When clients start to mention cryptocurrency in conversation, accountants may feel their hearts sink. While crypto-enthusiasts are often interesting people with a passionate interest in economics, most accountants, says Allan Kowall, don’t have the same appreciation or understanding of their cryptocurrencies.
This can be intimidating for many professionals who are afraid that they’ll say the wrong thing. However, it’s important for firms not to let this fear keep them from engaging with clients – whether through conversations or by helping them complete the necessary bookkeeping and accounting tasks. Here are some things you should know about how to account for cryptocurrency.
What is Cryptocurrency?
The first thing to understand is that cryptocurrency isn’t a tangible good, like gold or Euros. Cryptocurrency is a digital representation of value, one that’s designed to be decentralized and secure. Currency exists in the form of data, which means it can’t be touched or seen.
That said, there are different types of cryptocurrencies out there. They vary by how they’re mined (see mining below), how they store value, and how transactions are recorded on their respective blockchains. According to Allan Kowall, Bitcoin is the most popular type – Litecoin ($LTC) and Ethereum ($ETH) are two other more common types people may transact with regularly.
And Intangible Asset
Some intangible assets include goodwill on the company’s balance sheet, rights to use products and inventions, and brand names. These items don’t physically exist in the way coins and dollar bills do. Intangible assets can be expensive to acquire or develop, but they also make a company more valuable. Because of this, accountants need to understand how intangible assets affect a firm’s overall financial position before classifying them as such on balance sheets.
Allan Kowall says that Cryptocurrency falls into this same category because it only exists in the digital world. When you trade something for Bitcoin or Litecoin, that value is recorded digitally on its respective blockchain (see below), even when the transaction is done in fiat currency instead of crypto-assets.
How Do You Value Cryptocurrencies?
For all these reasons, a cryptocurrency needs to be handled similarly to other intangible assets. They need to be recorded as assets on a company’s balance sheet and marked down as the value depreciates over time.
Accounting for cryptocurrencies requires some research and due diligence because, says Allan Kowall, it can’t be done automatically because there are too many unknowns. The first step is understanding how cryptocurrencies fluctuate in price – they don’t usually perform like traditional currencies (see Intrinsic vs. Market Value below). This is mostly because they’re not backed by any central bank or government regulation, which means their value comes from user trust, and that trust can change quickly if users believe prices will go up or down tomorrow.
There are still relevant tax implications that accountants need to be aware of despite the complexity surrounding cryptocurrency. For example, if you receive Bitcoin in payment for goods or services (see barter transactions below), the fair market value of that currency at the time should be recorded as gross income.
However, it’s important to remember that additional capital gains taxes owed later – converting cryptocurrencies back into fiat currency often triggers a taxable event because this process reclassifies the assets from long-term to short-term holdings.
Be wary about including assets like Bitcoin and Litecoin that were received in exchange for goods or services in your net asset totals for reporting purposes. So far, most cryptocurrency exchanges allow trades in fractions of coins, so it’s not that difficult for people to acquire small amounts of currency at a time.
It’s hard to say whether or not the cryptocurrency will be as popular as traditional currencies someday, but it’s still a relatively small market for now. Because of this, accountants and auditors may need to adapt their methods before they can effectively audit cryptocurrency transactions.
For example, even though the first regulated Bitcoin exchange opened in 2013 (Coinbase), it wasn’t until 2016 that an accounting standard was implemented for how exchanges report virtual currency assets held by customers. In many cases, these exchanges use the same techniques as asset-backed commercial paper – which means auditors shouldn’t consider them risky from a financial reporting standpoint.
Accounting For Cryptocurrency Mining Profits
People earn money from crypto assets by becoming miners, which is when an individual or business that has invested in powerful computing equipment uses it to add transactions to the blockchain (for a reward).
These mining efforts result in new currency being created – but whether or not this income should be recorded as revenue is up for debate. On the one hand, the net income from adding new currency should be marked down in some way because it’s official and verifiable. On the other hand, since miners also incur expenses during their computing efforts (electricity costs), they may need to write off part of it.
By now, it should be obvious that cryptocurrencies can’t just be handled like other assets – at least for now. Their complex nature means they’re likely to keep accountants and business owners up at night until things settle down. The last thing any of us want is a company’s assets or liabilities to change in the middle of tax season.
At this point, it’s quite likely that more and more businesses will start accepting cryptocurrency for transactions. This means accountants need to prepare themselves on how they can best handle these types of transactions moving forward.