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  • An Accountant’s Guide to Cryptocurrency

An Accountant’s Guide to Cryptocurrency

10 June 2021

What is Cryptocurrencies?

Cryptocurrency is a type of digital asset that is an intangible, digital currency that uses a highly sophisticated type of encryption called cryptography to secure and verify transactions as well as to control the creation of new units of currency. It is designed to work as a decentralized medium of exchange, independent of a financial institution or any other central authority. While Bitcoin is the most well-known cryptocurrency, it is not the only one. Other major types of cryptocurrencies include Ethereum, Ripple, Bitcoin Cash and LiteCoin. There are also other digital assets (or “cryptoassets”).

These are commonly referred to as digital tokens. For example, a company can initiate a “token sale” or a “token launch” which is otherwise frequently referred to as an initial coin offering (ICO). In an ICO, a company is creating a new product and wants to build a user base who will benefit from purchasing the product early. The ICO also enables the company to raise proceeds to develop the product. It is attractive to companies because they can bypass the rigorous and regulated capital-raising process required by venture capitalists or banks. While this FAQ does not further explore ICOs or tokens, entities are encouraged to consult with their legal, accounting and tax advisors given the complexities and significant debate by regulators around such digital assets.

(Source: Cryptocurrency: The Tops Things You Need To Know, published by BDO USA, LLP)


How does it works?

Say you want to buy a Lamborghini (fun fact: Lamborghini officially accepts bitcoin as payment!) - you go to the dealership and say you want to make the purchase. They would say that it’s going to cost you 10,000 bitcoin (based on whatever the spot rate is on the day; the spot rate is dictated by just normal supply and demand economic principles).

At that point, you would transfer the amount of bitcoin required to settle the transaction. What happens next, is that the transaction gets recorded on an open ledger (open: because anyone can view it and is not editable). Bitcoin therefore allows for a transfer of value from one party to another without having to go through a centralised trusted third party provider and represents the first digital transfer of value from one party to another without going through a centralised third party (e.g. bank).

(Source: Financial Evolution: The new world of Crypto, published by BDO South Africa)


How are cryptocurrencies created?

The process of creating a new type of cryptocurrency coins requires either building a new blockchain or modifying an existing process to create a new variant, or “fork.” The majority of these so-called “altcoins” are forks of the Bitcoin protocol.

The only way more coins of an existing crypto coin can be created is through a process called “mining” in which the miner is awarded a transaction fee (a new coin) in exchange for contributing to the underlying blockchain algorithm by being the first to solve a cryptographic puzzle. Mining is extremely competitive and requires significant computing power.

Some cryptocurrencies, like Bitcoin, are finite in supply, meaning that there is a maximum number of coins that will ever be in circulation. Others do not have a maximum cap, but limit the number of new coins that can be generated each year.

(Source: Cryptocurrency: The Tops Things You Need To Know, published by BDO USA, LLP)


What is currently the accounting treatment of cryptocurrency?

From an accounting perspective, intuitively, one would think that a cryptocurrency should be viewed as a financial instrument (i.e. the contractual right to receive cash or another type of asset). This is based on the assumption that if we give away a Bitcoin, the receiver has a contractual right to receive cash at some point in the future.

However, “cash” has a very specific definition as defined by the International Financial Reporting Standards (IFRS): it is a commonly accepted medium of trade. The “commonly accepted” element of this definition is where this gets tricky.

Currently, coins and paper money are commonly accepted as a medium of exchange and they are the medium used by entities to present information in their annual financial statements.

From a cryptocurrency perspective – we are just not quite there - yet. As cryptocurrency becomes more widely adopted, accounting professionals may begin to challenge whether cryptocurrencies are “commonly accepted”.

Currently, cryptocurrencies are treated as intangible assets (e.g. software), thus falling under IAS38 IFRS standard. An intangible asset is an asset that you control, as a result of a past event and from which you expect to receive economic benefits from in the future.

(Source: Financial Evolution: The new world of Crypto, published by BDO South Africa)

Cryptocurrencies meet the definition of an intangible asset and would be recorded at acquisition cost (i.e. price paid or consideration given). Intangible assets are subject to an impairment test. Any recognised impairment losses cannot be subsequently reversed.

Some believe the intangible model does not properly reflect the economics of cryptocurrencies because they can potentially be written down for impairment but never written up when they appreciate in value. This outcome could be less than helpful for financial statement users when significant volatility exists.

In conclusion, accounting for cryptocurrencies is not as simple as it might first appear. There is currently no IFRS standard on cryptocurrencies and one would argue the current accounting treatment of cryptocurrency (as an intangible asset) has not caught up with today’s needs.

(Source: Cryptocurrency: The Tops Things You Need To Know, published by BDO USA, LLP)


What is the tax consideration for cryptocurrency in Malaysia?

According to the Inland Revenue Board of Malaysia (LHDN), cryptocurrency investors who actively trade their assets at the digital asset exchange are required to declare their gains for their annual income tax.

LHDN referred to Section 3 of the Income Tax Act 1967 and said that it will treat income earned through digital platforms similarly to income generated through conventional businesses.

This tax treatment is similar for active traders of shares and other assets. The profits made by individuals who occasionally trade cryptocurrencies or shares may be viewed as capital gains, which is not taxable in Malaysia. But the profits earned by individuals who trade actively may be viewed as revenue and thus, deemed as taxable income.


Impact of cryptocurrency

As cryptocurrencies become investment grade instruments which corporates begin to trade, hold and transact with, there will need to be robust discussions around accounting treatments and accounting policies.

This will have an impact on liquidity, capital adequacy and credit risk as new business models are being investigated as to the use cryptocurrencies as collateral.

It is only a matter of time for the first client attempt to disclose their annual financial statements with “Bitcoin” as their functional currency which could require the International Accounting Standards Board (IASB) to relook all accounting standards with regards to its applicability to crypto currencies and the new business models which are being attempted by entrepreneurs.

(Source: Financial Evolution: The new world of Crypto, published by BDO South Africa)