Several known cryptocurrencies exist today the best-known ones is Bitcoin and Ethereum.
Cryptocurrency refers to a medium of exchange that is designed to work digitally without third party oversight. It involves the use of cryptography to authenticate the process of transfer of funds. Cryptocurrency has transformed the form of interaction among the internet-connected global markets through solving the market barriers of exchange rates and national currencies. It is the lack of an intermediary interference that has enabled the widespread of this currency. Several known cryptocurrencies exist today the best-known ones is Bitcoin and Ethereum.
Blockchains
The existence of cryptocurrency is enabled by a technology called Blockchain. This technology acts as a ledger of all the transactions done in cryptocurrency. Application of this technology eases the confirmation of all the transactions by the users without the need for a central clearing authority. In the blockchain, a user first requests a transaction and immediately the requested transaction is broadcasted to a network consisting of computers. The user’s status and the transaction made is then validated using known algorithms. A list of contracts, records and cryptocurrency is then provided for verification and once verified, Afterwards, the transaction is combined with existing ones to create a data block for the ledger. The newly created blockchain of data is added to the existing one completing the transaction.
Bitcoins
It is the best-known cryptocurrency and from it, the blockchain technology was invented. Bitcoin is a currency that exists only in not redeemable for other commodities, it exists only in the network and its supply is as well not determined by a central bank. It’s a digital currency and also a payment system. These are some of the key features of how Bitcoins works. Its users should understand all this together with the existing values, trust and accept by them and an ultimate increase in the transaction will be evident.
Bitcoin transaction
A complete Bitcoin transaction takes about 10 minutes to be completed and is processed by computers that have some special software. Transaction details such as addresses of both the sender and the receiver as well as the amount to be transferred are first encoded in the bitcoin network then the unto the blockchain. These addresses are the public keys which are visible to other users that enable tracking. The transaction details are then passed through a signature algorithm with the user private key.
large distributed networks of a computer running special software. Whenever a transaction is done through bitcoin the network records the senders and receivers bitcoin addresses and the amount transferred and enters this information onto the blockchain. The blockchain is normally updated throughout the day and its sent to every computer that processes bitcoin. Thereafter, the transactions are sent out for verification. Once the software plugs in the signature and the public key, it can validate that the transfer is not being doubled spent by the user making it impossible to counterfeit. After the verification, the transaction gets to the blockchain together with the other previous transactions. This whole process is done by Bitcoin miners.
Bitcoin Mining
Bitcoin miners are the ones responsible for checking transactions making sure that bitcoin participants are not using the same Bitcoin twice. Normally, they use specialized software from which the bitcoin users connect to. All the transactions done are grouped into blocks and are connected to the mining software. Usually, it is from this process where miners can discover and harsh the blocks correctly then guide the computer on means of acquiring correct numerical values. Generally, this whole process is meant to keep the Bitcoin users honest to avoid double-spending issues.
Thereafter, a new bitcoin is generated on the system once a computer successfully processes a block and adds it to the blockchain. The generated Bitcoin is what the miners receive as a reward and its added to their digital wallet; Transaction reward and Block reward. Block reward is a reward generated by the system algorithm and one is rewarded by just creating a block while the transaction reward is linked to the transactions made and is normally paid by the transacting users. The whole process is as simple however it relies on effort and luck.
As much as Cryptocurrency is open to the public, It’s the most difficult virtual money to tamper with since financial reporting showing accessible to the public cryptocurrencies transactions are provided. Cryptocurrency auditing is the application of auditing principles into the evaluation, deploying and use of cryptocurrency-based networks that are vastly accepted. Auditing of the cryptocurrency is still a challenging practice today and therefore, a consistent approach is required in the crypto space. This is due to the existing ambiguity on whether they can be categorized as cash, inventories, financial asset or an intangible asset. Accounting for financial statements in cryptocurrency is pivotal since it provides verification of the financial reports as well as the financial results of the participants.
Cryptocurrency auditors should obtain an understanding of all the information involved for cryptocurrencies transactions, able to pinpoint some of the risks of misstatements materials in cryptocurrency financial statements transactions as well as the balances. Cryptocurrency miners and those who only purchase for investment purposes are the only entities that might require auditing of cryptocurrencies. Crypto fund managers, auditing companies and tax authorities are the people involved in accounting for cryptocurrencies.
Several entities have engaged in cryptocurrency transactions. The cryptocurrency industries, as well as participants, usually pick up their preferred auditing company. The most commonly known auditing firms that handle the majority of audits for companies include KPMG, Deloitte, PWC and lastly Ernst and Young. PWC is the most active compared to the rest when it comes to cryptocurrencies. Their main focus is on analyzing blockchains. However, their lack of proof of ownership has been the drawing point when auditing since the only proof of ownership of the funds is the private key only.
One important factor to be noted is that cryptocurrencies are not considered as currency but rather as a commodity therefore all the transactions involving cryptocurrencies are lay open to tax. Being that it is considered as a property, all the tax principles that are applied to properties ally to cryptocurrencies. The anonymity of participants in the cryptocurrency transactions may increase cases of suspected non- compliance with the cryptocurrency regulations therefore the auditor is always required to stay alert. Therefore, the auditor should ensure that all the transactions are keenly accounted for and all the transaction provided correctly appear as a fair value hierarchy. Cryptocurrency transaction is taken as a block and not into quarterly or annually like the rest of business transactions.
The objective of cryptocurrencies financial statements is that they provide information about all the financial performance and cash flows involved in the transactions made. Auditing of cryptocurrencies is also important in proofing to the third parties and the participants that they are transparent and the funds are held properly. There are various ways unto which the cryptocurrencies funds can be audited and the software are the commonly used digital assets to help in the accounting of the funds. Audits provided by the majority of this cryptocurrency software or either the internal auditors have so far proofed to be crystal clear though, very tough when a homogeneous data is involved.
To determine the best accounting standard that applies to cryptocurrencies, it is useful to first categorize cryptographic assets into sub-assets based on their key features. These features include the primary purpose and how cryptographic asset develops its inherent value. Normally, there are various accounting methods applicable to cryptocurrencies. The accounting method to be used usually depends on the purpose of holding the cryptocurrency. When accounting for cryptocurrencies purchased for investment purposes, the international standard 38 for intangible Assets is applied while the International standard accounting standard 2 Inventories is applied while accounting for cryptocurrencies for miners.
Outline of the Accounting procedure.
Bitcoin is the most popular cryptocurrency in the world, it is the best example to use for outlining the basics of auditing reserves. In addition to that, it is the most preferred company due to its open-source blockchain which is easily accessible to the auditing firms. The first essential step is an examination of the wallets of the participant. In this step, the auditors receive the information of the users such as the public addresses and the users signature. The auditor then authenticates the signatures provided and then extract the amount from the bitcoin blockchain record.
Thereafter, the auditor compares the extracted amount available with the users’ fund available in their wallet. The software then publicizes all the balances extracted for affirmation if at all they are true. The main aim of publicizing this is to affirm that the software is transparent about the user’s data file. The software then releases the amount provided by the auditor to the user for verification if at all their balances are included in the data provided. The hashing method is also disclosed in the provided data.
Limitation of this auditing software.
- The auditing software is not able to prove whether private keys have been tampered with in case of hacking.
- Audits are not frequently updated and this may lead to threats from the users.
- Auditing cannot be prepared without prior communication
- No proof is provided of custody of audited funds apart from auditing time
Accounting for Cryptocurrencies for miners
The vast resources used by miners in the verification process of the transactions together with the rewards they receive are all supposed to be accounted for.
v Accounting for the rewards received
- Block reward- this is the very first reward earned by the miners. The reward is characterized in a way in which it decreases with an increase in the number of blocks. For example, in Bitcoin, the blockchain reward is currently set to 12.5 BTC but undergoes a decrease up to 6.25 BTC immediately the number of blocks in the blockchain increases. The block reward is always equal to the inflow of economic benefits thus an income. Therefore, when accounting, it should be included as either profit or loss depending on its fair value. Since the block reward is created by the block algorithm, it does not involve a customer or a contract.
- Transaction reward- this reward is linked to the individual transactions made and is normally paid by the specific transacting users. When the miner confirms entitlement of the transaction fee, the transaction fee is considered as the revenue. Therefore, The International Financial Reporting Standards IFRS 15 is applied when accounting for this reward.
v Accounting for the expenses
Accounting for all the expenses incurred during mining be it a loss or a profit is important. However, this auditing is sometimes difficult because mining is majorly based on guessing and therefore accrediting the expenses to the specific revenue is at times challenging. All in all, IFRS 11 is applied when accounting for this.
Accounting for cryptocurrencies purchased for Investment
The cryptocurrencies purchased for investment purposes are categorized into two; for sale and one that consists of dealer and trader. The dealer and trader cryptocurrency is entirely based on inventories sold at a fair value. Therefore, when accounting for the sale one, IAS 2 inventories is applied while when accounting for the dealer- seller one, IAS 2.3b Inventories for commodity brokers and traders applies.
Reporting on Cryptocurrency Audits
Once the financial position statement, the comprehensive income statement, equity and cash flow statements at the period ended or from time to time during the financial period are prepared. The auditors are obliged to obtain audit shreds of evidence on the amounts and disclosures in the financial report. Once completed, the auditor issues an audit report to the director of the cryptocurrency company involved The director is then responsible for issuing the audit reports to the participants and the controlled entities according to the International Accounting Standards free from misstatements.