Currently, there are no specific accounting standards for crypto assets. As a result, the broader guidelines under International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) are applied to cryptocurrency accounting.
The balance sheet is one of the three primary financial statements a business needs, alongside the income statement and the cash flow statement. While the income and cash flow statements show a company's economic activity over a specific period, the balance sheet displays what assets the business owns, along with any equity and liabilities.
Also known as the statement of financial position, the balance sheet provides a complete picture of a company's financial health. It includes every accounting entry since the company's inception. Therefore, cryptocurrency transactions should be incorporated, especially those affecting the firm's financial standing.
The Importance of a Balance Sheet
A balance sheet offers valuable insights into a company's financial well-being and delivers key advantages. Since balance sheets are typically prepared at the end of a specific reporting period, they enable year-over-year comparisons of business performance. Consequently, they provide a quantifiable way to track a company's growth trajectory and progress.
Balance sheets also allow for the calculation of key financial ratios, such as the debt-to-equity ratio, which indicates whether a business can cover its debts with its equity. They also contain the information needed to compute other vital ratios, like the ratio of current assets to current liabilities, showing if the company can settle its debts within 12 months.
Finally, a balance sheet enables a reasonable assessment of a business's value. This is particularly useful when seeking investors—to demonstrate they will receive a solid return—or when planning to sell the company.
How to Handle Cryptocurrency on a Balance Sheet
One of the most common questions when preparing a balance sheet is: "Where should cryptocurrency be placed on the balance sheet?" As mentioned, neither IFRS nor GAAP currently offers specific guidance on cryptocurrency bookkeeping.
However, since cryptocurrency qualifies as an asset, the core principles of asset accounting apply when compiling a balance sheet that includes crypto transactions. Here are some practical key points:
When Purchasing Cryptocurrency with Fiat Currency
Recording cryptocurrency trading activity should resemble logging stock trading activity. If Bitcoin (BTC) or Ethereum (ETH) is purchased, these digital assets can be recorded on the balance sheet at their fair market value on the purchase date.
This would be reflected as a debit to the asset account. Additionally, since the cryptocurrency was bought with fiat currency, the cash account should also reflect the purchase price of the acquired crypto asset as a credit.
When Selling Cryptocurrency for Fiat Currency
Upon selling cryptocurrency, the asset account is credited, and the cash account is debited for the amount of fiat currency received from the sale.
Assuming a significant difference exists between the sale amount of the cryptocurrency and the amount paid for it (the original purchase price), the capital gains account should also be credited in this scenario.
Recording Unrealized Losses
Under GAAP accounting rules for intangible assets, impairment losses cannot be reversed, even if the asset's price recovers from a previous level. If a business buys BTC with a fair value of $500,000, and the value subsequently drops by $100,000, the company must recognize that loss and reduce its crypto holdings to reflect the decrease in value.
This principle still applies even if the fair value later increases to $600,000. The loss cannot be reversed, nor can the value be increased on the balance sheet. Per GAAP guidelines, the impaired value (in this scenario) would remain at $400,000.
Recording Cryptocurrency Mining Revenue
Businesses engaged in cryptocurrency mining must record crypto profits on their balance sheet, just like any other revenue-generating activity. This means their mining revenue account will be credited, while the newly generated digital asset must be debited at its fair market value.
Various expenses incurred during mining operations also need to be booked. For instance, if cash is used to pay for mining costs, the cash account must be credited. Correspondingly, purchasing mining equipment that requires capitalization and amortization would be debited to an asset account, or other items like supplies and utilities would be recorded as expenses.
Using Cryptocurrency to Pay Suppliers
When a business uses cryptocurrency to pay a supplier or vendor, this constitutes a disposal of an asset and should therefore be recorded in the same manner as selling cryptocurrency (i.e., crediting the asset account). At this point, any capital gain arising from the difference between the expense and the asset's book value must be recognized.
To illustrate, suppose a company holds 100 BTC with an initial value of $300,000, and the fair value of BTC later rises to $400,000. If the firm chooses to pay an audit firm with BTC worth $400,000 instead of cash, this amount should be debited to the professional services expense account. Simultaneously, the BTC asset account must be credited for $300,000, with the remaining $10,000 difference credited to the capital gains account.
Cryptocurrency Taxation
Tax compliance is an integral part of cryptocurrency accounting. Under current asset treatment guidelines, cryptocurrency is considered a capital disposition upon sale.
Capital Gains and Losses
Capital gains tax occurs when the profit from a capital disposition is higher than the cryptocurrency's purchase price. Conversely, if the disposal proceeds are lower than the purchase price, a capital loss is incurred. These losses can be used to offset capital gains from other assets or carried forward to the next financial year, thereby reducing tax liability.
Income Tax Liability
Individuals who receive compensation in the form of cryptocurrencies like BTC or ETH incur corresponding income tax liability. The transaction profit should be recorded at the market value of the cryptocurrency at the time of the transaction. Companies are also required to pay corporate tax on such profits.
When Financial and Tax Reporting Diverge
Although taxation and accounting are inherently closely linked, the rules applicable to both are not entirely identical in all situations. For example, unrealized cryptocurrency losses must be journaled under IFRS and GAAP rules, particularly when an impairment event occurs for an asset. These losses are generally not deductible for tax purposes.
The cryptocurrency tax system is complex, and financial reporting for accounting purposes can be even more challenging to understand in some cases. To avoid confusion, cryptocurrency transaction records are often divided into two broad categories based on their tax nature: those generating income tax and those generating capital gains tax.
Taxable Events Under GAAP and IFRS
According to GAAP and IFRS standards, the following events will require a company to pay income tax on the fair market value of the asset:
For this reason, all the activities mentioned above should be recorded as total revenue for the year. These will be taxed as ordinary business income, but all ordinary and necessary expenses arising from these activities will be deductible.
As for events triggering capital gains or losses, all transactions classified as cryptocurrency capital disposals that yield a gain (and differ from their cost basis) are considered taxable events:
- Selling cryptocurrency
- Exchanging cryptocurrency
- Using cryptocurrency to pay suppliers or vendors
Non-Taxable Events Under GAAP and IFRS
Cryptocurrency non-taxable events are transactions that do not increase a company's tax burden. These include:
- Transferring crypto between wallets you own
- Donating cryptocurrency to a tax-exempt organization
- Purchasing cryptocurrency with fiat currency (as no disposal occurs)
Conclusion
The foundation of prudent financial management is the accurate accounting of profits and losses. This plays a key role in ensuring financial reports are transparent and credible. For stakeholders such as investors, creditors, and regulatory bodies, this is an indispensable factor in assessing an organization's performance and financial health.
Therefore, rigorous accounting not only ensures legal compliance but also enables individuals, businesses, and organizations to make effective strategic decisions, paving the way for sustainable development and long-term success. To delve deeper into advanced financial strategies for digital assets, feel free to explore comprehensive accounting resources.
Frequently Asked Questions
How is cryptocurrency classified on a balance sheet?
Cryptocurrency is typically classified as an intangible asset on the balance sheet. It is recorded at its fair market value at the time of acquisition and is subject to impairment testing under relevant accounting standards, but generally cannot be revalued upwards after a write-down.
Do you record cryptocurrency at cost or fair value?
Initially, cryptocurrency is recorded at its cost, which is the fair market value at the time of purchase. Subsequently, under GAAP, it is held at cost less any accumulated impairment losses. The fair value might be disclosed in the notes to the financial statements but is not typically used for the core balance sheet valuation after initial recognition.
What is the journal entry for buying cryptocurrency?
The journal entry for buying cryptocurrency with cash involves debiting the cryptocurrency asset account for the purchase amount and crediting the cash account for the same amount. This records the exchange of one asset (cash) for another (crypto).
How do you account for crypto mining?
Revenue from crypto mining is recorded at the fair value of the mined coins at the time they are received. This involves debiting the cryptocurrency asset account and crediting a mining revenue account. Associated expenses, such as electricity and hardware costs, are recorded separately as operating expenses.
Are cryptocurrency transactions subject to VAT?
The treatment of VAT on cryptocurrency transactions varies by jurisdiction. In many countries, the sale of cryptocurrency by a business is subject to VAT, while others may exempt it. It's crucial to consult local tax regulations to determine the specific VAT implications for your business.
Can you reverse an impairment loss on cryptocurrency?
Under U.S. GAAP, impairment losses for intangible assets, including cryptocurrency, cannot be reversed even if the market value subsequently recovers. This is a key difference from some other accounting frameworks and emphasizes the conservative approach required in crypto asset valuation.