Cryptocurrency may sound foreign, but the virtual dollar is quickly becoming a mainstream form of currency. eBay, Dell, and PayPal — along with a growing list of online retailers, entertainment venues, and food delivery services — currently accept cryptocurrencies such as Bitcoin, Ethereum, and Ripple for transactions. As use of cryptocurrency grows in popularity, it presents challenges for accounting of which vendors and their accountants will need to be aware.
A cryptocurrency is a virtual medium of exchange. It works in many ways the same as paper money, although cryptocurrency has no physical form. Users make purchases with cryptocurrencies using "wallet software."
In other ways, cryptocurrencies are very different than traditional tender. Cryptocurrency is not regulated by the government or another legal entity. It has no centralized control for transactions, like a bank. Instead, transactions are recorded using technology called blockchain. Blockchains are created only after users (called "miners") solve complicated math problems that validate the encryption coded behind each piece of currency. Transactions are then listed in order — like a chain — on a public, web-based ledger.
Cryptocurrency also can be traded peer-to-peer via wallet software. It doesn’t have a stock, per se, but it can be treated as an investment asset that is bought and sold at current prices.
Cryptocurrency and Tax Accounting Issues
Because of its popularity, it's critical to know how cryptocurrency is treated for tax purposes if your organization decides to use or invest in the virtual money.
In 2014, the Internal Revenue Service issued a notice (2014-21) on the federal tax implications of transactions in, or transactions that use, virtual currency. In short, cryptocurrency is treated as property because, although it is accepted as a medium of exchange, it does not have legal tender status anywhere.
The way cryptocurrency is reported depends on whether it's used in business transactions or as an investment. For businesses that accept virtual currency as a form of payment, the virtual exchange can be reported as a net operating loss or gain. Investors, on the other hand, treat cryptocurrency as a capital gain or a capital loss. That reporting is subject to different tax rates and rules depending on the investor's tax bracket.
Because it's considered property, cryptocurrency users must track their gains and losses every time the virtual tender is exchanged. That can prove cumbersome, so it's recommended each transaction be kept in a separate online wallet. Businesses and investors will also want to be sure appropriate records on the time and date of each transaction are maintained.
Other Accounting Issues
On the accounting side, further guidance is still needed. Traditional investments typically meet the definition of financial assets and are reported at fair value. Cryptocurrency, however, does not meet that definition because it is neither legal tender nor a cash equivalent. It also has no contractual right to receive cash or a cash equivalent.
Making matters more complicated, the virtual dollar is a highly volatile asset. Its value changes every day, sometimes rising and falling within minutes or hours. Bitcoin's value reached nearly $20,000 at the end of 2017, but it's going through a sharp crash in price so far in 2018.
Further clarification is needed on whether to classify cryptocurrency as inventory or as an intangible asset. If it's inventory, cryptocurrency would be accounted for like property — at cost. If it's an intangible asset, cryptocurrency would also be measured at cost and the asset would need to be evaluated for impairment at least on an annual basis. But, an argument could be made to measure it at fair value because cryptocurrency is traded on an active market. The actual value at which investors realize their investments or use cryptocurrency in exchange for goods and services will be different than the initial cost. Movements in fair value would have to be recognized through other comprehensive income when investments are realized. At present, the front-runner for the conclusion seems to be the position that the cryptocurrency is an intangible asset with an indefinite life that is evaluated for impairment.
While there are a lot of unknowns in cryptocurrency accounting, there is one thing that is certain: More guidance is expected from regulators soon. MHM will keep you informed as more information becomes available. If you have any comments, questions, or concerns about cryptocurrency accounting, contact us.
Published on July 13, 2018