Topic: Bitcoin and Accounting Difficulty (Read 1068 times)

Why accepting bitcoins as a business can be difficult.

Bill's Army MIS3800 USU

Executive Summary

With changing technology comes more virtualization of physical things. A currency called Bitcoin was developed to create a virtual currency that can be used around the world. This currency is extremely safe to use and has low exchange rates.
This currency is not widely used yet and many businesses and companies do not accept or use it due to the need to change things around. Software and hardware is needed in order for transactions to take place. The major difficulty for businesses and the use of Bitcoin, is the practice of accounting. Standard accounting processes for bitcoin have yet to be created for bitcoin. Regular accounting practices do not have a way to account for bitcoins like normal currency. Bitcoins need to be altered to be used in regular accounting processes and for most businesses, this is difficult to do.
However, many businesses do accept bitcoins and special software can be put in place to make transactions easy. Also, some of these businesses have created methods to make accounting for bitcoin possible.
Bitcoin is revolutionising and becoming an easy, secure way to make transactions. The software called Blockchain that allows for bitcoin transactions is as secure as any program on the internet can possibly get. It is an open-source program with no owner. It can not be changed.
Bitcoin is expected to become more widely used around the world in the next decade. Accounting processes are being formulated to allow for easier bitcoin transactions and we will see this in the near future.
History of Bitcoin
Bitcoin was started back In October of 2008, by a person or persons named Satoshi Nakamoto. Nobody knows the real name of the creator(s). Bitcoin is a currency system that would essentially cut out a centralized bank or government treasury. A year and half after it’s release, Bitcoin made some progress when a person by the name of Laszlo Hanyecz bought pizza using Bitcoin. Bitcoin continued to catch fire as more businesses and people started to accept Bitcoin currency. With the rise in popularity of Bitcoin, came more hacks into websites that accepted and traded bitcoins, resulting in stolen information and Bitcoin currency. In June of 2011 there was a major breach where 60,000 accounts were hacked into and personal information was stolen such as names and email addresses. This plummeted the price of Bitcoin down to $.01 per Bitcoin. In October of 2013, the FBI shut down a black-market trading market called the silk road. The silk road sold drugs using Bitcoin currency to keep transactions anonymous.
Even with all the negative events that were associated with Bitcoin, federal officials and investors see the potential of Bitcoin and continue to support it and look for new ways to improve Bitcoin. Since Bitcoin was started, price per bitcoin has fluctuated dramatically. The reason for this is because of all the negative and positive events that have been associated with Bitcoin. As more people and businesses accept Bitcoin, prices tend to rise. As hacks and illegal transactions happen, prices tend to plummet.

Description of Bitcoin

Bitcoin is a currency that uses peer-to-peer technology to operate with no central authority or banks. It is open-source, which means it is available to everyone who wishes to use it and nobody owns or controls it (bitcoin.org). Bitcoins are a virtual currency.
Many businesses now accept bitcoin like any other currency. Bitcoin, like any currency, has an exchange rate. Currently, one bitcoin is equal to $1187.40 in U.S. dollars. This number does fluctuate up and down depending on the market.
The  use of bitcoins is a process. It is not as simple as pulling bills out of your wallet or swiping a credit card. In order to use bitcoin, Bitcoin wallet must be installed on either a mobile device or computer. A wallet is the user's Bitcoin bank account. This wallet is how bitcoins are stored, received, and sent. There are many different wallets that can be used with bitcoins. Some examples of these wallets are Coinbase, Electrum, Armory, and Bitcoin Wallet for Android and Blackberry. The Bitcoin wallets on computers use email and Bitcoin Addresses to send and receive bitcoins. A Bitcoin Address is a users unique address that bitcoins can be sent to. Bitcoin wallets on mobile devices can use NFC and QR codes to transfer coins.
Transactions of bitcoins are recorded in a ledger called Blockchain. Blockchain uses data to keep track of bitcoins. Nobody is in control of blockchain data. Anybody can go in and verify or see records.  Like Bitcoin, Blockchain uses the peer-to-peer technology by allowing bitcoin transactions without a central node. When a transaction takes place, the information is entered in the database and user accounts are updated. All the data in blockchain can’t be altered due to all transactions being linked to every other transaction before. Data also can’t be altered because of various algorithms to keep the database permanent. (Truth about Blockchain) Blockchain is said to be the answer to trustworthy, internet transactions
Blockchain is a distributed database that maintains a continuously growing list of ordered records called blocks. Blocks have a timestamp and a link to the previous block. These chains are impossible to modify making this a very trustworthy source for transactions.

Capabilities and Limitations of Bitcoin

Bitcoin has many capabilities that make it extremely useful. Mobile payments become easier. Bitcoin on mobile phones uses a simple two step scan-and-pay process for transactions. You don’t have sign up, swipe a card, use a PIN, or sign for the transaction. Open up your Bitcoin wallet app on your mobile, have your friend scan your QR code, and then the transaction is complete. (Bitcoin.org)
The user is fully in control of the security of their money. Bitcoin uses military grade cryptography to protect your transactions. Nobody can charge you or make purchases for you. Bitcoin has some required steps to protect your wallet that will protect against many types of fraud with a strong level of protection. (Bitcoin.org)
Bitcoin works everywhere and anytime. Service providers, software, and the phone being used doesn’t matter anymore. Bitcoin is compatible with everyone, because it’s the same open-source technology. Bitcoin is always up and running every day of the year. (Bitcoin.org)
Bitcoin allows for faster international payments. Country borders do not limit transactions and the person being paid does not have to wait a number of business days to receive a payment. There is no fee for making an international transfer and also there is no minimum or maximum amount that is required to be transferred.  (Bitcoin.org)
The user chooses their own fees. There is no fee to receive or send Bitcoins. Many wallets let you control how large a fee to pay when paying. Higher fees potentially encourage faster confirmation of transactions. Fees are unrelated to the amount transferred. (Bitcoin.org)
Bitcoin helps protect your identity. A scammer can’t steal your credit card number or try to impersonate you. One can even send a payment without revealing their identity. There is a lot of effort and good steps to protect privacy. Protection against fraud is another benefit. All businesses know that accepting credit cards creates a problem of payments that are disputed and later reversed. Frauds limit market reach and increase prices to the detriment of the customer. Payments are irreversible and secure so the cost of fraud isn’t on the merchant. (Bitcoin.org)
Businesses are required to produce accounting documents for their dealings. Bitcoin allows the highest level of transparency of all transactions. Non-profits could allow the public to see the amount of donations they have received. (Bitcoin.org)
One of the many limitations of bitcoin are that they are not widely accepted yet. There is a very small group of online businesses that accept Bitcoins. When a currency isn’t accepted widely enough it doesn’t make it feasible to rely on that currency. Governments could possibly deny the use of Bitcoin for merchants because it would be hard for them to track transactions and its value. (cs.stanford.edu)
Bitcoin Wallets can be lost. If technical problems were to occur such as: hard drive crashes or a virus corrupting data, the wallet file would be corrupted and essentially Bitcoins would be lost. There is no way to recover these Bitcoins. These are already orphaned into the system. If someone were to be a very wealthy Bitcoin investor they could potentially become very poor very fast. (cs.stanford.edu)
Bitcoin valuation fluctuates constantly according to demand.  Because of this constant fluctuation, online businesses would have to continually change prices. If a refund were to happen, the confusion of the refund amount would have to be figured out. Would the same amount of bitcoins be returned even if the valuation changed? (cs.stanford.edu)
No buyer protection. Since there is no reversing transactions, a seller that doesn’t send the promised goods to a customer could be out like a bandit. This could be solved by using a third party escrow service. Then third party services would act as banks and make Bitcoin more like a traditional currency. (cs.stanford.edu)
The total number of bitcoins is capped at 21 million, deflation will be inevitable. As the number of Bitcoins maxes out each Bitcoin will be worth more and more. Early adopters are rewarded because of this design. The value rises over time and spending surges could cause the economy to fluctuate unpredictably. (cs.stanford.edu)
There is no authority governing Bitcoin to guarantee its minimum value. If a lot of merchants decide to get rid of their bitcoins at once, its valuation could decrease dramatically. Those with a lot of investment in Bitcoin would be hurt. There is good and bad with the decentralized nature of Bitcoin. (cs.stanford.edu)
Accounting is one of the major drawbacks. The bitcoin constantly changing in value making accounting very difficult. However, the value is not the only difficulty of accounting, there are not standard practices of accounting for bitcoins. Businesses that accept bitcoin have to come up with their own way to keep track of bitcoin transactions and their accounting processes.

Possible Accounting Processes for Bitcoin

Bitcoin, like any currency, is taxed. Taxes still need to be paid when using bitcoin, as it is treated as property by the IRS. The user need to keep track of the fair market value of transactions to determine if there was a loss or gain to be reported on tax returns. (Intuit QuickBooks) When buying and selling, the fair market value of the bitcoin when it is received or paid will also need to be tracked on the day of the transaction for tax purposes.
Because bitcoin is a virtual currency, accounting practices are different. Marty Zigman, a member of the Digital Currency Council, listed three methods for Bitcoin accounting. They are the payment method, bitcoin as a foreign currency, and bitcoin as a base currency.
The payment method is the most commonly used and is like any other accounting practices. It can be used when businesses use bitcoin services that exchange the bitcoin for government currency. This allows the business to use their normal accounting practices without changing anything. (Zigman) However, this software can be expensive.
The foreign currency method requires businesses to accept bitcoin as a foreign currency like accepting Euros at a US-based organization. This requires the business to understand accounting for foreign currencies and their exchange rates. Bitcoin are kept track of to in decimals. One hundred USD is equal to 0.07958 Bitcoin. The Bitcoins are converted into micro bitcoins by moving the decimal over six places to allow for regular accounting. Then is just treated as a foreign currency. (Zigman)
The third method would be to make Bitcoin the base currency of a business. This method would be good for global companies because bitcoin is used globally. (Zigman) However the drawback of this method, is that accounting for regular currencies becomes more difficult.
As shown above, accepting bitcoins as a business is not as easy as accepting regular currency. Lots of tasks need to be done in the background for accounting and could end up being very difficult for a business.

Case Study: Accounting and Bitcoin

With the rise in the popularity of Bitcoin more and more businesses are starting to accept bitcoin to purchase their products and services. One of those companies who recently decided to make this move is Overstock.com. Overstock.com is a technology based retail store that offers everything from clothes to cars. Overstock.com decided strategically start accepting bitcoin in order to attract new customers to purchase from their web based store. Even though this could be a smart move there are challenges of how to properly account for bitcoins.
   This case study, “Accounting Issues Related to Accepting Bitcoins” examines the following accounting issues: “(1) the proper classification of Bitcoins on the balance sheet, (2) recognizing changes in value of Bitcoins after they are received.” (Gross, Hoelscher, Reed)
   So what would a company classify bitcoins as on financial statements? According to Accounting Standards Codification, bitcoins would be classified as cash equivalents. The reason being is because a bitcoin is a short-term, highly liquid investment that is readily convertible to known amounts of cash and presents insignificant risk of changes in value because of changes in interest rates. Even though it's technically considered a cash equivalent and not cash, most companies along with Overstock.com lump both cash and cash equivalents into one item on financial sheets. This is where the real accounting issues arise. (Gross, Hoelscher, Reed)
   To record bitcoins on the balance sheet, the current exchange rate needs to be used. The exchange rate is the amount of money that could be exchanged for bitcoins on that day. With bitcoin rapidly fluctuating, the bitcoins that were earned by a company could be worth a lot more or less at the time of the balance sheet depending on the exchange rate. (Gross, Hoelscher, Reed)
    Gross, Hoelscher, and Reed give the following example of how Overstock.com would account for bitcoins and the changing exchange rate. The transactions are as follows: “Assume that Overstock.com sells goods on 11/1/2013 for 10 Bitcoins. On 2/1/2014, Overstock.com converted 5 of the Bitcoins for cash. On 3/1/2014, Overstock.com used the other 5 Bitcoins to purchase inventory from a supplier.” (Gross, Hoelscher, Reed) Notice how they lose a good amount of money by accepting bitcoins. It is a risk for businesses.
(Gross, Hoelscher, Reed)
   Another case study done on Accounting and Bitcoin, lists many issues related to accounting. The first was asset classification. How do you define a bitcoin? In the previous section of this paper “Accounting for Bitcoin,” bitcoin is treated as a cash equivalency. It can also be treated as intangible or an investment. (Raiborn, Sivitanides)
   The next issue is the holding process. As mentioned multiple times, bitcoins increase and decrease like an investment. What should be the standard way to account for changes in price? This study goes on to explain that “Accounting, as the language of business, must be willing to accept this new currency “dialect” and provide credible reporting conventions by which organizations can communicate, and investors and creditors can ascertain, the financial implications of cryptocurrency transactions, their related tax effects, and the economic ramifications of such exchanges.” (Raiborn, Sivitanides).

Conclusion

   Bitcoin is a revolutionizing technology that could potentially be used regularly around the world in the near future. Bitcoin comes with many benefits over other currencies, some of which include security and convenience. However, there is always a downside. Accounting, a practice that is essential to the operation and management of a business, is that huge downside.
   As of now, there are no standard accounting practices for bitcoin. Once bitcoin has become a widely used currency, accounting practices will be formed specifically for bitcoin. The practices will allow for bitcoin to expand due to eliminating the big downside of using and accepting bitcoin.
   The Overstock case study demonstrates the difficulty of accounting for bitcoins. They accepted them expecting to bring in more buyers, which they probably did. However, accepting bitcoins brought other problems, such as the constant change in the value of bitcoins and how the company is going to accurately account and keep track of bitcoins.
   Overtime, bitcoins could possibly become more standard and accounting processes can be adapted to bitcoin transactions. For now, companies will experiment with bitcoins until they can be used efficiently.












References
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