How to account for crypto holding and mining according to the IFRS? Over the years, the perception of people about crypto assets have changed significantly for the better and more and more people are investing in this exciting and rewarding asset class.
Cryptocurrency offers a lot of money making and business opportunities which is why there are lots of people across the world who now hold or create crypto coins.
However, the issue is not with a lot of people making money from crypto but it is that most of them do not know how to account for their crypto holdings or the coins they create due to mining.
Typically, there are different types of crypto assets and all are not crypto coins, which however makes up the major part of the crypto asset world.
Therefore, the accounting procedures for crypto tokens in most cases will be different from the traditional crypto coins such as Bitcoin, Ether, Litecoin and others.
As for the tokens, it all depends on the terms and purpose of them.
This article however focuses on the accounting procedures only for the holders and miners of cryptocurrencies in particular.
Crypto holders are ideally referred to those investors who put in their money to buy crypto coins with no intention to sell them off any time soon.
And, crypto miners are those who use their computational power and electricity to validate transactions before they are added to the blockchain.
They are rewarded with a coin native to the blockchain which creates new coins in the process.
If you are either a crypto holder or a miner and also are not very confident about the accounting procedures, this is fortunately the right place to be in.
How to Account for Crypto Holding and Mining According to the IFRS?
In this article, you will come to know all about the ways for accounting your crypto holdings or the created coins according to the IFRS or the International Financial Reporting Standards.
Ideally, for the holders, the investment is made in the coins directly.
Therefore, for the holders of crypto coins, accounting for their assets purchased will largely depend on the store value or the return on their investment.
On the other hand, people who are involved in any form of mining activity typically invest their money on the hardware that includes:
- Powerful and expensive computers
- Advanced and powerful graphic cards and
- A lot of electricity.
The primary objective of the miners is to provide their computational power and skill to solve mathematical puzzles or complex algorithms to uphold the security of the blockchain network.
While serving the network, in the process, they create new crypto units.
Well, accounting for crypto holdings by the investors may seem to be a bit less complicated in comparison to accounting for the crypto miners.
This is due to the potential impacts accounting for the coins mined typically have.
As of now, the miners seem to be divided on opinions of accounting for the coins that they have received as a reward for their mining efforts.
While some of them view this activity as an exchange transaction that generates an income, some other parties believe that the process creates intangible assets internally.
Though both the parties are correct in their respective ways, it is such difference in opinions that influences the accounting process of the coins received eventually.
Therefore, you should be sure about the working process you follow so that you know what you are doing is right and is in line with the IFRS.
If the miners are not sure about the accounting process to follow, it is extremely likely to make errors in accounting which may result in violation of the rules and the non-compliance of the requirement of the IFRS.
This can have serious legal consequences.
Ideally, people who believe that the crypto coins generated during the mining process are intangible assets, they will need to treat their earnings as capitalized assets while accounting for them.
On the other hand, the people who consider their new coins as their income will have to treat the coins as their revenue provided there is an implementable contract with the customer.
Well, the problem here is that it is not very clear who actually the customer in the process of mining is.
Moreover, the crypto assets considered as income will be measured at its fair value while accounting.
However, it is also possible and permitted to consider the crypto earnings or new blocks in mining as inventory items.
Truly and naturally, things must have started to look very confusing already.
Well, do not fret because in the following sections of the article you will know how exactly you should treat your crypto assets for accounting under different conditions.
But, before you jump into the accounting procedures, here are a few things that you should know about cryptocurrencies that will help you a lot in your accounting efforts down the lane.
Things to Know
Cryptocurrency, as you may know, is a digital currency that is meant to perform as a medium of exchange.
This means that, if the other party accepts it, you can make financial transactions by using crypto coins.
And, of course, you can make investments in any type of crypto coins as well.
Typically, crypto coins in particular come with a few specific characteristics such as:
- These coins are not issued by any central authority like a bank or even the governments and therefore are decentralized
- All crypto transactions are recorded immutably on a long and distributed ledger called the blockchain
- Every participant on a blockchain network has an entire copy of this ledger
- It uses cryptography to prevent fraud and ensure security and
- Every transaction is verified for its authenticity and correctness before it is added to the blockchain as a new block with a kind of digital signature called hash.
All these things clearly mean that cryptocurrencies are not any kind of financial instruments, even though there is the word ‘currency’ in the term cryptocurrency.
Therefore, the accounting procedure of cryptocurrency is significantly different from cash and other traditional financial instruments.
According to the guidance of IAS 32, a traditional financial asset can be considered as a currency if:
- It corresponds to the medium of exchange
- All transactions based on it can be measured and recorded in a financial statement and
- It has a contractual right to obtain cash from or deposit cash into banks.
This means that any financial instrument is a specific type of contract that makes it an asset to one particular entity and at the same time it is an equity instrument or a liability to another, according to IAS 32.
However, in the case of crypto, in the case of crypto, the following things are also applicable:
- It can be used as a medium of exchange but it is not in as widely accepted as cash
- It is not considered to be a normal monetary unit
- Its pricing is derived from normal fiat currencies
- It is highly volatile in nature and therefore has a very poor store of value and most importantly
- It has no contract at all.
This clearly means that when you hold crypto coins, there is no contractual right that will allow you to receive any other financial asset or cash from the counterparty, which also does not exist.
Now, the question is, how do you account for the crypto coins you hold? And, here is the answer to it.
Accounting Procedure for Holders
The IFRIC or the Interpretation Committee of the IFRS issued some official guidance related to accounting for crypto by the holders in June 2019, though it needs a lot of clarity.
However, according to the IFRIC decision, cryptocurrencies are considered to meet the definition of intangible assets as it is IAS 38, Intangible Assets.
According to them, crypto is surely an asset because it is a resource that can be controlled by the holder and can have economic benefits to flow in the future as a result of an event of the past.
And, as per the definition in IAS 38, Intangible Asset is a non-monetary asset that is identifiable but does not have any physical form and this holds true for crypto.
Identifiable, according to the definition in IAS 38, means it is either separable from the entity and can be sold, rented, or transferred or it can arise from a contractual right or any other legal rights.
However, the latter is not applicable in the case of crypto coins because there are no legal rights or contracts but since it is separable, it falls under the definition of intangible assets.
This sounds great but that is not sufficient enough to start accounting for your crypto holdings.
You will need to select the right accounting method for that in the first place.
Choice of an appropriate accounting method will largely depend on the intention of your holding.
These can be any of the following:
- Held for trading – You can hold your crypto coins for trading or selling them in the normal course of your business. In that case you will need to consider your holding as IAS 2 Inventories. If you are a broker-trader of crypto, then IAS 2.3b will be applicable. In that case, the inventories will be measured at its fair value minus the cost to sell.
- Not held for trading – If you hold your crypto with no intention to trade them but just keep them as a store of value over a long period of time, the IAS 38 Intangible Assets standard will be applicable for the accounting purposes.
Though there are no recommendations made by the IFRIC, unfortunately, as to how IAS 38 should be applied for cryptocurrencies while accounting, here are a few specific considerations that may help you in that matter.
This model is applicable if you hold the crypto coins at a cost less impairment and less accumulated amortization.
This is quite a reasonable approach because cryptocurrencies usually do not have any amortization since these assets generally have an indefinite useful life.
On the other hand, when the fair value of the crypto coin you hold falls, you may account for the impairment.
However, there is one problem in this approach which is when the fair value of the crypto exceeds the cost.
In such situations, the cost model would not allow you to recognize such increases.
This is quite unreasonable, especially when you hold your crypto coins for the purpose of capital appreciation.
In this model of accounting your crypto holding, when there is an active market, you can revalue your crypto coins at the fair value and if there is any increase in it, you can account for it directly in other inclusive income.
If there is a decrease, you can account for it in profit or loss.
Though this model is not very symmetric, it is quite an appropriate one to use for your accounting purpose than the cost model, especially if you are holding your coins for capital appreciation.
In addition to that, you should also remember the correct disclosures while accounting, especially if you are setting its fair value or if there is any judgment used.
Here are a few specific considerations to make when you account for your crypto holdings.
It is due to the fact that cryptocurrencies are digital forms of currency many crypto holders think that it can be treated as cash while accounting for their crypto holdings.
However, unlike cash, crypto is not issued by a central bank or backed by the governments.
It is also not considered as a legal tender in most of the countries.
Therefore, according to the IAS 7 cash definition, which states that cash refers to the cash in hand and deposits, crypto cannot be considered as cash.
Also, according to the definition of financial instruments in IAS 32, which states that it represents medium of exchange, crypto cannot be considered as cash since it cannot be exchanged for any product or services.
Crypto cannot be considered cash equivalents either, which are defined as good as cash according to IAS 7 and highly liquid and short term investments that can be converted to cash.
Crypto clearly does not fall within this category from any angle especially due to its extremely volatile nature.
Considering crypto as a financial asset while accounting at Fair Value Through Profit and Loss or FVTPL is also another common approach followed by the crypto holders.
However, crypto should meet the definition of a financial instrument in the first place for that according to IAS 32, which states it is either cash or an equity instrument of some other entity.
Crypto does not meet any of these criteria.
Crypto cannot be considered as investment property as well according to IAS 40, it refers to physical assets such as land or a building that appreciates in value.
Crypto though may appreciate in value but is certainly not a physical asset and therefore is not an investment property or any other assets that are tangible.
Therefore, crypto can be considered as inventories and the cost or revaluation method can be used as its two potentially feasible accounting approaches.
Accounting Procedure for Miners
When it comes to crypto mining, there is no clear indication in the guidelines of the IRS or the Internal Revenue Service whether or not earnings from crypto mining will be considered UBTI or Unrelated Business Taxable Income.
However, with that said, it is indicated in an IRS Notice 2014-21 that the rewards received during crypto mining activities as a business or a trade will be included in the gross income.
Therefore, this means that it will be subject to taxes as any self-employment income.
According to this notice, the IRS holds its position stating that any earnings flowing to or is earned by any retirement account from any type of active crypto mining activity or business will be treated differently.
In such cases, it will be considered to be UBTI to the tax exempt purpose of the account if it provides savings for retirement for the account holder.
Moreover, in this regard, the income from crypto mining in terms of tax treatment as UBTI is pretty much the same as the income earned from the investment account in MLP or PTP.
This is a very common situation where the accounts generate UBTI inadvertently.
However, if income from crypto mining is considered as UBTI, it will not be treated as tax deferred.
Instead, it will be subject to current taxation at changeable rates which can go as high as 37%.
The retirement account holders can reduce their UBTI potentially by contributing their retirement funds to a ‘blocker’ C corporation that is newly created and this corporation then invests this fund for crypto mining business.
They can be an active participant in such business or be just an investor.
Therefore, this will ensure that the retirement account holds 100% of the blocker and the blocker is the direct earner or investor of the crypto mining process.
In this process, the blocker will be taxed for the income generated from the crypto mining process at a lower 21% corporate tax rate and not at the highest 37% individual tax rate.
When the blocker is taxed, the crypto mining earnings can be distributed by the blocker to the one and only 401(k) or IRA shareholder.
This earning from crypto mining by the account will be considered as dividend, which is a permitted type of investment income and therefore will not be subject to current taxes.
When it comes to accounting for the crypto coins earned from mining activities, there is factually no guidance related to it from the IFRIC as it is available in the case of crypto holders.
Therefore, it is elementary that you understand the process of crypto mining which was not literally required by the crypto holders.
The main reason behind it is that when you know the mining process it will be much easier for you to decide how exactly you should record it in your account.
In this aspect, it is important to know that crypto miners are not mining anything literally, as most people wrongly believe.
Therefore, the normal IFRS 6 Exploration for and Evaluation of Mineral Resources will not be applicable.
What the crypto miners are doing actually is that they are helping the network to maintain its security and prevent fraud.
This is ideally the fundamental characteristic of cryptocurrencies.
This is done by verifying each transaction and adding a digital signature or hash before adding it as a new block to the digital distributed ledger.
This means that when a transaction is made on the crypto blockchain network, it is invariably broadcasted to all the other participants in it.
This gives the miners additional responsibilities that include:
- Verifying transactions and
- Creating new blocks.
In simple words, the miners collect all available info that are broadcasted by the participants on the blockchain network regarding a transaction and add the Proof of Work to the block vouching for the authenticity and correctness of the digital code.
In short, they validate that the digital code meets the criteria of the algorithm and update the ledger.
For all their efforts and computational power put in, the crypto miners are rewarded in two specific ways. These are:
- By a block reward for creating it and
- In transaction fees for validating a particular transaction.
A miner can earn both types of rewards as well by solving puzzles since there are several transactions made on one blockchain.
And, when the miners are in work to verify transactions on the blockchain, they typically use a huge amount of resources such as lots of powerful computers, high electricity bills, graphic cards, ret and more.
Now, the question is how exactly a crypto miner can account for all these expenses and the rewards earned from the mining process.
Accounting for mining rewards:
First, take a look at the accounting process for block rewards earned by crypto miners. In such a kind of accounting, most people think that the IFRS 15 revenue standard is applicable.
However, there is a problem in this kind of accounting because there is no contract or a customer in the mining process.
The miners typically are rewarded by the algorithm.
This means that there is no obligation or right to implement. This means that IFRS 15 is not applicable.
Still, when a miner receives a block reward it signifies inflow of economic benefits for sure.
This can be therefore considered as an income according to the definition in Conceptual Framework.
Therefore, the best way to include block rewards earned from crypto mining is in the profit or loss but make sure it is measured at the fair value.
In the journal you must debit crypto as intangible assets and credit profit and loss as other income.
If the miner is a trader of crypto, the journal should be debited by Inventories.
Accounting for transaction fees:
The transaction fees are usually not received for verifying a block as a whole. For that the miner is paid a block reward.
The transaction fees are usually earned for each transaction.
The transaction fee is usually paid by the particular network participant, which is not in the case of block rewards that are created and paid by the underlying program or algorithm of the cryptocurrency.
Therefore, the transaction fees are not created out of thin air.
This means that, technically, there is a customer in this case, who is typically the originator of the transaction.
Also there is an implied contract in this case because it is expected that the network participant will pay the transaction fee.
This means that, in this case the IFRS 15 standard is applicable for accounting the transaction fees earned in crypto mining when the obligation of the performance is satisfied or, in other words, the miner will be entitled to receive the fee when he or she validates a transaction.
Accounting for other expenses:
While mining, as said earlier, the crypto miners incur some expenses, which are pretty high.
All these expenses should be capitalized or accounted for even if the miners are actually developing intangible assets.
However, the problem in this is that you may not be able to reliably measure the expenses ascribable to the intangible asset that is developed through mining.
There are two specific reasons behind it such as:
- One, there are too many miners out there who are trying to win the reward by solving the puzzle first. This means that it is more like winning a race or a lottery rather than producing anything that can be considered as creating some asset systematically.
- Two, it is pretty difficult to separate the expenses incurred of the successful mining effort from the unsuccessful mining efforts before that, considering the fact that the expenses are incurred in both.
As a result, the only feasible way for accounting the expenses incurred in crypto mining is to include them in profit and loss as and when these expenses are incurred.
Add to that, while accounting from crypto mining, it is also needed to consider whether you are engaged in solo mining or are using a mining pool by combining your computational power with other entities.
Though this approach increases the chances of earning mining rewards but at the same time it also means that the rewards or fees are shared.
The accounting principles for solo miners are also applicable for mining pools but the significant difference in it is that there may be some joint arrangement which means that the IFRS 11 standard will be applicable as well while accounting for it.
Now, if you consider the stock valuation method, be informed that in the case of crypto mining it will not be very relevant.
This is because in the mining process you will typically exhaust your primary capital outlay on your purchased contract.
This means that the Cost of Sale will be zero always since you will only have the crypto units that you have mined and this will typically cost you nothing.
Given such a situation, you can use these three specific valuation methods.
Average cost valuation method:
This is perhaps the best method to choose for valuation because it will still give you very little cost of sale that you can remove for tax purposes while accounting for it.
The main objective of this method is to decrease the cost of sale as much as possible since that will increase the taxable profit or capital gain correspondingly or diminish the tax loss or capital loss.
FIFO valuation method:
You may also go for the FIFO or First In First Out valuation method but in this process you will be selling off your units eventually at a zero base cost.
However, this is the one of the simplest methods that you may follow because in this method you can track the cost paid easily and chronologically.
LIFO valuation method:
The Last In First Out or LIFO valuation method can also be used but this method is actually a bit complicated in comparison to the FIFO method mentioned above especially when and if you withdraw more crypto units than you have mined.
However, this method seems to be a better one than the average cost method because the rate is applied chronologically but the time is considered backwards.
When all these there valuation methods are compared, the following inference can be made:
You can get maximum tax benefits when you use the average valuation method but it is quite difficult and complex to manage.
However, it will decrease the average cost of the stock on hand.
This means that the initial cost of the stock will come down to zero pretty quickly especially when the condition is inflationary.
This means that when you use the average cost method instead of the FIFO method, you will eventually reach the same point as the LIFO method and pretty soon.
And, irrespective of the stock valuation method you use, the cost of the average stock in hand will increase when you carry on purchasing new and supplementary mining contracts in cash.
However, for all these methods you will need to maintain proper and precise records.
However, if you fall under the SARS or South African Revenue Service regulation jurisdiction and do not want to keep any record at all, the LIFO method will be applicable according to the SARS regulation.
This is because this method is most beneficial to SARS apart from the fact that it is also one of the easiest ones to apply.
Another reason for SARS to favor the LIFO method is that all the units redeemed typically belong to the mined stock.
This stock normally has zero base cost. This means that the onus of proof required by SARS is left on the taxpayer.
And finally, if you think that it is too much of an effort for SARS and it will be unable to track your crypto transactions, be aware that such type of accounting has already started as a result of the enactment of Section 7C of the Income Tax Act.
The SARS mechanisms are also efficient enough to track these transactions and therefore it will not be very hard for SARS to conduct an audit on any individual.
If, in the process of investigation, it is found that the crypto transactions were not disclosed at the time of accounting, SARS has the right to realize 200% penalties and interest on the taxes due.
Therefore, it is best to consult a proper tax consultant and accountant who are knowledgeable about crypto to ensure that you follow the right accounting method whether it is for crypto holding or crypto mining.
This will ensure that your book of accounts meet all the tax and accounting requirements to save you from legal and penal consequences.
It is quite hard for the crypto holders and miners to shield their income because the IRS considers it to be subject to taxation.
Therefore, it is better to know the accounting rules and processes as mentioned in this article to avoid the ire of the IRS.