A Comprehensive Guide to Crypto Asset Accounting

Fair Value Measurement of Crypto Assets

Under crypto IFRS and US GAAP, the fair value is “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”. (IFRS 13, US GAAP ASC 820)

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With different exchanges quoting different prices, it’s important that you maintain a consistent approach with regards to the pricing source of your crypto assets where the greatest volume is being traded. Given markets never close, the recommended practice would be to use the same time for pricing the assets.

For actively traded assets like Bitcoin and Ethereum, an active market or principal market exists, enabling Level 1 valuation. In the absence of an active market, a valuation model can be applied consistently from period to period.

Tax Considerations: Calculating Capital Gains/Losses

To make more informed investments and better manage risk, most finance managers actively track the unrealized gains/losses of their digital assets.

Calculating capital gains or losses also may be relevant where taxation on capital gains is levied. In some cases, capital losses may be used to offset your tax liabilities. Typically, only realised gains are relevant for tax reporting purposes.

Capital gains are usually calculated by taking the fair market value at the time of sale, minus the cost basis at which the crypto asset was acquired.

Thus, if your organization is domiciled in a jurisdiction where capital gains taxes are levied on crypto assets, it is important to understand how to assess your cost bases (i.e. what did it cost to acquire the asset) when calculating the profit or loss of transferring, selling, or spending a digital asset.

There are several methods to calculate cost-basis, including:

• - First In, First Out (FIFO)
• - Weighted average cost (WAC)
• - Last In, First Out (LIFO)
• - Highest in, first out (HIFO)

These are summarized in the table below:

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Below, we will illustrate the impact that each of these methods have on the gains/losses. It is important to note that the explanation below is referring to cryptocurrencies that are fungible.

Consider the following example of Janet Saylor, CFO of MacroTactics, a Web3 fund:

• - Janet bought 1 BTC in Jan 2017 for $1,000 per BTC
• - Janet bought 2 BTC in Jan 2018 for $14,000 per BTC
• - Janet bought 5 BTC in Jan 2019 for $3,500 per BTC
• - Janet sells 2 BTC in Dec 2021 for $47,500 per BTC

With FIFO method, Janet would set her cost basis for the 2021’s sale as $15,000:

• - Capital gains on 2021’s sale = ($47,500 x 2) - $15,000 = $80,000

With WAC method, Janet would set her cost basis for the 2021’s sale as $11,625:

• - Capital gains on 2021’s sale = ($47,500 x 2) - $11,625 = $ 83,375

With LIFO method, Janet would set her cost basis for the 2021’s sale as $7,000:

• - Capital gains on 2021’s sale = ($47,500 x 2) - $7,000 = $88,000

With HIFO method, Janet would set her cost basis for the 2021’s sale as $28,000:

• - Capital gains on 2021’s sale = ($47,500 x 2) - $28,000 = $67,000

As seen above, HIFO often leads to lowest capital gains and hence tax liabilities. However, the FIFO methodology is the most widely accepted cost basis method. This is because it accounts for the frequent points of purchases and sale of crypto assets across accounting cycles. Discuss with your professional accountant when deciding on your preferred cost basis method.

Obtaining Clean Data for Cost Basis Calculations

When maintaining your ledger of digital assets transactions, it is essential to review the following data points across each wallet type:

Transaction fees

Not accounting for these may result in erroneous data being used in calculating the cost-basis of your team’s digital assets.

When calculating the cost-basis of your digital assets, it is essential to account for the fees incurred in the transaction. It is essential to deduct the transaction fees when determining the cost of the said digital asset. Some of these fees include:

Gas fees charged by the blockchain protocol

Fees imposed by the wallet provider (usually by centralised wallets)

For each of these activities, it is important to understand the relevant fees involved in the process and account for it. See table below.

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Timestamping of transactions

It is common for Web3 teams to have transactions involving both centralised exchanges and self-custody wallets. The good news is that for both centralised exchanges and self-custody wallets, users can quickly export their transaction records (e.g. via the central exchange’s records or block explorers such as Etherscan).

However, centralised exchanges and block explorers often mark the timestamp of transactions in different timezones.

When compiling a chronological record of transactions across centralised and self-custody wallets, finance managers have to ensure the transactions are in the same timezone before compiling them into a master journal. This matters because cost basis methods such as FIFO require an accurate chronological order of transactions.

It is best to keep all transactions to be in the same time zone, be it UTC or the local timezone of the entity in which financial statements are prepared for.

Here are the default time zones for popular block explorers and centralised exchanges. (Updated as of Dec 2022)

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Disclosure for Crypto Assets

As there are no explicit crypto IFRS and US GAAP standards, the presentation and disclosure of crypto assets and crypto asset transactions should follow the entity’s approach about the accounting model to apply to the crypto asset, i.e. as an intangible asset, inventory, a financial asset or otherwise.

However, such disclosures require significant judgement and a thorough understanding of the underlying facts and circumstances.

For example, below are the summarized disclosure details of Microstrategy for their Bitcoin holdings in the annual report 2021 (note (g) to consolidated financial statements);

• - The Company determines the fair value based on quoted prices on the Coinbase exchange, the active exchange that the Company has determined is its principal market
• - The Company performs an analysis each quarter to identify indicators for impairment

In determining if an impairment has occurred, the Company considers the lowest price of 1 Bitcoin quoted on the active exchange at any time since acquiring the specific bitcoin held by the Company.

Concluding Thoughts

We explored the disparity between the rapid innovation in the crypto space and the slower pace of accounting standard setters. As a result, existing accounting standards require a principles-based approach for crypto asset accounting. We highlighted the differing crypto asset accounting treatments under IFRS and US GAAP and emphasized the significance of adhering to the jurisdiction-specific guidelines.

If you’re a bookkeeper, investor, or financial professional, it’s important to stay updated on the evolving landscape of accounting standards, as new developments in the crypto industry continue to shape the way these assets are accounted for. By keeping abreast of regulatory changes and emerging best practices, individuals and organizations can ensure accurate and transparent financial reporting.