3 Considerations When Providing Forensic Services for Cryptocurrency
Cryptocurrency gained widespread attention in 2017 primarily due to the swift increase in prices. That attention brought about greater adoption and more users of cryptocurrency. As more and more individuals and companies buy, sell and transact with cryptocurrencies, maintaining accurate records of transactions has become extremely important.
Accounting firms have been thrust into action in recent years due to their clients using and holding cryptocurrencies. Many users of cryptocurrencies do not know the current regulatory framework or the tax implications. This is a great opportunity for CPAs to work alongside their clients in gathering the proper documentation and supporting materials around their cryptocurrency activities. CPAs can provide clients with a schedule of activity that calculates their purchases, sales, current cost basis, realized gains/losses and current positions in each cryptocurrency.
There are some important factors to keep in mind before starting an analysis:
- Make sure complete information is provided
- Determine if a software tool can assist
- Maintain consistency
1. Obtain Complete Information
Before beginning any data analysis, whether it is with cryptocurrency or not, it is vital to obtain a complete listing of all transactions to have a full population or data set. If there is only partial information, it is nearly impossible to be able to provide a proper analysis. The key items to look out for in obtaining complete information include the following:
- Obtain transactional activity since inception.
- Ensure the correct start and end point to calculate the correct cost basis.
- Make sure there are not any gaps in the data set.
- Request a list of all exchanges and wallets used. This is similar to requesting a listing of all bank accounts. If only a checking account is requested and not savings accounts or money market accounts, then the picture of that individual’s banking activity is incomplete.
2. Evaluate Software Tools
As the industry has matured in recent years, more cryptocurrency software tools have been created to help users compile and aggregate their data into a legible format. As cryptocurrency increased in popularity, many people found it difficult to sort through records and calculate their cost basis and associated gains or losses. There was a great opportunity in the market for software assistance tools and programs to help provide solutions to ease the burden, particularly for those individuals with a high volume of transactions. The main benefits that software solutions provide include the following:
- Time and money savings.Automating the tracking of cryptocurrency activities rather than requiring manual entry saves both time money.
- Formatting standardization. Since many exchanges and wallet providers have their own standard reports, some with more transactional detail than others, compiling data from multiple sources that is not in a similar format can be difficult.
3. Maintain Consistency
Accounting follows the consistency principle: Once a certain accounting method is adopted, one must continue to follow this method consistently in future periods. The Financial Accounting Standards Board refers to consistency as one of the characteristics or qualities that makes accounting information useful. This applies to cryptocurrency because there are certain advantages that one may apply in order to reduce their tax position, specifically with choosing the cost basis method. In September 2019, the IRS released frequently asked questions and responses as a follow-up to Notice 2014-21, which stated that the cost basis of cryptocurrencies can be at either specific identification or first in, first out (FIFO) for calculating gains or losses.
As the cryptocurrency industry continues to grow as an emerging marketplace, the reporting activity obtained from each exchange is not standardized and the records can vary in detail. Reliable source material is critical; having unreliable documentation can be a major bump in the road in providing accurate reporting.
As a trusted advisor, CPAs must stress the importance of properly storing historical data and transactional activity. As the cryptocurrency industry evolves, so should the quality of reporting standards and activity reports users can obtain from their exchanges and wallet providers.
This article appeared in the May/June 2020 issue of New Jersey CPA magazine. Read the full issue.