Cryptocurrencies have been around for some time. Bitcoin, Litecoin, Ethereum, and other digital currencies are now being used in many business transactions and are becoming an important financial instrument. The rising popularity of cryptocurrencies is drawing attention to the businesses that use them to transact, and especially how accounting for these digital currencies can be done properly.
This article provides essential information on cryptocurrency bookkeeping, and accounting best practices with tips to help simplify the process.
What is cryptocurrency bookkeeping?
Cryptocurrency in a nutshell
Cryptocurrency is a virtual or digital currency that is encrypted for security. By means of cryptocurrency, businesses can carry out their transactions peer-to-peer without centralized control or an intermediary such as a bank. According to Investopedia, the operation of most of the currencies is based on decentralized platforms with their blockchain technology, a distributed ledger enforced by a disparate network of computers, which we’ll be explaining in more detail in this article.
It is noteworthy, though, that cryptocurrencies are, by definition, not currency. In Canada, they are viewed as a commodity and therefore treated as an investment. Therefore, accounting for cryptocurrencies is similar to other securities, such as stocks or bonds. However, in the US and some other countries, cryptocurrencies are considered property, which means that when you acquire any crypto, you need to record it at its market value, just like when you purchase a house or building for example. The same goes for when you sell or use cryptocurrency, you need to make sure to record its value correctly. A gain is made if the value when you sell or use crypto is higher than that when you obtain it, otherwise, you suffer a loss. Such gains or losses, which result from transacting or trading cryptocurrencies are taxable, so every transaction must be kept track of and accounted for in a compliant manner.
For a better understanding of cryptocurrencies and how it works for your business, check out our review article on Bitcoin and cryptocurrency for the e-commerce industry. But first, here are some essential crypto terms that you should be aware of when working with Bitcoin and the likes:
- Blockchain is a form of distributed ledger technology (a database that is distributed to more than one computer or node) used to support Bitcoin and other cryptocurrencies, comprising pieces of digital information held together to record transactions.
- Tokens is a type of digital currency that represents its own asset or utility and relies on its blockchain. Tokens can be traded or transferred between users in the blockchain.
- Wallet is a system that tracks the ownership of virtual currencies.
- Mining: An act of earning cryptocurrency without having to put money down on it. Miners provide a service to the blockchain network using special software to solve math problems in return for the acquisition of more cryptocurrencies. Any cryptocurrency earned through this activity should be treated as income and reported accordingly.
As online transactions are becoming a norm, the advantages of cryptocurrencies compared to traditional payment methods are easy to see. You can easily use an online wallet to send and receive cryptocurrencies with other people who have the same wallet. In this way, cryptocurrencies are not subject to currency conversion fees or exchange rates, which fluctuate and make international transactions cumbersome and costly. However, cryptocurrencies have also posed new challenges to how businesses should do bookkeeping and accounting.
Bookkeeping for cryptocurrency businesses
As a form of digital money that is unregulated by banks or government, cryptocurrency hasn’t been essentially accounted for by existing accounting standards, although most agree that it should be classified as an intangible asset, referring to standards such as International Accounting Standard (IAS) 38 and IAS 21. Due to its anonymous nature which can be exploited for illegal activities including money laundering and tax evasion, it is only a matter of time before the government takes measures to monitor the use of cryptocurrency in business transactions.
Of course, you don’t have to pay any specific income tax or Capital Gains Tax (CGT) on purchasing goods or services. But as long as you use cryptocurrency for business investment or income generation, the actual tax accountancy surrounding Bitcoin and other digital money will inevitably be applied. To avoid potential troubles with tax and audits, bookkeepers and accountants should grasp some of the basics of crypto accounting as follows:
- Calculate capital gains and losses based on the adjusted cost base
The adjusted cost base is the average cost for all cryptocurrencies you have obtained, from past to present, and it must be calculated separately for each type of coin you own, in case there are several of them.
- Check the fair market value on the day of the transaction
Because cryptocurrency can be subject to variations in value, the value of a transaction, be it a commodity trade or a payment, depends on the fair market value on the same day.
- Make payments to vendors
Payments in cryptocurrencies with a fair market value of $600 and higher must be reported to the IRS, using form 1099-MISC.
- Record mined cryptocurrencies
It is necessary to record the currency you mined in the income account and the costs incurred by the mining act as an expense in your books. Because, when you’re “mining” cryptocurrencies, you’re creating new value for that currency (the digital equivalent of printing money, without the inflation) and creating compensation for yourself. To record your income and expenses, use tax form Schedule C if you are not incorporated, or Form 1120 if you are incorporated. Schedule C is used when you pay self-employment taxes.
- Trade cryptocurrencies
Cryptocurrencies are considered property as their holders can sell or transfer them separately. They do not give the holder a right to receive a fixed or determinable number of units of currency. As a result, trading cryptocurrencies is just like day trading. You need to record two things: first, the value of any currency on the day you acquire it, and second, its value on the day it is sold.
The difference in value recorded will reflect your gains or losses. When you do your tax return, record these gains and losses on the required form and categorize them as short or long-term gains or losses based on how long you have the currency.
- Account for more than one cryptocurrency
Accounting for transactions with one type of digital money is difficult enough, but in many cases, you have to handle transactions between two or more cryptocurrencies. Everything comes into play all at once, and you need to calculate multiple cost bases, adjusted cost bases, fair market values, gains, and losses. It will definitely take a great deal of time and bookkeeping skills to ensure nothing is overlooked and to maintain accurate accounting. But if you keep track every step of the way, it is definitely manageable.
Why is cryptocurrency bookkeeping complicated?
Business transactions that deal with cryptocurrencies between blockchain businesses, brokers, or funds often entail using an array of wallets or trading accounts, each with different purposes to serve. Because of the different cryptocurrency systems and formats, to report a crypto transaction for tax purposes, businesses must collect related data from various exchanges and account for them accurately according to regulations.
Since the value of a transaction is determined by the fair market value on the day it is conducted, the accounting tasks of obtaining, consolidating, organizing all data for various assets at different times and varying prices can be a hassle. Not every business has the willingness and ability to take up that challenge.
The complexity of this process, therefore, may lead to the reluctance of cryptocurrency businesses to maintain daily bookkeeping tasks, only to find out later that the accumulated workload is getting overwhelming, putting extra strains on accounting efforts for which enterprises must bear the resulting costs.
In addition to the complex and high volume of crypto exchanges, accountants and bookkeepers in cryptocurrency businesses must also deal with the constantly changing regulation of digital assets. With most financial guidelines on reporting and accounting meant only for fiat currency-based businesses and with few assisting tools, managing and tracking different digital assets and meeting compliance requirements can cause major hurdles for any crypto business seeking tax-effective bookkeeping practices.
Working with highly volatile investments such as cryptocurrencies means that financial professionals have to do their tasks with utmost care. It is part of their duties to fulfill the tax obligations, so the least desirable thing is to fall behind the regulatory updates and make accounting mistakes that harm their companies.
Cryptocurrency bookkeeping best practices
1. Track all transactions
While accounting guidelines regarding cryptocurrencies remain unclear, crypto businesses can still benefit from executing proper bookkeeping. Keep all proofs of invoices and payments safe and organized to be ready for any tax event or to help your business with a better picture of its financial situation. Besides this, other information that you’d better keep close include the list of exchange accounts, addresses, wallets used for each transaction, and especially the records of cryptocurrency value at the time you obtain it and when you get rid of it.
The burden of keeping up with piling documents can be worrying, but there are bookkeeping-friendly tools to assist you in recording necessary receipts like Shoeboxed. No more missing receipts and messy folders, Shoeboxed digitizes your documents into verified images which you can get access to anytime and anywhere. With its customized reporting feature, Shoeboxed can also help you to categorize all crypto transactions into operational costs, expenses, revenue, or other relevant transaction types.
Because all crypto-related costs, expenses, and transactions need to be converted into fiat currency at the end of the day, it is best practice for crypto businesses to track fiat and cryptocurrency transactions, and then create consolidated reports for both. Accurate data collection surely takes time, but it is the key point of this process that any crypto business must find a way to handle, whether by manual entry or by utilizing supporting software.
2. Integrate automation tools to reduce time and errors
The main problem with using standard accounting programs for cryptocurrencies is that they are only compatible with fiat currency. With the help of specialized software to export the crypto transactions to standard accounting software, though, the booking procedure for cryptocurrencies is becoming easier. There are now increasingly more such tools, so you have the options to take advantage of those with convenient functions such as the ability to integrate with cloud-based accounting systems. Reducing the time-consuming manual input and user errors, it is undoubtedly worth your investment to automate the crypto accounting processes.
3. Comply with rules and regulations
Understanding and adhering to the regulatory treatment of cryptocurrencies is crucial to the success of any business that transacts in crypto. However, defining exactly how to execute a crypto bookkeeping strategy is complicated because cryptocurrency is still a volatile financial instrument, the regulatory practices of which vary widely across different countries. In any scenario, it is wise for bookkeepers and accountants to get accustomed to these distinctions in order to guarantee regulatory compliance, especially if cryptocurrency is being used for international transactions.
Since crypto bookkeeping has not been standardized without an existing bookkeeping framework, crypto businesses have mostly carried out their bookkeeping on a case-by-case basis. Confusions regarding implementing such practices are inevitable, but above all, cryptocurrency is generally classified as a property with applicable property tax principles. Given that fact, it is sensible to prepare all the documents to justify transaction activities for tax purposes, ranging from invoices, proof of ownership of the addresses, to wallet balance.
To look on the bright side, many believe in the potential of the technology under crypto assets to disrupt the current bookkeeping system. Small improvements have been steadily introduced and it may pave the way for a new accounting model to emerge. With changes brought by blockchain technology being underway, accountants and bookkeepers should be aware of the possible opportunities and challenges these changes offer and keep themselves updated with cutting-edge knowledge and technology to stay competitive in the field. our staff from Shoeboxed would be glad if our product could accompany those who need help with storing and organizing receipts, so let us hear your voices on the crypto industry as well as the bookkeeping services you may wish you had.
Share with us your thoughts on bookkeeping for cryptocurrency in the comment section below!