There has been an astounding amount of uncertainty around cryptocurrency markets since January 2021. The Lok Sabha schedule was circulated, mentioning a proposed Cryptocurrency and Regulation of Official Digital Currency Bill. There are over 7 million Indian users who have either held or are currently holding cryptocurrencies. While there is a need for paying taxes on the gains and also accounting for the said cryptocurrencies into the books of accounts, a clear clarification is missing altogether.
As of today, after the Supreme Court lifted the RBI’s ban imposed on banks and financial institutions to encash virtual currencies, there is no legal document which outright terms cryptocurrencies as illegal. Seeing the gains, retail investors have been pouring their money constantly into the cryptocurrency market, and 97% of them have made profits.
While crypto isn’t considered legal tender, it still has plenty of uses:
- Accepting payments
- Earning interest incomes via staking, yield farming
- Providing liquidity into the pools of platforms like y.Earn and Uniswap
With these many use cases, and no clear guidelines on how to treat them, accounting for crypto and calculating taxes on it becomes a very difficult task.
The accounting standards in India do not have any guidelines for accounting of this market.
One of the major issues here is that crypto is a 24/7 market, which means it is difficult to adopt a closing price for valuation purposes. There are no benchmarks and each crypto exchange will have subtle price differences. Websites like CoinMarketCap have applied algorithms to derive the closing prices of the cryptocurrencies for accounting purposes, but none have any governing body certifications.
Another practical issue with accounting is how to classify crypto. Each coin or token has a different use case and we cannot use a blanket definition to say they’re a capital asset or a tradable commodity.
Ether (ETH) is a utility token which helps run the whole Ethereum ecosystem of defi and smart contracts. For this particular ecosystem, it could be classified as a medium of exchange.
We’re also beginning to see tokenized Tesla shares being traded on Binance. These will need to be treated like standard equity shares.
Sometimes even the same crypto has different uses for different organizations. Grayscale pays its board members in Bitcoin, using it as a medium of exchange. Conversely, Tesla holds Bitcoin in its treasury as an investment
There is a need for for a standard classification of crypto use cases
Let’s see how we can refer to the International Financial Reporting Standards for these accounting purposes.
IAS 7 and IAS 32:
You can equate crypto to cash when you see it for the first time. However, it doesn’t have one of cash’s major qualities:
It’s not readily exchangeable for goods and services taken by anyone.
Entities may choose to accept crypto as a form of payment but they are not legally bound to do so. Tesla accepting Bitcoins for their cars is totally their choice. But a local vendor accepting cash is a compulsion if it’s their home currency.
We could try to value crypto at Fair Value through Profit and Loss (FVTPL).
However, as per the definition of a financial instrument, it does not represent cash, an equity interest in an entity, or a contract establishing a right or obligation to deliver or receive cash or another financial instrument.
Cryptocurrency is not a debt security, nor an equity security, because it does not represent an ownership interest. Therefore, it appears cryptocurrency should not be accounted for as a financial asset.
We can also try and value cryptocurrencies as per the IAS 2 which relates to the inventory valuation. IAS 2 defines inventories as assets which are held for sale in the ordinary course of business and in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of services.
Classification will also depend on whether an entity holds cryptocurrencies for sale in the ordinary course of business and, if it is treated as inventory. Normally, this would mean the recognition of inventories at the lower of cost and net realisable value.
However, if the entity acts as a broker-trader of cryptocurrencies, then IAS 2 states that their inventories should be valued at fair value less costs to sell. This type of inventory is principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin.
Thus, this method can only be applied when the business model is to sell cryptocurrency in the near future with the purpose of generating a profit from fluctuations in price.
IAS 38 Intangible Assets:
We define an asset as intangible if it is separable or arises from contractual or other legal rights.
An asset is separable if it is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability.
Cryptocurrencies are capable of being separated by the holder and sold or transferred individually. In accordance with IAS 21, it does not give the holder the right to receive a fixed amount of income or a determinable number of units of currency.
This also is not completely applicable but could be by far the best classification of cryptocurrencies.
This post has been authored by Aishwary Gupta, our guest writer for the week.