Cryptocurrency Taxation

Cryptocurrency taxation and reporting transactions on your balance sheet differ. Here’s how to treat cryptocurrency on your balance sheet.

Currently, no accounting standards are dedicated to crypto assets, so broader guidelines per the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Practice (GAAP) are applied to cryptocurrency accounting.

Balance sheets are among the three primary financial statements that businesses need, alongside income and cash flow statements. Whereas income and cash flow statements show a business’s economic activity over a certain period, a balance sheet shows how many assets it has, and whether it has equity and any debt.

Balance sheets are also referred to as statements of financial position because they provide a complete picture of a business’s financial situation. It also includes every journal entry since the business started. For this reason, crypto transactions ought to be included, especially those that impact a business’s financial situation.

Why a balance sheet is needed

A balance sheet provides valuable insights into a business’s financial health and offers key benefits. Since balance sheets are typically prepared at the end of a specific reporting period, they allow one to compare business performance year-over-year. As such, balance sheets provide a measurable way to track the growth and progress of one’s business.

Balance sheets also allow one to calculate key financial ratios, such as the debt-to-equity ratio, which shows whether or not a business can pay off its debts with its equity. It also includes information necessary to compute other important ratios, such as current assets vs. current liabilities, showing whether a business can pay off its debts in 12 months.

Lastly, balance sheets allow one to reasonably evaluate the business. This can be helpful when looking for investors (to prove that they will enjoy profitable returns) or when looking to sell the business.

How do you treat crypto on a balance sheet?

One of the most common questions when preparing a balance sheet is, “Where does crypto go on the balance sheet?” As mentioned previously, both the IFRS and GAAP do not currently have any specific references with regard to crypto bookkeeping.

However, since cryptocurrencies qualify as assets, the core principles of accounting for assets apply when preparing a balance sheet that includes crypto transactions. Here are some helpful pointers:

When purchasing cryptocurrency with fiat money

Cryptocurrency trading activities should be recorded similarly to those of stock trading activities. If one buys Bitcoin (BTC) or Ether (ETH), these digital assets can be added to the balance sheet at their fair market value on the date the assets were purchased.

This will reflect as a debit on one’s assets account. Additionally, since the cryptocurrency was purchased with fiat currency, the cash account should also reflect the credit for the purchase price of the acquired crypto assets.

When selling cryptocurrency for fiat money

When selling cryptocurrency, however, the assets account will be credited, and the cash account will be debited with the amount of fiat received upon selling the cryptocurrency.

Suppose there is a significant difference between the sale amount of the cryptocurrency vs. the amount paid for it (original purchase price). In that case, a capital gains account should also be credited.

Recording unrealized losses

Following GAAP’s accounting rules on intangible assets, impairment losses can’t be reversed even if the asset recovers from previous price levels. If a business purchases BTC with a fair value of $500,000, which then drops by $100,000, then the company has to recognize that loss and reduce its cryptocurrency holdings to reflect the decrease in value.

This holds even if the fair value later increases to $600,000. The loss can’t be reversed or increased in value on the balance sheet. Per GAAP guidelines, the impaired value (in this scenario) will remain at $400,000.

Recording crypto mining income

Businesses that engage in cryptocurrency mining must record cryptocurrency profits in their balance sheet like other income-generating activities. This means their mining income account will be credited. Then, the newly generated digital asset will need to be debited onto their books at the asset’s fair market value.

Expenses incurred during mining operations will also need to be accounted for. For instance, if cash is spent to pay for mining expenses, then the cash account must be credited. The corresponding asset account will then be debited (buying mining equipment that has to be capitalized and amortized) or otherwise recorded as an expense for things such as supplies and utilities.

Using cryptocurrency to pay suppliers

When using cryptocurrency to pay a supplier or vendor, it qualifies as a disposal and should thus be recorded in the same way as selling the cryptocurrency (i.e., assets account credited). A capital gain will, therefore, be recognized for the difference between the expense and the book value of the asset.

For example, if one has 100 BTC, equivalent to $300,000, and the BTC has since increased in fair value to $400,000 — but then pay the certified public accountant firm who did the audit $400,000 worth of BTC instead of cash — the amount will need to be debited to their professional services expense account. Meanwhile, the BTC asset account will need to be credited $300,000. The remaining $100,000 balance will then be credited to a capital gains account.

Taxing cryptocurrencies

Tax compliance is an essential part of accounting for cryptocurrencies. As mentioned earlier, when cryptocurrencies are sold, it is considered capital disposal as per the current guidelines on assets.

Capital gains and losses

Whenever the profits from capital disposal are higher than the price the cryptocurrency was purchased at, cryptocurrency incurs a capital gains tax. However, when proceeds are lower than the purchase price, it incurs a capital loss. Capital losses may then be used to balance out capital gains on other assets or carried over to the next financial year. In any case, it can reduce one’s tax liability.

Income tax liability

When someone is paid in cryptocurrencies such as BTC or ETH, they will be liable for income tax. The market value of the cryptocurrency at the time of the transaction should be used to account for such under one’s trading profits. Companies also need to pay corporation tax on said profits.

Related: Cryptocurrency tax guide: A beginner’s guide to filing crypto taxes

When financial statements and reporting for tax purposes have discrepancies

Taxation and accounting are intrinsically linked, but the rules that apply to both do not align under all circumstances. For instance, unrealized cryptocurrency losses will require one to keep journal entries under both IFRS and GAAP rules, especially concerning impairment events during which there wouldn’t be a deduction on taxes for such losses.

Cryptocurrency taxes can be complicated, but financial reporting for accounting purposes can be even more mind-boggling in several instances. To avoid confusion, cryptocurrency transaction recordings are often split into two groups based on cryptocurrency taxes: Transactions that generate income taxes and transactions that generate capital gains taxes.

Related: How to track and report crypto transactions for tax purposes

Taxable events under GAAP and IFRS

Taxable events that cause businesses to owe income taxes on an asset’s fair market value under GAAP and IFRS are as follows:

For this reason, all the above activities should be recorded as gross revenue for the year. These will be taxable as ordinary business income, but all ordinary and necessary expenses resulting from these activities will be deductible.

As for events that trigger capital gains or losses, all transactions that fall under the category of capital disposal of cryptocurrency for proceeds (and that differ from their cost basis) are considered taxable:

• Selling cryptocurrency
• Exchanging cryptocurrency
• Using cryptocurrency to pay a supplier or vendor

Non-taxable events under GAAP and IFRS

Cryptocurrency transactions that are non-taxable events are those that do not contribute to the tax liability of one’s business. These include:

The basis of prudent financial management is accurate accounting for gains and losses. It plays a crucial role in ensuring that financial reporting is transparent and trustworthy. It is essential for stakeholders like investors, creditors and regulatory authorities to evaluate an entity’s performance and financial health.

Accordingly, careful accounting guarantees compliance with laws and gives people, companies and organizations the power to make tactical decisions that can result in sustainability and long-term success.