One of your customers has offered to pay you in a cryptocurrency. You’re nervous, as this is something your company has never handled before.
Not to worry. This guidance can set you on a smart path to accepting crypto, converting it to cash and accounting for it on your books.
First, some background. Transactions executed with U.S. dollars use a traditional ledger. This means one party (typically a bank or other financial institution) has centralized control and access over the ledger. Each party in the transaction exchanges their information with the centralized party, which then executes and records the transaction.
By contrast, cryptocurrency is a digital currency that uses a distributed ledger, generally blockchain, to execute transactions. Distributed ledgers are decentralized, meaning the ledger is distributed to all parties and there’s no single intermediary controlling and recording the transaction. Since the information is public, all parties on the ledger agree on recordkeeping, making it immutable. Also, since the intermediary is gone, transactions can be processed almost immediately. The most popular cryptocurrency today is Bitcoin.
Accepting and disposing of crypto
You have several main options for managing crypto payments and managing the risks.
- You can accept crypto and immediately convert it back to dollars by partnering with a third party. No cryptos will be held on the balance sheet, and thus entities will not be subject to crypto gains and losses under this option. The third-party agent accepts crypto on your behalf and converts it to dollars in exchange for a fee. This is the simplest method.
- Another option is to accept the crypto yourself. You will need to set up a crypto wallet, a digital version of the wallet you have to keep cash on hand. Crypto wallets have two main components: a public key and a private key. A public key is similar to an e-mail address. A private key is similar to your password to the e-mail address.
Private keys are generally a very long string of characters and need to be stored in the crypto wallet. There are several different types of crypto wallets. “Hot” wallets are connected to the internet, which leaves them more vulnerable to hacking than “cold” wallets. Cold wallets are not connected to the internet and are stored on removable devices such as USB drives. Just don’t lose your device as one man in Wales did. This would mean losing any assets stored on the device.
Most wallets today are hierarchical deterministic (HD) wallets. HD wallets use a seed phrase to generate infinite pairs of public/private key pairs. The seed phrase is a long random string of digits but can be represented as a mnemonic phrase of common words (dog, ball, desk, etc.). As long as you save your seed phrase, you can lose your device but still recover your assets. It should be kept completely offline and held in a separate location from the wallet.
There are also software wallets that help store private keys. The software is typically installed as an extension on a web browser. Similar to owning a home and installing a security system, the software will mitigate hacking risks but cannot 100% prevent hackers.
If accepting crypto directly into a wallet, the receiver will need your public key. Use a wallet capable of creating an infinite number of public keys. This allows each invoice issued to have a unique public key and allow entities to easily track who payments are coming from and where to apply the payment.
Once in the wallet, it is recommended that the entity convert the crypto into a stablecoin or dollar. A stablecoin is a type of crypto that is designed to have a relatively stable price, typically through being pegged to a commodity or currency. Holding stablecoins should reduce the amount of gains/losses experienced while holding cryptos. Most online wallet platforms have capabilities to easily trade cryptos or convert to dollars.
Accounting for crypto
Although currency is in the name cryptocurrency, cryptos should not be treated as a cash and cash equivalent because they’re not legal tender or backed by the U.S. government or any other sovereign entity. Cryptos also don’t meet the definition of a financial asset or inventory.
As noninvestment entities, cryptos should be classified as an intangible asset on the balance sheet using nonauthoritative guidance that exists today. Cryptos are considered an indefinite life intangible asset and are not subject to amortization. They are subject to impairment testing at least annually but should be evaluated more frequently, if evidence indicates the crypto is more than likely impaired. Impairment occurs when the fair value of the crypto is less than its carrying value.
Some cryptos are actively traded on a digital exchange (think stock market). The price that trades occur at represent the fair value at that specific point in time. If a trade occurs at a price below the carrying value, an impairment has occurred, and the value of the cryptocurrency should be written down.
Consider the following scenario. Entity A has a December 31 year-end. Entity A receives 100,000 units of a cryptocurrency valued at $1 per unit on September 30. On October 31, units of the same cryptocurrency were traded at $0.80 per unit on an exchange. On December 31, the cryptocurrency is now trading at $1.20. Did an impairment occur?
The short answer is yes. Although the price recovered by December 31, the $0.80 trade occurring on October 31 was evidence that showed the fair value of the crypto was less than its carrying value. A $20,000 impairment loss should be recorded during the current year. Nonauthoritative guidance currently in use does not allow for the reversal of an impairment loss.
The carrying value of crypto will be the lower of 1) the lowest price it was traded during the time you hold it or 2) original purchase value.
Payment timing and pricing
Received crypto from a customer generally leads to two types of situations. The first is when goods or services will be delivered concurrently in exchange for a fixed amount of cryptocurrency. In this situation, the unit price of the cryptocurrency is measured at fair value at contract inception. Revenue is recorded as the goods or services are transferred in accordance with ASC 606. Subsequent changes in fair value after contract inception should be accounted for under the intangible accounting model described above.
The second situation is when goods or services will be delivered in exchange for a fixed amount of cryptocurrency to be received in the future. In this situation, the unit price of the cryptocurrency will not be set until the cryptocurrency is received. This situation is more complex than the first.
Accounting for cryptocurrency is a work in progress. In May 2022, the FASB approved a digital asset project be added to their technical agenda with changes expected to the current digit assets accounting model.
How Wipfli can help
Wipfli’s team of professionals is focused on digital assets and cryptocurrency. We can provide guidance and confidence to clients in need of assistance in navigating the impact of digital assets on accounting and audit, financial reporting and technology controls, and tax and regulatory compliance. No matter where you are in your journey with digital assets, Wipfli can help you stay on top of the changes in this complex and fast-moving area.
Contact us to learn more about our audit and accounting services and how our advisors can work with you on digital assets management.
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