Nowadays, cryptocurrencies are becoming increasingly popular not only for investors but also for more businesses who will accept these cryptocurrencies as payment for their products or services. As a result, cryptocurrencies like Bitcoin and Ether are becoming more common in the marketplace.
The thing is, irrespective of whether you buy Bitcoin or Ether as an investment for your business or whether you accept them as payment, you must know how to account for them.
To make this easier, we’ll show you how you should include Bitcoin or Ether in your balance sheet.
What is a balance sheet?
A balance sheet is one of the three main financial statements you’ll use in your business. The other two are your business’s income statement and its cash flow statement, and all these financial statements have different purposes.
With your income and cash flow statements, you'll be able to show your business’s economic activity over a certain, specified, period. For example, your income statement will show you how much income your business has generated over, for instance, a period of a year.
In contrast, your business’s balance sheet shows you how many assets your business owns, what debt it has, and if there’s any equity in the business. For this reason, it's also commonly referred to as a statement of financial position.
It's able to give you a complete picture of your business’s financial situation because it includes every journal entry since you started your business.
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Why you need a balance sheet?
Now that we’ve recapped what a balance sheet is, let's look at why you need oke. Because it shows you every transaction since you started your company, it gives you valuable insights into your business’s overall financial health. This means you'll be able to, at a glance, see exactly how much money you've invested in your business, what assets you've acquired, and what debt you've accumulated.
This has several key benefits, including:
Tracking growth and progress
Although you can prepare a balance sheet at any time, you’ll typically do it at the end of a specific reporting period. So, you’ll, for example, prepare a balance sheet at the end of your business’s financial year. This allows you to compare your business’s performance to that of previous years, which, in turn, allows you to see how your business is progressing and track its growth.
Key financial ratios
With the information contained in your business’s balance sheet, you'll be able to calculate key financial ratios. For example, you’ll be able to calculate your business’s debt-to-equity ratio, which shows you the ability of your business to pay off its debts with the equity in the business should this be necessary. You’ll also be able to calculate the ratio of current assets to current liabilities, which will show you whether your business could pay off all its debts within the next 12 months.
Finally, by using your balance sheet, you'll be able to put a value on your business. This value is especially relevant if you want to, for instance, show investors that investing in your business will have a profitable return on investment, or even when you want to sell your business.
What are Bitcoin and Ether?
We’ve now recapped what a balance sheet is and why it’s important, let’s now look at what Bitcoin and Ether are. By this time, everyone knows that Bitcoin and Ether are cryptocurrencies.
But let’s consider how you should deal with them from an accounting perspective. In other words, are they cash, an asset, or some other type of instrument?
Now, when you think of the term ‘cryptocurrency’, you might assume that cryptocurrencies should be cash. To see if it is, we’ll need to look at the UK's Financial Reporting Standard (FRS 102).
According to the standard, something qualifies as cash or cash equivalents if it’s widely accepted as legal tender, not volatile, and can be readily converted into fiat currencies. Clearly, based on the standard, cryptocurrencies won't be regarded as cash or cash equivalents.
Likewise, cryptocurrencies can’t be seen as financial instruments because there are
no rights to convert them into fiat currencies, nor is there any liability or equity recognised by another entity, as is the case with options, future contracts and other derivatives.
Now that we've eliminated cash and financial instruments, cryptocurrencies can only be inventory or intangible assets. Inventory, as the name implies, are assets you hold for sale during the ordinary course of your business.
So, if trading in Bitcoin and Ether is your primary business activity, then you could account for these assets using inventory. However, for most businesses, this will not be the case and, as a result, Bitcoin and Ether will not be inventory for accounting purposes.
That leaves only tangible assets. These intangible assets can be separated or divided from an entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset, or liability.
Tangible assets could also arise from contractual or other legal rights, no matter if those rights are transferable or separable from the entity or from other rights and obligations.
Cryptocurrencies like Bitcoin and Ether meet this definition perfectly and would, thus, qualify as intangible assets for accounting purposes.
Accounting for Bitcoin and Ether
There’s currently no specific reference to cryptocurrencies in the IFRS (International Financial Reporting Standards) or the UK GAAP (Generally Accepted Accounting Practice).
However, because they qualify as assets, the core principles of accounting for assets will apply when you account for Bitcoin and Ether.
So, when you buy Bitcoin or Ether, you should add it to your balance sheet at its fair market value on the date you bought it. Here, you’ll need to debit your assets account. Likewise, if you bought Bitcoin or Ether with a fiat currency, you’ll need to credit your cash account for the purchase price.
At any time when you sell either Bitcoin or Ether, you’ll reverse this process. In other words, you’ll credit your assets account and debit your cash account with the amount you received when you sold it. When there’s a significant difference between the amount you received for the sale of the Bitcoin or Ether and the amount you paid for it, you could also credit a capital gains account.
There’s one aspect you should note. If you pay a vendor or supplier with cryptocurrencies like Bitcoin and Ether, it’ll qualify as disposal. This means that you'll record the transaction in your balance sheet in the same way you did as if you're selling the cryptocurrency.
Tax on Cryptocurrencies
When accounting for cryptocurrencies, you should also consider taxation. The first question is: What tax do you pay on cryptocurrencies? As mentioned above, cryptocurrencies are regarded as assets and when you sell them, it will be regarded as capital disposal.
If the proceeds from the disposal are higher than the purchase price, you’ll have a capital gain, on which you’ll pay capital gains tax. If, however, the proceeds are less than the purchase price, you’ll have a capital loss which you can use to balance out any capital gain on other assets or even carry over to the next financial year. In this way, you’ll reduce your tax liability.
When you’re paid in cryptocurrencies like Bitcoin and Ether, you’ll also be liable for tax but in this instance, you’ll be liable for income tax. Here, you’ll need to use the market value of the Bitcoin and Ether at the time of the transaction to account for it in your trading profits. You’ll then pay corporation tax on these profits if you’re a company.
The bottom line
Irrespective of whether you buy Bitcoin or Ether as an investment for your business or whether you accept them as payment for your services, it’s crucial that you know how to account for them in your financial statements. Hopefully, this post helped illustrate how you should include Bitcoin or Ether in your balance sheet.
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