What standards should be used for crypto accounting? There are lots of procedures to follow and, as a result, a lot of issues that may come up when it comes to accounting for different types of investments assets.
A lot of invoices, bills, transactions records, bank statements, investment documents, insurance if any, and a host of other documents need to be referred to for accurate accounting.
This is quite a tedious task by itself and it is all the more profound in the case of cryptocurrencies.
This is mainly because crypto assets do not have any physical or tangible form.
Moreover, another significant accounting issue regarding crypto is that there is no specific accounting standard designed for crypto assets in particular, at least as of now.
This means that the accountants usually do not have enough documental proofs for such virtual investment assets and there is no specific accounting standard for them to follow.
In such a situation, the accountants are left with no other options but to follow the existing accounting standards for crypto accounting.
However, it is needless to say that when the general accounting standards are followed, the accountants are bound to face some significant challenges.
It is elementary that the accountants need to overcome these challenges in order to ensure foolproof and a totally-compliant crypto accounting practice.
Since the IRS or the Internal Revenue Service is very strict with crypto taxes, you cannot be complacent but have to be compliant in order to avoid monetary fines and legal consequences.
Through this article you will get a fair idea about the ways in which you can ensure that.
What Standards Should be Used for Crypto Accounting?
Cryptocurrencies are virtual or intangible digital tokens that are stored in crypto wallets that are digital as well, and all its transactions are recorded digitally on a distributed ledger infrastructure, which is commonly referred to as the blockchain.
The digital tokens provide the holders with different rights to use, depending on their features.
For example, cryptocurrencies can arguably be used as a medium of exchange.
On the other hand, other types of digital tokens may allow the holders to use other services or assets. A few others can also symbolize ownership interests.
Typically, the holders of these digitized tokens are provided with a key, called the private key with which they can access their wallets, transfer assets from or to it, and make other transactional activities such as creating new entries on the blockchain.
However, access to the distributed ledger permits the re-assignment of the rights of the tokens.
The unique feature of these digital tokens is that these are not stored on the computer system of an entity in a physical form.
In fact, the entity is only allowed to store the keys to the blockchain rather than the tokens themselves.
They represent the particular amount of digital resources that the holder is given the right to control and this control can be reapportioned to any third party. This is the fundamental of crypto transactions.
Convenient and safe as it may sound, this specific principle of crypto makes accounting these investments much more difficult.
The investors are unaware of the systems and there is not much clarity regarding the rules.
This means that the investors or a company does not have a strong and proper guidance when it comes to presenting the ever-changing value of the digital assets they hold, which are typically extremely volatile bets.
However, there has been a significant rise in the use of these virtual assets over the past couple of years and therefore the need for a proper set of accounting rules is felt badly.
This creates a huge gap or deficiency in the accounting procedures.
This is not the case in the United States only.
To be very precise, there is no basic international rule for accounting specifically designed and mentioned anywhere regarding crypto coins such as Bitcoin or other stablecoins.
All that the crypto accountants have at their disposal is an advice that comes in the form of a set of non-binding guidance for crypto accounting from the American Institute of Certified Professional Accountants or the AICPA and a three-year old direction akin to it from the formulators of the International Financial Reporting Standards or the IFRS.
The guidance from both these organizations requires further analysis and explanation but both imply that investments in crypto assets should be done in the same way as it is done for any intangible asset.
This means that, when it is needed to make adjustments in the values of the tokens, it is to be made only in the case of price declines.
It also means that, there will be no provisional upward adjustments to be made in the interim to show gains in the value of the tokens unless these are sold.
Therefore, such unclear guidelines leave a lot of room for the listed companies that hold volatile crypto assets to maneuver.
These choices are therefore diverse and shape up different market narratives regarding the crypto strategies of the different companies.
All these dissimilar metrics may mislead any crypto investor because these can redirect them to figures that are either incomplete or tell a completely different story about the results of the individual companies.
All these give a chance to people to argue that they do not consider crypto or Bitcoin as a non-cash impairment loss and to be important information if there is no equivalent consideration of successive increments in the market value.
They may further argue that since buying crypto or Bitcoin is a part of their regular business operation, considering impairment losses on these coins may otherwise divert from investor analysis.
However, the SEC or the Securities and Exchange Commission has the right to rule out such ideologies and subsequently reprimand any company who thinks likewise.
The SEC also has the right to discontinue the use of non-GAAP or Generally Accepted Accounting Principles adjustments when any crypto asset holder makes any earnings.
The reason for saying all these is that in the absence of specific crypto accounting rules, companies holding crypto assets may follow a diverse range of accounting procedures for the same.
For example, Tesla combines the negative impact of impairment losses with other items in the accounts.
In another example, Coinbase explicitly reports impairments of huge amounts in a stablecoin USDC but classifies it as a current asset which is a very liquid balance sheet category that can be sold off for cash in a year.
This means that the value of their holdings is in USDC and it is just like any other financial instrument.
It can be valued at cost that is amortized and the fair market value of it is written down in due course.
Some other companies, such as the data analytics group Palantir, follow almost the same process as Coinbase but instead of a stablecoin they record and report impairments based on gold and write down the fair market value of it after each period.
However, over time, accounting for crypto became even trickier with the advent of the Non-Fungible Tokens or NFTs in particular.
This is because the NFTs have a very little or no secondary market.
Now, if the current accounting standards are followed for crypto, there can be significant issues cropping up such as:
Change in value – This is because crypto coins are not cash, cash equivalent or a legal tender. Just as the term cryptocurrency is a misnomer, these digital assets also create a lot of confusion.
Moreover, most governments have not made it quite clear how they will treat crypto from a regulatory point of view since it experiences wild price swings unlike cash or a cash equivalent and therefore the fair value cannot be fixed.
Treatment as an intangible asset – When it comes to reporting crypto it is required to follow an alternative model for inventory or financial instruments. However, the features of it may be attractive but it still poses some significant challenges.
As of now, in the United States and according to the IFRS abroad, digital currencies are to be accounted as intangible assets by the public companies that have an indefinite life under GAAP.
This means that the companies need to consider crypto at their cost basis on the balance sheet initially without needing to amortize them as any intangible asset with indefinite life.
Instead, they must realize a loss if the asset ever becomes impaired or the price falls below the cost basis, which is a commonplace due to their extreme volatility.
Recording losses instead of gains – In the United States, only the losses get recorded, unfortunately, and not the gains on crypto. This is because the intangible asset rule of GAAP does not allow any consequent reversal of any impairment loss.
You will have to reduce the value of your holdings to show the decrease in value and cannot change it even if the value recuperates or goes beyond its earlier price levels.
This is quite an unfavorable and unfair accounting treatment for the companies that invest in digital currency. Add to that, such type of treatment may also result in confusing information for the readers of the financial statements.
This is because there will be no actual alignment between the financial realities of the holding of a company and how that holding is reflected in the accounts.
Now, these are only a few specific issues that the current accounting standards will cause if it is used for crypto accounting.
It is for this reason that the companies want to have a new set of accounting standards by the FASB or The Financial Accounting Standards Board that will be specific to crypto and other digital assets.
However, as of now, crypto is still considered to be an asset in spite of the different unique complications that it may give rise to during accounting.
This means that the basic principles of accounting are still applicable while you record transactions of crypto and other digital assets in your business ledger.
When you make any purchase of crypto coins, it should be recorded as an asset in your book of accounts at the fair market value of the coins as on the date of its purchase.
This is typically done by recording a debit into the asset account and in the balance sheet.
Now, if you purchase these coins in exchange of fiat money, you will then need to credit the cash account with the exact value of the purchase of the coins.
When the asset is sold off at a later date you simply have to do the opposite.
This means that you will need to credit the asset account at the book value to remove the entry of it from the balance sheet and debit the cash account with the sale proceeds along with other considerations that you may have received in the process.
Now, chances are the proceeds are pretty much higher than the current book value of the asset due to appreciation of value or impairment or both.
In such a situation you may recognize a credit to the capital gain account as well to reflect the difference between sales proceeds received and the book value.
When you make a payment to any vendor by using crypto coins, the records in your books of account will be similar to those you need to do while selling off your crypto asset.
This is because in both these ways it is considered to be a disposal of your assets and therefore there will be a capital gain recognized due to the difference between the book value of the crypto coins and the expense.
If in case the fair value of the crypto asset decreases at any point of time while it is still in your balance sheet, there may not be a capital loss on the proceeds received at disposal.
This is because you would have already made a record for an impairment while the value of the coins got reduced.
In that case, all that you can do is credit a capital gain which is even more significant so that you can account for the difference between the book value and the current fair value of the asset.
If you are into mining crypto coins wherein you bring in new crypto coins into circulation your business record should reflect it in the ledger just like any other activity performed to generate more income.
This means that you should credit your income through mining in your books of accounts and debit the newly created crypto coins at the fair market value.
However, you will also need to take the expenses incurred in this process of mining into account.
Suppose that you pay for these expenses in cash, then you will have to credit the cash account with a simultaneous debit of an asset account.
This asset account could be anything from buying a piece of new mining equipment which should be capitalized and afterward amortized to any other expenses for supplies and utilities.
In general, if you are into mining activities then any income from it should be ideally treated as revenue and recorded in the books of accounts right from the very moment you earn the proceeds from it.
There may be a couple of times when the financial statements of your crypto holdings may not align completely with the reporting for tax purposes.
It may be due to the lack of journal entries for the unrealized crypto losses, which are essential to make according to the current GAAP and IFRS rules.
Or, it can also happen when there is an impairment loss when you may not have made the necessary deduction for that unrealized loss on your taxes.
Talking about crypto taxes, which is also a very important aspect to consider and comply with during crypto accounting, the challenges posed by crypto taxes are relatively smaller hurdles as compared to the GAAP reporting for most public companies.
The tax basis in terms of crypto accounting is pretty simple and is quite easy because in most of the cases it steers clear of the notion of impairment.
However, these implications are not to be ignored or scoffed at.
Now if you do not know what type of crypto transactions are considered as taxable events and what are not, you should typically divide all of your crypto transactions into two specific heads based on the type of tax they generate. These are:
- Transactions that that generate income tax and
- Transactions that generate capital gains tax.
While you segregate your crypto transactions, you may get confused at the difference in treatments and considerations of taxable events by the GAAP and the IFRS.
Well, for that you will need to consider the activities behind each transaction.
It will then be easy to determine the taxable events and know the amount of income taxes you owe on the fair market value of the crypto assets generated on the date of their receipt.
These activities are:
- Crypto staking
- Hard forks or AirDrops
- Mining income and
- Interest earnings.
Therefore, make sure that you include all of these particular crypto activities in the gross revenue of your business for the year.
All these will be taxable just as any ordinary income of your business.
However, you will be allowed to remove all necessary and ordinary expenses that you may have incurred while performing these specific activities.
Typically, the list of events that may attract capital gains taxes will be pretty short because it can be abridged as any disposal of your crypto coins for sale proceeds that are actually different from the cost basis should feature in the list.
Such activities include:
- Selling the coins
- Exchanging the coins and
- Using the coins to pay a vendor.
Any other activities related to crypto that are different from those listed above should be treated as non-taxable events while accounting for crypto. The list may include and not limit to:
- Gifting crypto
- Donating crypto to charity
- Purchasing crypto with fiat currency and
- Transferring similar crypto assets between two exchanges.
Therefore, all these indicate that accounting for crypto is not at all an easy process.
You will need to know a lot of things and consider different aspects and elements to make sure it is precise and compliant with the IRS and other guidelines.
Apparently, it may seem like crypto coins can be accounted as cash or cash equivalents. However, as said earlier, that is not the case with this kind of digital money.
This is because according to the definition in IAS 7 and IAS 32 crypto coins cannot be used readily for exchanging any product or service.
Business entities may choose to accept these coins as a form of payment but there is practically no requirement, reason, or compulsion to do so.
Though there is a large number of business entities that are accepting digital coins as a mode of payment, such as Starbucks, and the number is increasing with each passing day, it is still actually not widely accepted as a legal tender or a medium of exchange.
According to IAS 7, cash equivalents are referred to those that are highly liquid investments in the short term.
These are also subject to risks of no consequence in terms of value and can be converted readily into recognized amounts of cash.
On the other hand, the crypto coins in comparison cannot be categorized as cash equivalents simply due to the fact that they are known to have extreme levels of volatility.
Now that crypto cannot be considered as cash or cash equivalent, you may think that it can be considered as a financial instrument at a Fair Market Value through Profit or Loss or FVTPL while accounting for it according to IFRS 9.
However, and once again, crypto seems to fail to congregate with the characterization of a financial instrument either.
This is because cryptocurrencies are not considered to represent any of the following:
- An equity interest in any business
- A contract that establishes any right or
- An obligation to pay or receive cash or any other type of financial instrument.
Moreover, according to the definition, cryptocurrencies cannot be considered as debt security.
Furthermore, in spite of the fact that digital assets can have a form of an equity security, crypto coins are not considered to be as such.
The main reason behind it is that crypto coins do not represent any ownership interest for any entity.
Therefore, crypto coins cannot be considered as financial assets at fair value for accounting purposes.
You cannot even consider cryptocurrencies as intangible assets as well in spite of the fact that these coins do not have any physical form.
This is because this digital form of money does not meet the definition of intangible assets according to IAS 38.
According to the definition on IAS 38, an intangible asset is referred to those non-monetary assets that do not have any physical substance but are identifiable.
IAS 38 further explains an identifiable asset. It is those assets that can be separated from or arise from legal or other contractual rights.
This means that an asset that is separable can be divided or separated from an entity and it can be sold, transferred, rented, licensed, or exchanged either as an independent asset or together with a related and identifiable asset, contract or liability.
This aspect of an intangible asset also matches up with The Effects of Changes in Foreign Exchange Rates of IAS 21.
This affirms that a non-monetary asset should essentially come with a specific feature.
This is the lack of a right to receive or deliver as an obligation any definite or quantifiable number of units of the currency.
It is important to note the differences between the definitions between the two here.
Crypto satisfies the definition of an intangible asset according to IAS 38 since it can be separated from the holder transferred and sold independently.
On the other hand, according to IAS 21, crypto does not give the holder any right to receive or deliver any specified number of units.
This means that there is a significant conflict between the definitions of intangible asset and therefore the crypto coins cannot be considered as an intangible asset.
Moreover, according to the basic principle of cryptocurrencies, users can trade them on an exchange.
This automatically translates that one can expect to receive some economic benefits in the process.
However, crypto coins are subject to dramatic price variations due to its extreme volatile nature and therefore it is essentially non-monetary in nature.
And, since these coins do not have any physical form, it is easy and quite appropriate to consider them as intangible assets, though arguably, by any common person.
Continuing the discussion on intangible assets, IAS 38 allows measuring them at cost or revaluation.
While using the cost model, the intangible assets, just as the name signifies, are calculated at the initial cost and consequently at a cost that does not include the accumulated impairment losses and amortization.
However, when the revaluation model for measuring can be applied to determine the fair value of crypto, according to IFRS 13, Fair Value Measurement must be used for that.
This is not easy because it requires determining whether the market for a particular crypto coin is active.
You should apply your judgment based on the definition of an active market in IFRS 13.
Apart from that, you should also consider the principal or most beneficial market for the crypto coins for that matter.
Since Bitcoin is traded daily, it is easy and correct to say that this market is very active.
However, the same cannot be said for other crypto coins since they do not demonstrate the same characteristics.
However, it is very important to determine the market condition because the quoted price of an active market will provide all the necessary and trustworthy proof of fair value.
That is why the quote of an active market is used for measuring fair value whenever needed without requiring making any adjustments to it.
When you use the revaluation model to determine the fair value of the intangible assets you can use the revalued amount of them in an active market,
but for crypto coins that is not the case.
This is because the same revaluation model for measurement is required to be used for all different coins in this particular asset class.
If that is not possible due to absence of an active market for a specific type of crypto then the fair value of these coins should be measured by using the cost model.
In general, it is quite unusual for intangible assets to have an active market. Still, in the case of crypto coins, you can use the revaluation model because these coins can be traded over an exchange.
However, when you use a revaluation model, according to a statement of IAS 38, it is required to recognize an increase in the revaluation in accumulated equity and any other inclusive income.
But there is a catch here.
This increase in revaluation of a particular crypto asset should be recognized in both profit and loss situations and it should be to the same extent as its reverses for a decrease in revaluation that may have been recognized previously either in profit or in loss.
This means that any loss due to revaluation must be recognized in profit or loss but the decrease should be recognized in other comprehensive types of income.
This should however be to the extent of the credit balance if any in the revaluation surplus with respect to that particular crypto asset.
Finite or Indefinite Useful Life
Typically, for any business entity it is not required to determine whether or not the useful life of a crypto coin is finite or indefinite.
It is said to be an indefinite useful life when there is no predictable limit to the period through which the crypto coin can produce net cash flow for the users.
And, quite naturally, the finite useful life of a crypto coin is just the opposite.
It seems that crypto coins have an indefinite life, especially for the purpose of IAS 38.
When it comes to an intangible asset that has an indefinite useful life, it is typically not amortized.
However, these assets must be tested for impairment on an annual basis.
Inventories of Intangible Assets
There are a few specific situations when it may be suitable to account for your crypto coins in accordance with IAS 2 Inventories.
However, it will depend on the business model of the entity.
The primary reason behind doing so is that IAS 2 typically pertains to inventories of the intangible assets. According to IAS 2, inventories are defined as assets in different ways such as:
- When these are held with an intention to sell them off later on but in the usual course of business
- When these are used in the production process for making such sales and
- When these are in the form of supplies or materials that are to be consumed during the production process or while rendering any particular type of service.
Usually, intangible assets are sold during the normal course of business which means that the assets are recognized as inventories at the lower cost and at the net value that can be realized from such sales.
However, if the business entity serves as a broker-trader of crypto coins, then, according to IAS 2, their inventories will be valued at a fair value minus the costs involved in making such sales.
This is the most common activity of a broker-trader and therefore the inventory is primarily attained with an intention to sell them off at a near future date to make profits.
The amount of profit made will depend on the differences in the price of purchase and sales or due to the broker-traders’ margin.
As a result, this specific measurement method can only be applied to a handful of situations especially when the business model of the entity is designed to sell these coins sometime soon to make profits from the price fluctuations.
Requirement of Disclosures
Therefore, you can see that when it comes to accounting for crypto, there are a lot of uncertainties and judgments involved at the time of measuring and recognizing crypto coins.
As a result, these types of ‘uncertain’ accounting need a significant amount of disclosure according to IAS 1, Presentation of Financial Statements.
According to IAS 1, these disclosures should confirm all the decisions and judgments made by the management of the business entity in terms of accounting their holdings of crypto assets.
This is essentially required in situations when these crypto assets are a significant part of the judgments and has the most noteworthy effect on the amounts that are recognized in the financial statements.
The disclosures should be proper and is specifically necessary to inform the users so that they can make more informed economic decisions.
Add to that, according to IAS 10, Events after the Reporting Period, a business entity is obligated to disclose any non-adjusting material events.
One of the most significant events in this regard is any changes made in the fair value of the crypto coins after the reporting period.
These changes should be of significant proportion to the extent that not disclosing it may sway the economic decisions that the users of the financial statements may make depending on the entries in it.
With all these requirements and considerations, accounting for crypto is quite a complex job and a lot of references need to be made on the basis of the current accounting standards. It is elementary that it meets all the requirements to be accurate and compliant.
So, as you have come to know from this article, accounting for crypto coins is not as simple as it seems to be.
Since there is no IFRS standard existing as of now, everyone may not be able to maintain accounting records without professional assistance.