Cryptocurrency is a form of currency that can be used for investment purposes, as well as to buy and sell stuff, however, the big question is why doesn’t it behave like the money?
And if it doesn’t what does it have to do with cryptocurrency accounting?
This is a detailed guide on cryptocurrency accounting.
Let’s get started.
What is CryptoCurrency?
Cryptocurrency is a type of digital or virtual currency that uses cryptography for security and operates independently of a central bank. It is decentralised, meaning it is not controlled by any government or financial institution, and transactions are recorded on a public digital ledger called a blockchain.
The most well-known cryptocurrency is Bitcoin, where it all started, but there are many others, such as
- Ethereum
- Ripple
- Litecoin
- Dogecoin
- Etc
People often invest in cryptocurrencies as speculative investments, hoping to profit from their fluctuating values. However, they are also associated with risks, such as volatility and the potential for fraud and scams.
Cryptocurrency accounting and its importance
A massive explosion in the cryptocurrency market has been challenging for accountants in many ways as they had to deal with an entirely different kind of asset that was neither similar to currency nor commodity.
However, the industry had to adapt and cryptocurrency accounting evolved as a process of recording and managing financial transactions involving cryptocurrencies. It includes
- Tracking the purchase
- Sale
- Exchange
- Investment
- Transfer of digital assets
- As well as calculating the gains or losses associated with those transactions.
Cryptocurrency accounting is important for several reasons
Firstly, it ensures compliance with tax and regulatory requirements. Depending on the jurisdiction, cryptocurrencies may be subject to capital gains tax, income tax, or other types of taxation.
Proper accounting allows individuals and businesses to accurately report their cryptocurrency transactions to the relevant authorities and avoid penalties for non-compliance.
Also, cryptocurrency accounting helps individuals and businesses understand their financial position and make informed decisions about their investments. By tracking the value of their cryptocurrency holdings and analysing their gains and losses, they can assess the performance of their portfolio and make adjustments as necessary.
It is also very important for security and risk management. By monitoring their cryptocurrency transactions and holdings, individuals and businesses can identify any unusual activity or potential security breaches and take steps to protect their assets.
To sum it up, cryptocurrency accounting is important to:
- Manage digital assets
- Ensure compliance
- Transparency
- Security and risk management
- Taxation
Difference between Cryptocurrency accounting and bookkeeping
Cryptocurrency accounting and bookkeeping both involve tracking financial transactions related to cryptocurrencies, but they differ in their scope and purpose.
Cryptocurrency Bookkeeping
Let’s talk about Bookkeeping first. It is the process of recording and categorising financial transactions systematically. It involves maintaining accurate records of transactions, such as purchases, sales, and payments, and organising them into financial statements like balance sheets and income statements.
Bookkeeping provides a clear and organized view of a financial situation and helps to ensure compliance with tax regulations. It is more focused on the recording of financial transactions for a single entity or organisation.
Overall, bookkeeping is more important for maintaining accurate financial records even when it comes to cryptocurrency.
Cryptocurrency Accounting
Cryptocurrency accounting, on the other hand, involves more complex processes that go beyond bookkeeping.
It includes analysing and interpreting financial data to provide insights and guidance on investment strategies, risk management, and tax planning.
Cryptocurrency accounting involves a more detailed analysis of the transactions, including the calculation of gains and losses, cost basis, and tax liabilities.
Another significant difference between the two is that cryptocurrency accounting involves the management of multiple wallets, exchanges, and other platforms where cryptocurrencies are bought, sold, or stored.
However, cryptocurrency accounting provides a more comprehensive and sophisticated analysis of transactions and their financial implications.
Current Accounting rules and most frequently reported difficulties
In September 2021, the accounting rules for cryptocurrency in the UK are outlined by the Financial Reporting Council (FRC) in their guidance document called “FRS 102 Section 28 – Cryptocurrencies”.
This document guides how cryptocurrencies should be accounted for under UK Generally Accepted Accounting Principles (GAAP).
The FRC guidance states that cryptocurrencies should be recognized as intangible assets, which means they should be valued at their fair value at the end of each reporting period. The guidance also requires entities to consider the nature of the cryptocurrency they hold and determine if it is a financial asset or a non-financial asset.
In terms of difficulties, some of the most frequently reported challenges with accounting for cryptocurrency in the UK include
Valuation
The volatile nature of cryptocurrencies makes it challenging to accurately value them. There are often discrepancies in the prices of cryptocurrencies across various exchanges, which can make it difficult to determine their fair value.
Classification
There is a lack of clarity on whether cryptocurrencies should be classified as financial assets or non-financial assets. This can create confusion for companies when determining how to account for their cryptocurrency holdings.
Taxation
There is still uncertainty regarding how cryptocurrency transactions should be taxed in the UK, which can create difficulties in determining the correct accounting treatment.
Regulation
Cryptocurrency regulation in the UK is still evolving, which can create uncertainty for companies in terms of complying with reporting requirements and other regulations.
What is the best method to keep a record of the crypto transaction for tax purposes?
The best method to keep a record of cryptocurrency transactions for tax purposes in the UK is to maintain accurate and detailed records of all cryptocurrency transactions.
Here are some tips on how to do this effectively:
- Keep a record of each transaction: Record the date of the transaction, the amount of cryptocurrency involved, and the value of the cryptocurrency in GBP at the time of the transaction.
- Keep track of the type of transaction: Identify whether the transaction was a purchase, sale, exchange, gift, or any other type of transaction.
- Record any fees or charges: Note any fees or charges associated with the transaction, such as transaction fees, network fees, or exchange fees.
- Record the source and destination of the transaction: Note the source and destination addresses of the cryptocurrency involved in the transaction.
- Use reliable accounting software: Consider using reputable accounting software that is specifically designed for cryptocurrency transactions. Some popular options include CryptoTrader.Tax, CoinTracking, and Koinly.
- Keep a separate record for each cryptocurrency: Keep separate records for each type of cryptocurrency to make it easier to track your transactions and calculate your tax liability.
- Export data: It is essential that you export data from the exchanges as well as wallets that you use on regular basis.
- Recording the data: Even after submitting tax returns, it is important to keep the data secure.
It is also important to regularly review your records to ensure that they are accurate and up-to-date. Keeping accurate records will not only help you calculate your tax liability more easily but also provide evidence in the event of an audit or investigation.
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FAQs Section
Do you have to report every crypto transaction on taxes?
In the UK, you are required to report any gains or losses resulting from cryptocurrency transactions on your taxes. This means that you must report all cryptocurrency transactions that result in a gain or loss, regardless of the amount.
The rules on how cryptocurrency gains and losses are taxed in the UK can be complex, and they depend on several factors such as the frequency and nature of the transactions. However, as a general rule, if you sell, trade, or exchange your cryptocurrency for fiat currency, goods, or services, this may result in a taxable gain or loss.
What happens if you don’t report taxable cryptocurrency transactions?
It is important to note that failure to report taxable cryptocurrency transactions could result in penalties and interest charges. Therefore, it is recommended to keep accurate and detailed records of all cryptocurrency transactions to ensure compliance with tax regulations and to facilitate the preparation of your tax return.
If you are unsure about your tax obligations related to cryptocurrency, it is advisable to consult with a tax professional or seek guidance from HM Revenue and Customs.
How much crypto can you spend without paying taxes?
There is no specific threshold or limit for sending or receiving cryptocurrency without paying taxes. Any gains or losses resulting from cryptocurrency transactions may be subject to taxation, regardless of the amount.
If you buy, sell, or exchange cryptocurrencies, you may be required to pay Capital Gains Tax on any gains you make above the tax-free allowance. The tax-free allowance for the tax year 2021-2022 is £12,300. This means that if your total gains from all assets, including cryptocurrencies, are below this amount, you will not have to pay Capital Gains Tax.
However, if your gains from cryptocurrency transactions exceed the tax-free allowance, you will need to report these gains on your tax return and pay the appropriate amount of tax. The amount of tax you pay will depend on your income tax band and the amount of gain you have made.
Can I claim my crypto loss on taxes?
Yes, you can claim cryptocurrency losses on your taxes. If you sell, exchange, or dispose of your cryptocurrency at a loss, you can use this loss to offset any gains you have made from other taxable assets, including other cryptocurrencies, and reduce your overall tax liability.
To claim a cryptocurrency loss on your taxes, you will need to report the loss on your tax return, specifically in the Capital Gains Tax section. You should report the loss in the tax year in which the loss occurred. You will need to provide details of the cryptocurrency transaction that resulted in the loss, including the date of the transaction, the amount of cryptocurrency involved, and the amount of the loss.
It is important to note that you can only claim cryptocurrency losses if they are incurred as part of a trade or investment, and not if they are personal losses. It is also important to keep accurate and detailed records of all cryptocurrency transactions and losses to supporting your claim in case of an HM Revenue and Customs audit.
What records should I keep for tax purposes on crypto?
For tax purposes, keeping detailed records of all cryptocurrency transactions is crucial. This includes transaction dates, amounts, fiat values, and the purpose of transactions. Maintain exchange records like trade confirmations, account statements, and deposit/withdrawal details.
Record wallet transfers, mining rewards, airdrops, forks, staking rewards, purchase costs, and transaction fees. Track sale proceeds and fees, and document expenses for goods and services bought with cryptocurrency. Keep all relevant tax forms, tax return filings, and capital gains/losses reports.
Utilise software tools for easier tracking, back up records regularly, and stay informed about tax law changes.
How to determine the crypto cost basis?
Determining the cost basis of cryptocurrency is essential for accurately calculating capital gains or losses for tax purposes.
Start by identifying the purchase price, including any transaction fees. For mined, airdropped, or staked crypto, use the fair market value at the time received. Use accounting methods like FIFO, LIFO, or Specific Identification to track sales.
When selling part of your holdings, calculate the cost basis proportionally. Utilise software tools for accuracy, and maintain detailed transaction records. Stay informed about tax regulations as they can impact cost basis calculations.
