Businesses are increasingly accepting crypto-assets as payment, paying in cryptoassets, or holding cryptoassets as investments, but CFOs must not confuse cryptoassets with electronic cash that links to a country's traditional currency. Companies that transact in cryptoassets face different accounting and tax requirements, unique financial process and internal control needs, and new risk management scenarios.
A cryptoasset is a digital asset with ownership records stored in a computerized database using cryptography — communications techniques that allow only the sender and intended recipient of a message to view its contents — to secure transaction records that verify the chain of ownership in a digital ledger. The most well-recognized cryptoasset is bitcoin, but there are other digital assets such as digital art, also known as nonfungible tokens, or NFTs. While a cryptoasset may embody some of the traits of traditional currencies, in that it can be used as a medium of exchange for goods and services, it is not currency because it is not issued by any country or central bank.
According to FASB Concepts Statement No. 5, a monetary unit or measurement scale in financial statements is "nominal units of money [that] are relatively stable." This means that transactions need to be expressed in currency form and that the currency value remains constant over time. This consistency does not presently exist with cryptoassets, as we have seen recently with bitcoin's high valuation volatility. Because a cryptoasset is not a currency, cryptoasset transactions and investments require different accounting and tax treatment.
CRYPTOASSET ACCOUNTING TREATMENT
As of this writing, FASB has not issued cryptoasset guidance. In December 2019, the AICPA issued the practice aid Accounting for and Auditing of Digital Assets. Based on first ruling out other asset classifications, the consensus from the AICPA, based on current standards, is that a cryptoasset generally should be classified on the balance sheet as an intangible asset with an indefinite life.
FASB ASC Topic 350, Intangibles — Goodwill and Other, guides cryptoasset accounting and defines intangible assets (not including financial assets) as lacking physical substance. An indefinite life exists if no legal, regulatory, contractual, competitive, economic, or other factors limit the intangible asset's useful life. This means there is no foreseeable limit on the time the entity expects the intangible asset to contribute to its cash flows.
An indefinite-life asset requires annual impairment testing unless events require testing sooner. If the cryptoasset valuation drops and triggers testing that concludes an impairment exists, the business recognizes an impairment loss on the income statement. If, however, the cryptoasset value goes back up, as we witnessed in the first quarter of 2021, the business does not get to mark up the asset value. As a result, the use of GAAP can result in understating cryptoassets on the balance sheet and prohibits reporting the true value of cryptoassets, which would occur if they were classified as financial instruments.
Bitcoin values have had high volatility recently. As of this writing, bitcoin's value rose above $63,000 in April 2021 from less than $10,000 in the previous year, then fell to below $40,000 as recently as May 19. This volatility increases impairment loss risk. Companies holding cryptoassets must monitor relevant events and circumstances that may indicate whether it is more likely than not that the asset is impaired. One impairment indicator is third-party market transactions at a value less than the reporting entity's carrying value. Cryptoasset transactions the reporting entity makes itself are also impairment indicators.
Some cryptoassets might meet the asset definition if their value can be measured reliably. FASB Concepts Statement No. 6 defines an asset as having "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events."
Other cryptoasset classifications may not be deemed appropriate, and the reasons are discussed below:
- Cash and cash equivalents: A cryptoasset is not backed by a sovereign government; thus, it is not legal tender.
- Financial instruments: A cryptoasset is neither cash nor representing a contractual legal right to receive cash or another financial instrument.
- Inventory: A cryptoasset is intangible, which means it may not meet the inventory definition.
FASB ASC Topic 606, Revenue From Contracts With Customers, provides revenue recognition guidance. Entities receiving cryptoasset payment, for purposes of revenue recognition, record the payment as noncash consideration measured at a transfer price at the cryptoasset estimated fair value on the contract inception date. Since a timing difference exists from the contract inception date to the cryptoasset payment date, entities need to follow subsequent measurement guidance for the pre-revenue-recognition timing.
Further complication exists for post-revenue-recognition timing if the selling entity has a future receipt of cryptoassets upon accounts receivable settlement. Guidance from FASB ASC Topic 815, Derivatives and Hedging, may apply.
CRYPTOASSET TAX TREATMENT
In 2014, the IRS provided guidance on virtual currency, including cryptoassets, in Notice 2014-21, which was later supplemented by Rev. Rul. 2019-24. (See the sidebar, "Example: Riot Blockchain Inc. 10-K for 2019," for a look at how one company presented its cryptoassets in an SEC disclosure.)
For federal tax purposes, a cryptoasset is treated as property under this guidance. A cryptoasset is not treated as currency, and general tax principles applicable to property transactions apply to transactions using virtual currency.
Depending on the taxpayer's facts and circumstances, cryptoassets can be business, investment, or personal property and can be a capital asset or inventory.
A taxpayer that buys a cryptoasset has a cost basis in it. A taxpayer who receives a cryptoasset as payment for goods or services must include in income the fair market value (FMV) of the cryptoasset at the time it is received; therefore, the taxpayer's basis in the cryptoasset is its FMV at the time it is received.
If a taxpayer exchanges a cryptoasset for other property, the taxpayer has a gain on the exchange if his or her adjusted basis in the cryptoasset is less than the FMV of the property received, and a loss if it is more. When a taxpayer sells a cryptoasset, the taxpayer recognizes a gain or loss of the difference between the FMV of the cryptoasset at the time of the sale or purchase and the taxpayer's basis in the cryptoasset.
If the taxpayer holds the cryptoasset as a capital asset, generally the gain or loss on the sale of the cryptoasset or an exchange of it for other property is a capital gain or loss; however, if the taxpayer holds the cryptoasset as a noncapital asset (e.g., inventory), generally the gain or loss on the sale of the cryptoasset or its exchange for other property is ordinary income.
For individuals, gains or losses from transactions involving a cryptoasset usually are also subject to the 3.8% net investment income tax unless the transaction occurs in the ordinary course of a trade or business other than a passive activity or trading in financial instruments or commodities.
If a taxpayer receives a cryptoasset as payment for services, the payments are treated as made in property for withholding and employment tax purposes. The FMV of a cryptoasset received for services performed as an independent contractor, measured in dollars as of the date of receipt, constitutes self-employment income subject to the self-employment tax. The FMV of a cryptoasset paid as wages is subject to federal income tax withholding, Federal Insurance Contributions Act tax, and Federal Unemployment Tax Act tax and must be reported on Form W-2, Wage and Tax Statement.
Also, a taxpayer that "mines" a cryptoasset must include in gross income the FMV of the cryptoasset mined as of the date of receipt. Furthermore, if an individual mines a cryptoasset, and his or her mining activity constitutes a trade or business, the net earnings from the activity are subject to self-employment tax.
Mining is the process of creating new crypto-assets by solving complex mathematics problems. Cryptoassets using Proof of Work consensus, including bitcoin, require many computers and use massive amounts of energy, but other consensus models, such as Proof of Stake, do not require this level of resources. According to the University of Cambridge's bitcoin electricity consumption index, bitcoin miners are expected to consume about 135 terawatt-hours of energy (TWh) annually, which is more than Sweden's annual energy consumption. Since producing electricity to meet this need often requires the burning of fossil fuels, questions have been raised about mining's environmental footprint costs. Accordingly, Tesla stopped accepting bitcoin payments for its vehicles in May 2021.
Cryptoasset payments with an aggregate value greater than $600 to certain other individuals require reporting on Form 1099-MISC, Miscellaneous Information. On page 1 of the 2020 Form 1040, U.S. Individual Income Tax Return, the IRS asks whether the taxpayer received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency during the year. Also, cryptoasset payments are subject to backup withholding to the same extent as other payments made in property. (See "Example: Riot Blockchain Inc. 10-K for 2019.")
RISK MANAGEMENT AND INTERNAL CONTROL CONSIDERATIONS
Cryptoasset transactions, assets, and liabilities introduce new risks and require unique internal controls for risk mitigation. Selected risk examples follow:
- Valuation: FASB ASC Topic 820, Fair Value Measurement, defines fair value as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." Concepts of similar assets, orderly transactions, active and principal markets, and market participants are different for crypto-assets. Recent high cryptoasset price volatility in the first quarter of 2021 casts doubt on market price reliability.
- Existence: Evidence is more tenuous for intangible asset existence. Cryptoasset evidence is only digital, which may not be sufficient to validate existence and perform confirmation. Additionally, security for private keys has no backup functions, such as a password reset. Thus, losing a private key is a strong risk.
- Authorization authority: Board of directors—approved authority levels need to be modified for cryptoasset transactions.
- Accounting processes and systems: These are based on currency, including foreign currency accounting. A cryptoasset is not currency, and using intangible assets as a transaction medium needs accounting policy, procedure, and process establishment and documentation. Available cryptoasset accounting system technology includes back-office software solutions such as CoinTracker, Gilded, Ledgible by Verady, and Lukka.
- Knowledge and understanding: Employing or contracting for people with adequate crypto-asset expertise is difficult because few people possess sufficient capability. This is necessary for designing operational policies, procedures, and processes; performing risk assessment and mitigation; and enabling boards of directors to perform proper oversight.
Example: Riot Blockchain Inc. 10-K for 2019
Asset impairment charges of $1.5 million were recognized during the year ended December 31, 2019, and were related to $0.8 million for the impairment of our cryptoassets accounted for as intangible assets and $0.7 million related to our intangible assets acquired in connection with our RiotX/Logical Brokerage business.
Cryptoassets (including bitcoin, bitcoin cash, and litecoin) are included in current assets in the accompanying consolidated balance sheets.
Cryptoassets purchased are recorded at cost, and cryptoassets awarded to the Company through its mining activities are accounted for in connection with the Company’s revenue recognition policy disclosed below.
Cryptoassets held are accounted for as intangible assets with indefinite useful lives. An intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount exceeds its fair value, which is measured using the quoted price of the cryptoasset at the time its fair value is being measured. In testing for impairment, the Company has the option to first perform a qualitative assessment to determine whether it is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, a quantitative impairment test is not necessary. If the Company concludes otherwise, it is required to perform a quantitative impairment test. To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset. Subsequent reversal of impairment losses is not permitted.
Purchases of cryptoassets by the Company are included within investing activities in the accompanying consolidated statements of cash flows, while cryptoassets awarded to the Company through its mining activities are included within operating activities on the accompanying consolidated statements of cash flows. The sales of cryptoassets are included within investing activities in the accompanying consolidated statements of cash flows, and any realized gains or losses from such sales are included in other income (expense) in the consolidated statements of operations. The Company accounts for its gains or losses in accordance with the first-in, first-out (FIFO) method of accounting.
Fair value of the cryptoasset award received is determined using the quoted price of the related cryptoasset at the time of receipt.
About the author
Mark D. Mishler, CPA, CMA, MBA, is a principal at CFO Resource Management in Morristown, N.J., and an adjunct professor of accounting, finance, and management at Seton Hall University in South Orange, N.J., and Rutgers University in New Brunswick, N.J.
To comment on this article or to suggest an idea for another article, contact Sabine Vollmer, a JofA senior editor, at Sabine.Vollmer@aicpa-cima.com or 919-402-2304.
- "5 Ways Accountants Can Track Cryptocurrency," CPA Insider, June 29, 2020
- "How to Handle Accounting for Digital Assets," JofA, Dec. 16, 2019
- "What CPAs Need to Know About 4 Cryptoasset Classes," CPA Insider, Jan. 7, 2019
- "Tax Practice Corner: Documenting Virtual Currency Transactions," JofA, Jan. 2018
- Reporting virtual currency transactions, Tax Section Odyssey
- Virtual currency tax guidance and resources
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