While the FASB may consider new guidance for the treatment of digital assets, here’s a guide to accounting for cryptocurrency under the current standards.
Cryptocurrencies and other digital assets are receiving increased amounts of attention and interest from consumers, corporations, and governments. Consumers are adding exposure to their personal investment portfolios, major payment processors are facilitating digital asset payments at scale, and both private and public companies are exploring and increasing investments into digital assets; their cryptocurrency holdings are becoming increasingly material.
Despite the increased attention digital assets are receiving, the financial reporting for these assets doesn’t fit cleanly into existing accounting guidance under US generally accepted accounting principles (GAAP).
As a result, many certified public accountants (CPAs) and accounting firms have requested the Financial Accounting Standards Board (FASB) address this growing concern, and consider issuing updated guidance more tailored to this new asset class.
A growing contingency outside of traditional accounting players have also raised concern and a desire for more clear accounting guidance.
Members of Congress, the Chamber of Digital Commerce, and others have sent letters to the FASB urging them to take action, and the discussion is also becoming increasingly popular in mainstream media.
In June of 2021, the FASB issued an invitation to comment where interested parties can voice their opinion regarding its upcoming technical agenda. While it remains unclear whether or not cryptocurrency and digital assets will appear on the FASB’s formal agenda, below is an overview of the currently applicable accounting treatment.
Changes in value
Unfortunately, you can’t account for a crypto asset using the same standards applicable to cash or cash equivalents. At first glance, it would seem like the most readily apparent way to account for cryptocurrency, but it poses some problems.
The term cryptocurrency is a bit of a misnomer for accounting purposes. Virtual currencies aren’t legal tender—unless you live in El Salvador—and most governments haven’t confirmed or clarified how digital assets will be treated from a regulatory perspective.
More importantly, unlike a cash or a cash equivalent, digital assets regularly undergo significant swings in value. Cash, or a cash equivalent, must have an insignificant risk of change in its fair value by definition.
Reporting as an intangible asset
An alternative accounting model for digital assets is to follow the inventory or financial instruments guidance. While these present some attractive features, again, they aren’t a perfect match and raise some challenges.
Currently, public companies must account for a digital currency as an intangible asset with an indefinite life under GAAP in the United States and international financial reporting standards (IFRS) abroad.
In both cases, companies would initially recognize cryptocurrencies on the balance sheet at their cost basis. There’s no need to amortize them as an indefinite-lived intangible asset, but rather a loss must be recognized should the asset ever become impaired.
Cryptocurrencies are impaired whenever the price dips below the cost basis, and because of their aforementioned volatility, this happens quite often.
Recorded losses, not gains
Unfortunately, only unrealized losses, not gains, get recorded in the United States. GAAP's intangible asset accounting rules don’t allow for the subsequent reversal of an impairment loss, even if the asset recovers or surpasses previous price levels.
If your business buys $500,000 worth of Bitcoin, then its fair value drops to $400,000, you'd have to recognize a $100,000 loss and reduce your Bitcoin holdings to reflect the decrease in value.
Even if the market value later increased to $600,000, you aren’t allowed to reverse the loss or increase its value on the balance sheet. It stays at the impaired $400,000 value according to GAAP.
Not only is that an unfavorable accounting treatment for businesses that invest in virtual currency, it also has the potential to create misleading information for the readers of financial statements.
For example, MicroStrategy Incorporated, currently the public company with the most Bitcoin holdings, owned 70,469 BTC on December 31, 2020. Its holdings had a fair market value of $2 billion at the time, but its balance sheet showed only $1.1 billion at year end because only unrealized losses were recorded. This creates a clear misalignment between the economic realities of a company’s holdings, and how accounting standards reflect those holdings.
These issues are the primary reasons that so many are requesting the FASB to issue new standards specific to cryptocurrency and other digital assets.
While cryptocurrency transactions present many unique complications, they’re still an asset, and fundamental accounting principles apply.
When your business purchases cryptocurrency, you should recognize the asset on your balance sheet at its fair market value on the date of purchase. This is done by recording a debit to the asset’s account.
Assuming your business purchased the virtual currency using fiat currency, you would credit your cash account for the same amount.
When your business later sells the asset, you do the opposite. Credit the asset to remove it from your balance sheet at its book value, and debit your cash in the amount of your proceeds or other consideration received.
Because the proceeds could be much higher than the asset’s current book value—whether due to impairment, appreciation, or both—you could also recognize a credit to a capital gain account reflecting the difference between the book value and proceeds received.
When you use cryptocurrency to pay a vendor, you must record the transaction in the same way as if you’d decided to sell it.
Either way, it counts as a disposal, so you would recognize a capital gain for the difference between the expense and the book value of the digital asset.
Example of vendor payments
Imagine you hold 100 BTC on your balance sheet at $300,000. Since you acquired the coin, its fair value has gone up to $400,000.
Your business pays the CPA firm responsible for your audit $400,000 using the intangible asset as a means of payment instead of cash.
You’d record a $400,000 debit to your professional services expense account, credit your Bitcoin asset account for $300,000, and credit the remaining $100,000 balance to a capital gain account.
Note, if the asset’s fair value decreased to $200,000 at some point while it’s on your balance sheet, prior to recovering its current value of $400,000, there likely wouldn’t be a capital loss upon disposal because you already recorded an impairment when the value reduction occurred.
In that scenario, you'd actually credit an even more significant capital gain of $200,000 to account for the difference between the $200,000 book value of the asset and the $400,000 expense and current fair value.
Mining is a fundamental component of blockchain technology and brings new digital assets into circulation.
If your business engages in mining activities, they should appear in your ledger like any other income-generating activity. You’ll credit your mining income account and debit the newly generated cryptocurrency asset onto your books at its fair market value.
Because you’ll inevitably incur expenses in the process, you’ll have to account for those too.
Assuming you use cash to pay for these activities, you’ll credit the cash account and debit either an asset—if you’re buying mining equipment that must be capitalized and subsequently amortized—or an expense for things like utilities and supplies.
Generally speaking, any proceeds from your mining activities should be recognized as revenue at the time the proceeds are earned.
You should record your cryptocurrency trading activities similarly to how you would record stock trading.
When you buy a crypto asset using fiat currency, put the investment on your books by crediting your cash account and debiting the newly acquired crypto-asset account.
You'll need to make the necessary journal entries to account for any impairments as they occur by debiting your loss account and crediting your asset account.
When you dispose of your crypto investment, remove the asset from your books by crediting the asset account at its book value, and debiting the account that represents the consideration received in exchange for trading your digital asset away.
If you’ve sold your crypto for fiat currency, debit your cash account. If you exchanged it for another digital asset, debit the new crypto account.
Then, plug the difference into a capital gain or loss account to balance the transaction as necessary.
Accounting and taxes are intimately linked. However, the accounting rules for your financial statements and your reporting for tax purposes won’t align 100% of the time.
For example, unrealized cryptocurrency losses may require you to make journal entries under the existing IFRS and GAAP rules, particularly when there’s an impairment event, where there wouldn’t necessarily be a deduction for unrealized losses on your taxes.
In fact, while the challenges of cryptocurrency taxation are nothing to scoff at, crypto taxes pose a smaller hurdle to most public companies than GAAP reporting. The tax basis of accounting is more straightforward and, in most cases, avoids the concept of impairment.
You can split your crypto transactions into two general camps based on the type of cryptocurrency tax they generate: those that generate income taxes and those that generate capital gains taxes.
The following activities constitute a taxable event and will cause your business to owe income taxes on the fair market value of the asset they generate on the date of receipt:
You should include all of these activities in your gross revenue for the year; they will be taxable as ordinary business income. Of course, you’ll be able to deduct all ordinary and necessary expenses incurred as a result of these activities as well.
The list of events that trigger capital gains or losses is much shorter since it can be summarized as any disposal of your cryptocurrency for proceeds that are different from the cost basis including: selling it, exchanging it, or using it to pay a vendor.
Other than the events listed above, your cryptocurrency transactions should be non-taxable. None of the following will contribute to tax liability of your business:
This article briefly highlights some primary accounting considerations, but it quickly becomes clear that the accounting and tax repercussions for your crypto transactions are a lot of work.
Due to the complexity, volume, and rapid growth of crypto transactions, you’ll want to seek out and leverage technology to help you with your digital asset reporting.
TaxBit’s enterprise software combines the expertise of a specialized accounting firm and the efficiency of cutting-edge technology to automate your crypto reporting needs.
Contact us today to schedule a custom demonstration tailored for your business.