Whether it's Bitcoin, Ripple, or Coinye, virtual currencies are becoming a legitimate means of transacting business. And while no one expects them to give the dollar or euro a run for the money anytime soon, accountants and auditors at some companies are starting to explore the benefits and challenges of virtual currencies.
Overstock.com became the first public company to dip its toe in the water, announcing it will accept Bitcoin as payment for online purchases and will convert the Bitcoin it receives into U.S. dollars on a daily basis. To some extent, that makes the accounting a little more straightforward, says Jacob Farber, senior counsel at law firm Perkins Coie and a member of the technology transactions practice. But there are still plenty of accounting questions to consider, he says. “The accounting issues are an unknown,” Farber says. “Bitcoin has aspects of money, but it could also be a commodity. There's still some thinking being done about what it is from an accounting perspective.”
As companies consider following Overstock.com into the brave new world of virtual currency, the plan to convert the currency immediately into U.S. dollars means companies presumably can follow straightforward accounting conventions for recognizing revenue from sales and showing the dollars in the financial statements, says Farber. “It's handling dollars, and companies know how to do that,” he says. Complications arise, however, if companies consider holding Bitcoin and using it as payment with their own vendors, or if they consider holding it as an investment. “How do you account for that?” Farber asks.
So far, regulators and leaders in the accounting and auditing profession aren't lining up with answers. The Financial Accounting Standards Board has nothing on its agenda related to virtual currency. None of the Big Four audit firms, or the Center for Audit Quality, which represents the major audit firms, was willing to discuss Bitcoin. The American Institute of Certified Public Accountants also declined to comment. And the Securities and Exchange Commission only pointed to a three-page letter it sent in August to a Senate committee to answer questions about its limited exploration into Bitcoin and some related fraud concerns.
Bitcoin, an internet-based, peer-to-peer currency system backed by nothing of value and no government authority, has been mostly unregulated to date, says Laura Birger, a trial attorney at law firm Cooley. She sees U.S. federal authorities mobilizing in the Senate and Treasury department, as well as the Internal Revenue Service considering tax guidance, among others. But she's heard nothing from the accounting profession. “I can't think of anyone who's spoken directly about the accounting,” she says.
On the tax front, the IRS told the General Accountability Office it was considering guidance, and experts generally are hopeful it will materialize soon so it can be applied to the 2013 tax year. Alesya Tepikina, an associate with law firm Dorsey & Whitney, says even in the absence of guidance on Bitcoin or any other virtual currency, there's no U.S. guidance that explicitly exempts income denominated in a virtual currency. “Just to be on the safe side, they should report it,” she says.
“The accounting issues are an unknown. Bitcoin has aspects of money, but it could also be a commodity. There's still some thinking being done about what it is from an accounting perspective.”
Birger points out regulators looking at virtual currencies aren't showing any signs that they plan to make the use of a virtual currency illegal. “Nobody is saying this needs to be stamped out,” she says. “Even law enforcement is saying this is potentially valuable technology with a lot of upside. We just have to deal with the challenges.”
As regulators work their way through whether and how to regulate Bitcoin or other virtual currency activity, experts say companies should start work of their own to consider whether and how to do business in the virtual world. First and foremost, “they should understand it is quite a risky area,” says Tepikina. “There are many uncertainties at the moment.”
Risk arises not only because the currency is unbacked and unregulated, but also because its value is highly volatile, and the anonymity behind it raises big concerns about anti-money laundering compliance. Still, the upsides are enticing. “To the extent you could have one currency where everyone agrees on the value and it could become stable, that could really facilitate international trade,” says James Jalil, a partner at law firm Thompson Hine. There are ways, he says, to get around the anonymity problem and assure secure transactions.
WHAT GAO FOUND
Below is an excerpt from the U.S. Government Accountability Office's report to the Senate on virtual economies and currencies.
Transactions within virtual economies or using virtual currencies could produce taxable income in various ways, depending on the facts and circumstances of each transaction. For example, transactions within a “closed-flow” virtual currency system do not produce taxable income because a virtual currency can be used only to purchase virtual goods or services. An example of a closed-flow transaction is the purchase of items to use within an online game. In an “open-flow” system, a taxpayer who receives virtual currency as payment for real goods or services may have earned taxable income since the virtual currency can be exchanged for real goods or services or readily exchanged for government-issued currency, such as U.S. dollars.
Virtual economies and currencies pose various tax compliance risks, but the extent of actual tax non-compliance is unknown. Some identified risks include taxpayers not being aware that income earned through virtual economies or currencies is taxable or not knowing how to calculate such income. Because of the limited reliable data available on their size, it is difficult to determine how significant virtual economy and currency markets may be or how much tax revenue is at risk through their usage. Some experts with whom we spoke indicated a potential for growth in the use of virtual currencies.
Beginning in 2007, IRS assessed the tax compliance risks from virtual economies, and in 2009 posted information on its website on the tax consequences of virtual economy transactions. However, IRS has not provided taxpayers with information specific to virtual currencies because of other priorities, resource constraints, and the need to consider the use of these recently developed currencies, according to IRS officials. By not issuing guidance, IRS may be missing an opportunity to address virtual currency tax compliance risks. Given the uncertain extent of non-compliance with virtual currency transactions, formal guidance, such as regulations, may not be warranted. According to IRS officials, formal guidance requires extensive review,
which adds to development time and cost. However, IRS may be able to develop more timely and less costly informal guidance, which, according to IRS officials, requires less extensive review and can be based on other existing guidance. An example is the information IRS provides to taxpayers on its website on the tax
consequences of virtual economy transactions. Posting such information would be consistent with IRS's strategy for preventing and minimizing taxpayers' non-compliance by helping them understand and meet their tax responsibilities.
Source: Government Accountability Office.
There is another major benefit of open source currencies like Bitcoin: low or no transaction fees. Companies certainly won't mind escaping the costs associated with credit card payments, says Farber. “Imagine if a big merchant said we're accept Bitcoin and give you a 1-percent discount,” he says. “That would be a way for them to get rid of the 2 or 3 percent they are paying for credit card sales. That's enormous. That would really spark mass consumer adoption.”
Sandra Richtermeyer, accounting professor at Xavier University and former chairman of the Institute of Management Accountants, says companies that are accustomed to dealing with foreign currency translations already have a foot in the virtual currency door. “They probably have foreign currency integrated into their existing enterprise system, and they probably have exchange rate tables set up or integrated with the system,” she says. “For them, this would not be as hard to implement.”
Taking a step back however, any company considering doing business in a virtual currency needs to start with clearly documented processes for how it will track and capture that activity. “What are all the steps in the process?” Richtermeyer asks. “How does it affect revenue and expenditure processes?” Because Bitcoin is so new and abstract for many people, clear documentation will be critical, she says, including for internal control purposes.
Valuation will be a challenge as well, says Jalil. “The market for Bitcoin in terms of valuation is not as robust or mature as the market for gold, silver, stocks, or anything else,” he says. “So how do I value it? There are a number of different exchanges, the prices can vary, and it's very volatile.” That's another good reason, if a company were to accept Bitcoin as payment, to convert it immediately to a stable currency.
Stephen Ambler, a director at consulting firm RoseRyan, says companies will want to review their investment policies if considering a foray into virtual currencies. “A lot of companies have investment policies that say they will only hold AAA-rated securities,” he says. “I'm not sure where Bitcoin fits into that, but I'm pretty sure it would never be classified in its current state as an AAA investment.”
Jalil says he thinks it's too early for companies to jump into Bitcoin, but certainly not too early to study it. “Understand market uses and its role, form task forces, develop policies and procedures, work with your audit committee and your outside accountants, and start handling issues like valuation, AML compliance, and others,” he says. “If there's a market to be had and people want to pay in Bitcoin, why not participate in that market?”