for crypto entities and provide clear answers to these pressing concerns.

This article will help you understand consolidation and will cover:

• What is consolidation and why is it needed
• Challenges of consolidation
• Issues unique to crypto entities

📚 What is consolidation and why is it needed

A consolidated financial statement may be required by:

• Regulators for compliance purposes,
• Banks and investors for funding purposes,
• Annual statutory filing requirements.

It can give a more complete picture of the financial health of a company compared to a standalone financial statement and enable stakeholders to make decisions.

In simple words, consolidation adds up the results of individual entities and consolidated journal entries to give a consolidated result.

A + B + C + CJE = Consolidated Figures

Where:

• A, B, C: Financial results of companies A, B and C.
• CJE: Consolidated Journal Entries. Common CJE includes elimination of investment, elimination of intercompany balances and transactions, and elimination of prior period adjustments.
• Consolidated Figures: The financial statements of a group in which the assets, liabilities, equity, income, expenses, and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.

IFRS 10 Consolidated Financial Statements outlines the requirements for the preparation and presentation of consolidated financial statements, requiring entities to consolidate entities they control. Control requires exposure or rights to variable returns and the ability to affect those returns through power over an investee.

🔍 Challenges of Consolidation

[fs-toc-h2]GAAP differences

One of the primary challenges in consolidation arises from the differences in Generally Accepted Accounting Principles (GAAP) across jurisdictions. Crypto entities often operate in multiple countries, each with its own set of accounting standards. i.e. IFRS vs US GAAP. These variations can create significant discrepancies in financial reporting, making it challenging to present a unified financial statement. 

Comparing US GAAP to IFRS, leases and crypto have different accounting treatments, and such differences have to be identified and adjusted before consolidation. 

Example: Company A might be in US GAAP while Company B and Company C are in IFRS. In this case, if we want to produce IFRS-compliant consolidated reports, we have to first adjust Company A to be IFRS-compliant.

[fs-toc-h2]Functional Currency vs Presentation Currency

Another challenge is dealing with multiple currencies. The functional currency is the currency in which a company's financial transactions are primarily conducted, while the presentation currency is the currency in which the financial statements are reported. For crypto entities operating in various regions, the functional and presentation currencies may differ, leading to complications in currency translation and exchange rate volatility. 

Example: Company A and Company B’s functional currencies might be in USD while Company C’s functional currency is in HKD. In this case, if we want to produce IFRS-compliant consolidated reports, we have to first adjust Company C to USD presentation currency.

[fs-toc-h2]Intercompany balances and transactions

Intercompany balances and transactions can further complicate the consolidation process. When different entities within the same corporate group engage in transactions, such as loans, management services, or custody, these need to be eliminated during consolidation to prevent double-counting. This process can be complex, especially when intercompany transactions involve digital assets or are conducted at non-market rates. Properly identifying, documenting, and eliminating these transactions is vital to presenting a true and fair view of the consolidated financial position.

[fs-toc-h2]Use of different accounting systems

The use of different accounting systems across various entities within a corporate group can pose significant challenges during consolidation. Disparities in accounting software and systems can lead to inconsistencies in data recording and reporting such as different Chart of Account codes or formats. This makes it difficult to aggregate and standardize financial information for consolidation. 

Example: Company A and Company B use Xero while Company C uses Netsuite. In this case, if we want to produce IFRS-compliant consolidated reports, we have to first adjust all their accounts to align.

[fs-toc-h2]Accounting Treatment during a change in control

One of the more complex challenges in consolidation involves the accounting treatment during a change in control. This occurs when a parent company acquires or loses control over a subsidiary, requiring a reassessment of the financial reporting. Changes in control can result from acquisitions, divestitures, or changes in ownership stakes. 

The accounting treatment for these changes can be complex, involving the revaluation of assets and liabilities, recognition of goodwill or gains and losses, and adjustments to the financial statements.

🤔 Issues Unique to Crypto Entities 

Intercompany Balances Denominated in Cryptocurrency

It is common for intercompany balances within crypto entities to be denominated in cryptocurrencies. This can lead to discrepancies due to fluctuations in the value and amount of the cryptocurrency. 

Therefore, it is crucial to clearly define in the contract how intercompany transactions will be recorded, specifying whether they will be accounted for in USD at the date of the transaction or in cryptocurrency. Additionally, the method for valuing the cryptocurrency should be explicitly stated. To avoid issues, intercompany balances should be reconciled monthly or using an appropriate system, rather than waiting until the year-end.

Frequent Changes in Corporate Structure

Due to evolving compliance regulations and business processes, changes in the corporate structure are common within the crypto industry. It is essential to maintain consistent and effective communication between the finance team and the corporate secretary team. This ensures that any changes are addressed and resolved promptly, rather than being discovered only when highlighted by auditors.

Aligning Accounting Treatments for Cryptocurrencies

It's important to align the accounting treatments for cryptocurrencies across the group. This includes standardizing the valuation methodology and the accounting treatment. Distinct accounting treatments should be established for cryptocurrencies held for use by the company versus those held for sale. These discussions should occur as early as possible. Unlike fixed asset accounting policies, which are well-established, accounting for digital assets presents unique and complex challenges.

💯 Conclusion 

Congratulations! You're now equipped to tackle the complexities of consolidation, ensuring a smooth process when preparing the consolidation working papers and consolidated figures. 

By understanding the fundamentals of consolidation, the unique challenges it presents, and the specific issues faced by crypto entities, you can confidently navigate this crucial task. 

One final tip: I highly recommend that all accountants submit their consolidation working papers to auditors well before the audit begins. This allows ample time for clarification and discussion, helping to prevent any delays in the audit process.