Crypto Taxes and Accounting

Accounting For Cryptocurrency 101: Understanding How To Account For Cryptocurrency

Published
February 9, 2022
Written By
Share

Topics

    Bitcoin and other digital currencies like Ethereum, Ripple, Dogecoin, and the likes are frequently featured in the newspapers, charting a roller coaster of dramatic ups and downs.

    The realm of cryptocurrency investing is still relatively unknown. Before investing in or accounting for cryptocurrency, it's critical to grasp how to open an account for cryptocurrency and understand the accounting standards for cryptocurrency. 

    Accounting Standards For Cryptocurrency

    Presently, there are no particular accounting rules for cryptocurrencies in the United States. However, as the number of cryptocurrency transactions grows, questions regarding how they should be accounted for are being put forward.

    The Financial Accounting Standards Board (FASB) is the equivalent of the Internal Revenue Service in the accounting industry. The FASB is in charge of setting up the Generally Accepted Accounting Principles (GAAP).

    The FASB issued an invitation in June 2021. Here they invited interested parties to provide feedback on the future technical agenda concerning the accounting for cryptocurrency. Unfortunately, it’s still unknown whether digital assets will be included on the FASB's formal agenda.

    Existing Accounting Standards For Cryptocurrency

    Since cryptocurrency is an intangible asset, accounting for it can be a little baffling at first. For reference, here are some standards put in place by the United States to deal with digital assets:

    The IRS considers Bitcoins and other crypto-assets as ‘property’ for federal taxes. They are subject to the same tax and accounting procedures that apply to real estate.

    • Cryptocurrency is not considered a currency for the purposes of calculating losses and gains under IRS tax regulations.
    • When digital assets are used to pay for goods or services, taxpayers must include the FMV or fair market value (the price of the asset in the open market) of those assets as taxable income.
    • The fair market value is calculated as of the acquisition date; in essence, it is (virtually) swapped for US dollars for tax reasons as an accounting treatment.
    • A taxpayer can have a virtual loss or gain from a tax standpoint.

    Accounting Standards For Cryptocurrency: Crypto Reporting Issues

    Let us now take a look at the most common issues with reporting and accounting for cryptocurrency:

    Price Fluctuation

    It is worth mentioning that the accounting requirements that apply to cash and cash equivalents do not apply to digital currency. It appears to be the most obvious factor that accounts for bitcoin at first appearance, but it has several drawbacks.

    The IRS has categorized cryptocurrency as ‘property’ for federal taxes, and it is not a legal tender. Most governments haven’t laid down guidelines on the accounting standards for cryptocurrency. Except for El Salvador where virtual currency is regulated and is a legal tender.

    In simpler words, digital assets are subject to severe price fluctuations unlike cash or financial assets. In comparison, the digital currency has a very high risk of fluctuation in its value.

    Intangible Assets

    GAAP classifies crypto as intangible assets that should be reported at cost and subject to impairment. This indicates that the value on a firm’s balance sheet might decrease with time. If the crypto is being held as an asset and it rapidly grows in value, this may not appropriately reflect the economic worth to a firm.

    The GAAP in the United States and International Financial Reporting Standards (IFRS) elsewhere has some guidelines for digital assets. According to these organizations, public firms must consider digital currency as intangible assets.

    Cryptocurrency taxes would be calculated on the accounting records at their cost basis. However, a loss has to be recorded if the asset is depreciated. Cryptocurrencies are affected when their value drops below their cost basis. This happens very frequently due to their high volatility.

    Accounting For Cryptocurrency: Reporting Crypto For Businesses

    While bitcoin transactions have their own set of challenges, they are still assets, and basic accounting standards apply.

    1. In Ledger

    When your company buys bitcoin, you should record the asset on your accounting records at its fair market value on the day it was bought. This is accomplished by debiting the asset's account.

    When your company paid for the virtual currency using fiat money,

    • Credit the cash account with the equivalent amount

    When your company later sells the asset, 

    • Credit the asset to remove it from your balance sheet at its book value
    • Debit the cash to reflect the proceeds or other consideration you received

    Because the proceeds could be significantly more than the asset's current book value—due to impairment, appreciation, or both—you could record a credit to a capital gain account for the difference.

    1. To Vendors

    When you pay a seller with bitcoin, you must document the transaction in the same way that you would if you were selling it.

    In any case, it's a disposal, and you'll have to account for the difference between the expenditure and the digital asset's book value as a capital gain.

    Example

    Suppose you hold 50 BTC valued at $150,000 recorded on your balance sheet. The coins’ fair market value increased to $200,00 since you bought it.

    Let us assume that you pay $200,000 for a CPA audit in the form of intangible assets, instead of paying in cash. So, your record would look like this:

    Credit/ Debit Transaction Amount (in $)
    Debit Professional services expense account $200,000
    Credit Bitcoin asset account $150,000
    Credit Capital gains account $50,000
    1. Mining

    Mining is an important part of blockchain technology since it allows for the creation of new crypto assets.

    If your company is involved in mining operations, 

    • Record mining in your ledger is just like any other source of revenue. 
    • Debit the newly minted bitcoin asset from your accounts at its fair market value
    • Credit your mining income account
    • Keep a record of the costs incurred during the process

    If you're paying for these things with cash, 

    • Credit the cash account
    • Debit either an asset or an expense

    In general, all proceeds from your mining operations should be recorded as revenue when they are received.

    1. Trading

    You should keep track of your bitcoin trading activity in the same way that you keep track of your stock trading.

    When you buy a cryptocurrency with fiat currency,

    • Credit cash account and record the investment
    • Debit the newly acquired crypto-asset account 

    By debiting your loss account and crediting your asset account, you'll need to make the proper journal entries to account for any impairments as they occur.

    When you sell your cryptocurrency,

    • Credit the asset account to book value for removing them from your records
    • Debit the consideration when exchanging the digital assets or trading

    Debit your cash account if you've sold your crypto for fiat currency. Debit the new crypto account if you exchanged it for another digital asset.

    Then, if necessary, balance the transaction by plugging the difference into a capital gain or loss account.

    Taxable Events Under GAAP And IFRS

    The activities listed below are taxable events that will result in your firm owing income taxes based on the fair market value (FMV) of the asset. This is generated on the date of receipt:

    • Airdrops
    • Hard forks
    • Interest earnings
    • Mining rewards, income, and bounty bonus
    • Staking

    All of these operations should be included in your gross profit generated for the year. These can be taxed like regular business income. You can, of course, deduct all usual and required expenditures incurred as a result of these actions.

    The events that result in capital gains or losses are fewer. This is because it can be characterized as any disposition of your cryptocurrencies for proceeds other than the cost basis, such as using them, swapping, or selling them.

    Non-Taxable Events Under GAAP And IFRS

    Besides the aforementioned events, your cryptocurrency exchanges should be tax-free. The following crypto events will not increase your company's tax liability:

    • Buy crypto with fiat currency
    • Gift crypto to family or friends
    • Donating crypto to a tax-exempt charitable organization
    • Transfer crypto assets between exchanges

    Bonus Question: How To Open An Account For Cryptocurrency

    Selecting a crypto trading provider is the first step in purchasing bitcoin. Brokerage, payment services, and cryptocurrency exchanges are all popular services for acquiring cryptocurrencies. Cryptocurrency exchanges are the most convenient alternative because they provide a wider range of functions and a greater number of cryptocurrencies to trade.

    You can purchase, sell-off, and hold cryptocurrency by signing up for a cryptocurrency exchange. Using an exchange that allows consumers to withdraw cryptocurrency to their own personal online wallet for safety is often the best strategy. Although, this feature may not be important to those looking to trade Bitcoin or other cryptocurrencies.

    When opening a bitcoin exchange account, it's critical to follow safe Internet practices, such as 

    • Two-factor authentication
    • Long, unique password with a mix of upper and lower case letters, special characters, and digits
    • Deciding on a cryptocurrency wallet

    The Bottom Line

    One thing to keep in mind is that most small firms are not obligated to provide accounting information that adheres to GAAP. These companies prepare financial statements using either cash or tax basis accounting systems, which give them more options when it comes to categorizing crypto assets.

    ZenLedger can help you easily calculate your crypto taxes, and also find opportunities for you to save money and trade smarter. Get started for free now or learn more about our tax professional prepared plans!

    Accounting For Cryptocurrency FAQs

    1. What are the accounting standards for cryptocurrency?

    The IRS considers Bitcoins and other crypto-assets as ‘property’ for federal taxes. They are subject to the same tax issues and accounting procedures that apply to real estate.
    Presently, there are no particular accounting rules for cryptocurrencies in the United States. However, as the number of cryptocurrency transactions grows, questions regarding how they should be accounted for are being put forward.

    2. How should cryptocurrencies be classified on financial statements?

    Under GAAP in the United States and International Financial Reporting Standards (IFRS) elsewhere, public firms must account for a digital currency as an intangible asset with an unlimited life.
    Cryptocurrencies would be recognized on the accounting records at their cost basis. There's no need to recoup them as an intangible asset with an indefinite life; instead, a loss must be recognized if the asset is ever damaged. Cryptocurrencies are affected when their value drops below their cost basis, which happens frequently due to their high volatility.

    3. Which crypto transactions are taxable?

    The activities listed below are taxable events that will result in your firm owing income taxes on the fair market value of the asset generated on the date of receipt:
  1. Airdrops
  2. Crypto staking
  3. Hard forks
  4. Interest earnings
  5. Mining income
  6. Get Started Now

    Simplifying DeFi, NFT, and Crypto Taxes for Investors and Tax Professionals

    FB logolinkedin logotwitter logoyoutubrmedium


    Copyright © 2022 ZenLedger
    10400 NE 4th St, Floor #5,
    Bellevue, WA 98004, USA