Cryptocurrencies can impact the financial returns of both public and private companies. There are tax ramifications as well as accounting considerations that public companies need to disclose. The volatility in the exchange rate of many more popular cryptocurrencies could significantly impact the way public companies report financial results.
What Companies Will Need to Disclose
Large-cap technology companies such as Tesla, Square, PayPal, and MicroStrategy have become some of the biggest backers of cryptocurrencies. Many of these companies, such as PayPal and Square, are at the forefront of the digital currency wave and allow clients and vendors to transact using digital coins. While these companies do not expressly say they trade cryptocurrencies, many of these do not hedge their exposure immediately and have risk exposure to the movements of these digital coins.
There are some significant benefits to their strategy, and the price of their stock has benefited from the rise in the value of many of the cryptocurrencies during Q3 of 2021. Unfortunately, the movement of cryptocurrencies cuts both ways. The price of Bitcoin tumbled 41% in Q2, which impacted Tesla’s financial results.
One of the issues related to holding and trading cryptocurrencies is writedowns. U.S. accounting practices differ depending on the type of company. Suppose a company purchases a cryptocurrency, and the price falls from the original entry price. In that case, the company might need to take a writedown to reflect the declining value of the assets held from trading cryptocurrencies. A company also might not recognize gains from an increase in the value of a cryptocurrency asset. The only time they might add improvements from trading cryptocurrency is when they eventually sell the cryptocurrency asset.
There are two types of accounting practices that public companies often use. The first is called mark-to-market accounting. This type of accounting methodology requires that you value the asset based on the investment’s current market value. So, if the value of a cryptocurrency asset declines, you recognize the writeoff. If the value of the cryptocurrency asset increases, you realize the gains. The gains and losses that are incurred are unrealized gains and unrealized losses. An unrealized gain or loss means that you have not locked in the profit or loss and it can change based on the change in the price of the underlying investment.
When a company invests in a liquid product, such as Bitcoin or Ether, they can mark the asset to market by looking at the value on a reputable exchange to determine the value of the investment. If the purchased investment is not liquid, such as a private company or a building, then the company might use another form of account called accrual accounting. An accrual account is an accounting methodology that allows the owner to hold the asset’s value at the original purchase price and account for the gains when the asset is sold or when cash is realized rent or operations.
Taxes are Another Issue
Another issue that companies face is the tax consequences associated with trading cryptocurrencies. The IRS in the United States sees the sale of cryptocurrencies as a taxable event. When a realized gain or loss occurs, a company has to pay or offset its tax liabilities. Unrealized gains in cryptocurrencies are generally not a taxable event.
The Impact is Not Significant Yet
While the writedowns associated with trading cryptocurrency have yet to make a significant impact, some gains and losses are of interest. In Q1 2021, Tesla generated a $128 million in profit from the sale of cryptocurrencies. Chief Executive Officer Elon Musk said that the gains from the sale of Bitcoin demonstrated Bitcoin’s liquidity. Tesla, which held Bitcoin valued at more than $1.3 billion as of March 31, wrote off $27 million of its Bitcoin holdings in Q1. Tesla faced a much steeper charge in Q2 after Bitcoin dropped beneath $29,000 at the end of June.
How Will the Markets Evaluate Companies Issues with Cryptocurrency?
The cryptocurrency holdings might become an issue as large holders might wait until after their fiscal year to generate a sale of cryptocurrency. This scenario might help them avoid a tax liability if they have gained. If the market knows that a company is looking to trade cryptocurrency after a fiscal year-end, it might push the market against the company and wait for the sale before allowing the price to rebound.
The upshot is that many public companies are allowing customers to purchase products and make payments using cryptocurrencies. These activities have both accounting and tax consequences for these firms. How governments across the globe deal with these issues will eventually play a significant role in the acceptance of cryptocurrencies in the public company marketplace.