Bitcoin: A Fad or the Future for Business?
Virtual currencies seek to transform the conduct
of financial transactions
The jury is still out on the prospects for
bitcoin. Will perceived flaws lead to its
ultimate demise, or will the world of commerce
be upended in a way not seen in hundreds of
years? Three aspects of this phenomenon that
accountants will want to consider are:
transacting business in bitcoin, accounting
treatment, and audit implications.
But first, some background may be
helpful. Long ago, the single entry system of
accounting developed, at one time with clay
tokens representing various commodities. These
were eventually replaced with coins that could
be added together, but still as one single entry
list. About 800 years ago, double entry
accounting appeared on the scene, enabling
commerce to expand more readily with the
built-in check and balance of the dual entries.
This system was codified in the fifteenth
century by the Italian Friar, Pacioli, who as a
result became known as the Father of Accounting.
Bitcoin is a much more recent
occurrence, first introduced in an October 2008
paper, written under the name Satoshi Nakamoto.
Drawing upon concepts from the field of
cryptography, bitcoin is basically a peer to
peer virtual monetary system. Compared to a
bank, which keeps a centralized ledger recording
each transaction, the bitcoin “ledger” resides
on the internet. Just as the internet is spread
around computers all over the world, bitcoin
exists in a similar fashion, and thus is
decentralized and not controlled by anyone, but
collectively by the users.
In January 2009, the first bitcoin
came into existence when the initial open-source
network was established online. Each transaction
created has a public key and a private key. The
public key is like an email address and can be
seen by everyone, but the private key is like an
email password and can only be seen by the party
to the transaction. When a transaction is
created by a user, it is in effect date stamped
by being added chronologically to an ongoing
chain of all transactions. Independent users
employ specialized software to verify that
transactions are correctly entered into the
system. The system compensates these users by
awarding bitcoins to them. The continuous nature
of the transaction chain and the volume of
entries help to deter tampering. The Nakamoto
paper describes the structures as “…a public
history of transactions that quickly becomes
computationally impractical for an attacker to
change if honest nodes control a majority of CPU
power.”
The internet chain of transactions
provides a triple entry form of accounting,
which will be expanded upon later, when auditing
implications are discussed.
As for transacting business in bitcoin,
Habif, Arogeti & Wynne, LLP (HA&W), an Inside
Public Accounting Best of the Best CPA firm in
Atlanta, has already responded positively,
recently announcing that the firm is accepting
bitcoin payments for its services. One of the
first US accounting firms to accept bitcoin,
HA&W (quoting Forrester Research) stated in a
press release that “25 percent of consumers
across all generations plan to try using bitcoin
for payment. The digital currency has an
estimated market value of $3 billion, with
millions of dollars traded in bitcoin each day.”
The fact that Bitpay, the “world’s leading
bitcoin payment processor,” is a HA&W client,
provides the firm with a helpful resource.
Clear anxiety still surrounds the use
of bitcoin, considering the alarming reports of
theft and losses in cyber space. The worry
appears to be not so much with bitcoin itself,
but with the companies that hold bitcoin for
customers. Just as a bank can be robbed, a
bitcoin company can be hacked. When a business
is merely receiving or paying in bitcoin, that
concern is apparently mitigated, by using a
third party such as Bitpay. The process can be
set up such that the bitcoin goes directly to or
from Bitpay, who converts the payment to the
appropriate local currency, which then is
remitted to the business.
When bitcoin is held by the business,
then the question of proper accounting arises.
Don’t look to the FASB or IASB for guidance,
since standards have not been developed.
Informally members of the FASB indicated that
bitcoins fall under an other comprehensive basis
of accounting (OCBOA); in other words not GAAP.
Proponents may prefer the same
accounting as for traditional currencies. But as
a virtual decentralized currency not tied to any
legal jurisdiction, and subject to extreme
volatility, bitcoin needs to develop a more
stable track record before receiving general
acceptance alongside conventional currencies.
Others would characterize bitcoin as a
commodity used in a manner akin to bartering.
That treatment would require analysis for
revenue recognition purposes.
The US Internal Revenue Service (IRS)
has weighed in and treats virtual currencies,
including bitcoin, as property, to be recorded
at fair market value in US dollars as determined
by a market based exchange. The IRS issued
Notice 2014-21 that explains how to report
sales or exchanges of virtual currencies:
The character of the gain or loss
generally depends on whether the virtual
currency is a capital asset in the hands of the
taxpayer. A taxpayer generally realizes capital
gain or loss on the sale or exchange of virtual
currency that is a capital asset in the hands of
the taxpayer. For example, stocks, bonds, and
other investment property are generally capital
assets. A taxpayer generally realizes ordinary
gain or loss on the sale or exchange of virtual
currency that is not a capital asset in the
hands of the taxpayer. Inventory and other
property held mainly for sale to customers in a
trade or business are examples of property that
is not a capital asset.
Auditing presents challenges other than
just testing the valuation determined above.
Virtual currencies, of which bitcoin is one of
many, are considered by some as offering a
transparent form of security, made possible by
what is characterized as a triple entry system.
Virtual currencies, such as bitcoin,
offer a triple entry approach, signified by an
underlying technology known as the “blockchain.”
The blockchain is described by Ryan Lazanis of
Xen Accounting in a recent Techvibes article:
The blockchain is a public,
decentralized, distributed ledger that is
capable of storing and confirming the
transactions that pass through it. This means
that the ledger is not owned nor controlled by
any one party. Instead the control of the
network, or protocol, is distributed among the
network’s users. As transactions hit the
blockchain, they are confirmed as true and
accurate by the network’s users, called miners.
If you see a transaction on the blockchain, the
transaction has been confirmed and it cannot be
reversed.
When two parties enter into a virtual
currency transaction, the blockchain becomes the
third party, independently holding a copy of the
entry, thus completing the triple entry. Lazanis
sees the role of the auditor diminishing in the
future, since anyone can verify the blockchain
content at anytime from anywhere. Even if not
reduced as Lazanis predicts, auditor procedures
could undergo substantial changes if virtual
currencies prevail.
When computers first took over
accounting functions in the twentieth century,
auditors realized that their traditional audit
techniques were inadequate. Computer experts
were engaged to help navigate through the new
technology to assure the reliability of the
numbers. Similarly, with the complex new world
of virtual currency, those experts will again be
vital for the audit function.
At this point, there are still more
questions than answers as to how to gain
adequate audit assurance, or whether such
assurance is attainable, with regard to virtual
currency. Controls will need to be developed to
protect the bitcoins from theft, loss, or
improper use. Password security and encryption
will also need to be evaluated. In addition,
since the blockchain is public, means of privacy
will need to be devised.
Nevertheless, Reuters reported last
month that IBM is considering using the
blockchain technology to create a digital
currency that would consist of virtual dollars,
as opposed to bitcoins, under the purview of a
central bank like the U.S. Federal Reserve. That
approach would resolve some of the current
concerns that limit widespread appeal of virtual
currencies.
With the benefits of speed, versatility
and transparency, virtual currencies could well
become the commercial form of choice in the
future. The unknown is how long before that
reality arrives.
For further information, see
How Technology Behind Bitcoin Could Transform
Accounting As We Know It and
Habif, Arogeti
& Wynne, LLP Now Accepting Bitcoin as Payment
for Accounting Services and
What You
Should Know about Bitcoin.
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