Accounting For Cryptocurrencies – The Complete Guide
There are various problems that accountants may encounter in practice for which no accounting standard yet exists.
The example here is accounting for cryptocurrencies.
Because there is no accounting standard on how to account for cryptocurrency, accountants are forced to turn to existing standards.
This article aims to give you a better idea of the current state of cryptocurrency accounting and how we got here.
It will also reference many standards accountants use when dealing with cryptocurrencies.
So, let’s get started!
What is cryptocurrency?
A cryptocurrency is a form of digital or virtual currency secured through cryptography, making it nearly impossible to counterfeit or replicate.
Blockchain technology is the basis for cryptocurrencies, decentralized networks based on blockchain technology run by a computer network.
Cryptocurrencies have several characteristics in common, including that they are typically not created by any central authority and, as a result, are theoretically resistant to government intervention or control.
They represent particular quantities of digital resources the entity has the authority to manage, which can be transferred to third parties.
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What are some of the most frequent crypto reporting difficulties with current accounting rules?
1. Changes in value
Unfortunately, you can’t account for a cryptocurrency using the same cash or cash equivalents criteria.
On the surface, it appears to be the simplest method to account for cryptocurrency, but it has several issues.
Regarding accounting, the term “cryptocurrency” is a misnomer.
Most governments don’t consider virtual currencies legal, and there has been little agreement or clarification on how digital assets should be regulated.
Digital assets, unlike cash or a cash equivalent, are subject to wild fluctuations in value regularly.
By definition, cash or a cash equivalent has an insignificant risk of fluctuation in its fair market value.
2. Reporting as an intangible asset
Another method for valuing digital assets is using the standards of inventory or financial instruments.
However, despite these advantages, they aren’t a perfect match and pose certain problems.
Under current GAAP and international financial reporting standards (IFRS), public companies must recognize a digital currency as an intangible asset with an unknown duration.
In most situations, businesses would initially record cryptocurrencies on the balance sheet at their cost basis.
There’s no need to amortize them as an indefinite-lived intangible asset. Rather, if the asset becomes impaired, a loss must be taken.
When the price of a cryptocurrency drops below its cost basis, it becomes debased. Because cryptocurrencies have such high volatility, this happens frequently.
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3. Not gains but rather recorded losses
Unfortunately, only unrealized losses are recorded in the United States, not gains.
Even if the asset’s value rises or breaches earlier price levels under GAAP’s intangible asset accounting guidelines, it is difficult to reverse an impairment loss.
If your firm purchases $600,000 worth of Bitcoin and the fair value drops to $400,000, you’ll have to recognize a $200,000 loss and decrease your Bitcoin holdings to reflect the drop in value.
You can’t reverse or increase the value of a loss on the balance sheet even if the market value rises to $700,000 later.
According to GAAP, it remains at an impaired $400,000 worth.
Information on virtual currencies can be deceptive if not properly accounted for in financial reports. This accounting method may mislead investors about a company’s finances.
A company called MicroStrategy Incorporated has 70K Bitcoins on their balance sheet.
They are worth $2 billion, but only 1/10 of that value can be seen because it’s unrealized losses from the last year-end report, which means those coins didn’t exist in 2020 when they recorded them!
In an increasingly crypto-savvy world where more and more people invest in cryptocurrencies every day without understanding how these work or knowing much about investing outside of “penny stocks,” this creates some problems with accounting standards as well since companies will have a difficult time reporting accurately even though everything might seem fine right now
Because of these difficulties, many investors are calling for the FASB to create new standards tailor-made to cryptocurrency and other digital assets.
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How should your firm keep track of cryptocurrencies and other digital assets in its ledgers?
Transactions in cryptocurrencies, like all cryptocurrency transactions, have several concerns. They are property, and basic accounting principles apply.
When you buy cryptocurrency, make a debit to the asset’s account on the date of acquisition.
You must first reverse the transaction if you want to convert your virtual currency back into real currency.
Assuming your firm acquired the digital money using fiat money, you would credit the same amount to your cash account.
When your company later sells the asset, you reverse the process. Credit the asset to take it off your balance sheet at its book value and debit cash in the amount of any proceeds or other consideration received.
Because the proceeds may be considerably greater than the asset’s current book value (due to impairment, appreciation, or a combination of both), you can also establish a capital gain credit for the difference between book value and receipts received.
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How should your company handle payments to vendors?
When you pay a vendor with cryptocurrency, you must record the transaction in the same way as if you were selling it.
Depending on your accounting method, it’s either a tax loss or a capital gain.
For example: Imagine you hold 100 BTC on your balance sheet at $300,000. Since acquiring the coin, its fair value has gone up to 400k!
However, your business pays a CPA audit firm responsible for their work using this intangible asset as payment instead (just like how credit cards are used today).
However, there’s no credit card company in our world, so that expense will show up instead under professional services expenses.
$400K is recorded as a debit from one account and credits to two others: Bitcoins (the emitter) & capital gains ($100).
Note: If the fair value of an asset fell to $200,000 while it was on your balance sheet before recovering its current value of $400,000, there would probably be no capital loss upon disposal because you previously took an impairment.
In that scenario, you’d record a much more significant capital gain of $200,000 to account for the difference between the asset’s $200,000 book value and its $400,000 cost and fair value at the time of sale.
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What is the best method for your company to keep track of its crypto-mining operations?
Mining is an essential element of blockchain technology and generates new digital assets.
Your business’s ledger needs to include its mining activities, just like any other source of revenue.
You’ll credit your mining income account and debit the new cryptocurrency asset at its fair market value to your books.
Because you’ll almost certainly incur costs during the procedure, you must also factor those in.
Assuming you pay in cash for these items, you’ll credit the cash account and debit an asset; if you’re purchasing mining equipment, that must be capitalized and then amortized or an expense like utilities and materials.
Any money obtained from your mining activities should be recorded as income when received, provided that no significant costs have been incurred in obtaining said funds.
What is the nature of digital asset trading on your ledger?
You should keep track of your cryptocurrency trading in the same manner that you would with stock trading.
When you purchase a crypto asset with fiat money, credit your cash account and debit the crypto-asset account.
To account for any losses as they occur, you’ll need to debit your loss account and credit your asset account.
When offering your cryptocurrency investment for sale, you must remove the asset from your records by crediting the asset account at book value and debiting the account representing the value received in exchange for selling your digital asset.
Debit your cash account if you’ve sold your Bitcoin for real money. Debit the new cryptocurrency account if you exchange it for another digital asset.
Then, to balance the transaction, add the difference to a capital gain or loss account.
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Will there be times when your tax returns and financial statements don’t match?
Accounting and taxes are closely related.
However, your accounting standards for financial statements and tax reporting will not always be in sync.
Because the rules have changed, you must make journal entries by IFRS and GAAP when reporting income from cryptocurrency transactions under the old standards.
In particular, if an impairment event occurs, which wouldn’t result in a tax benefit for unrealized losses, you’ll need to record journal entries under the existing IFRS and GAAP rules.
Most public firms would find it easier to comply with cryptocurrency reporting than GAAP. The tax basis of accounting is simpler to comprehend and, in most cases, eliminates the concept of impairment.
You can categorize your crypto transactions into 2 types of taxes based on the kind of cryptocurrency tax they create:
- Those that produce income taxes.
- Those that create capital gains taxes.
What are the tax consequences of crypto transactions under GAAP and IFRS?
The following 4 occurrences are taxable and will result in a business’s obligation to pay income taxes on the market value of the asset acquired on the date of receipt:
- Mining income.
- Crypto staking.
- Hard forks.
- Interest earnings.
Remember: You should include all of these activities in your annual revenue.
They will be taxable as ordinary business income. Of course, you can deduct all routine and unavoidable expenditures incurred due to these operations.
Because it may be summarized as any disposal of your cryptocurrency for proceeds that aren’t equal to the cost basis (such as selling it, swapping it, or employing it to pay a vendor), the list of transactions that result in capital gains or losses is much shorter.
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What are some of the tax-free events that cryptocurrencies enable?
Your cryptocurrency transactions should not be taxed.
Aside from the abovementioned events, your company’s cryptocurrency operations should be tax-free.
There is no way for any of the following 3 points to contribute to your business’s taxable income:
- Purchasing crypto with fiat currency.
- Sending crypto as a gift or donating it.
- Exchanging cryptocurrency assets in the same way that equities are traded is known as trading.
What Should You Do if you are Overwhelmed? (Which is not your fault)
As your company grows, the issues you face with crypto investments become increasingly complicated.
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FAQ
How do you handle cryptocurrencies in accounting?
When your company purchases cryptocurrency, you must record a credit to the asset account on your balance sheet at its fair market value on the date of acquisition. This is done by debiting the account.
What exactly do you mean by GAAP?
The set of generally accepted accounting standards (GAAP) is a collection of widely-used accounting regulations and standards for financial reporting.
The goal of GAAP is to guarantee that financial reporting is transparent and consistent across organizations.
What does cryptocurrency have to do with accounting?
According to standard accounting practices (GAAP), cryptocurrencies are recorded as intangible assets at cost, and the diminution in value must be recorded.
This implies that the value of a company’s balance sheet may erode over time.
How do you handle cryptocurrencies by IFRS?
Include it in your profit or loss at the point when you obtain the block reward, which is at market value. The journal entry is as follows: Debit Intangible assets – cryptocurrencies; Credit Other income in profit or loss.
