Accounting Treatment for Crypto Over-The-Counter (OTC) Brokers

Hello Curious Accountants 👋

Today we are going to hash the accounting treatment  for crypto OTC Brokers using Elven, a crypto sub-ledger. More specifically, this article addresses:

• What is an OTC Broker? 
• What are the challenges faced by OTC Brokers when preparing financial reports?
• Should customer crypto assets be presented on the Balance Sheet for crypto OTC Brokers?
• Should the revenue of OTC Brokers be presented as gross/net in the financial statements?
• Accounting treatment at the time of purchase and valuation used for cryptocurrencies found on OTC Brokers?
• Accounting treatment at the time of sale and valuation method used for COGS measurement for OTC Brokers?
• Accounting Treatment at the end of the period and crypto reconciliation

What is an OTC Broker?

OTC Broker: A business that facilitates crypto exchanges by allowing customers to trade crypto for other assets, such as conventional fiat money or other digital currencies. It is usually one of the business lines of crypto exchanges and payment services financial institutions. 

What are the challenges faced by OTC Brokers when preparing financial reports?

1. Navigating voluminous cross-border transactions spanning various currencies, along with thousands of tokens dispersed across   diverse chains, wallets, and exchanges;
2. Ensuring timely crypto reconciliation of on-chain data to exchanges' internal system and company’s books;
3. Identifying the correct cost for individual transactions according to the chosen cost method such as FIFO, LIFO, WAC & accurately calculating net profit

Since traditional accounting software does not cater to digital assets, the use of sub-ledgers such as Elven, TRES, Cryptoworth, Bitwave, Cryptio, Consola Finance, amongst others is recommended for the accounting of digital assets. These tools enable tracking and reconciling the transactions from the block explorers.

The Elven software allows the integration of different chains, exchanges, banks, custody, and payments to produce sub-ledgers.

Should customer crypto assets be presented on the Balance Sheet for Crypto OTC Brokers?

TL;DR - USGAAP: Yes, IFRS: Usually Yes.

US: SEC Staff Accounting Bulletin (SAB) 121 was released on March 31, 2022. SEC clarified that obligations related to custody arrangements should be reported on the balance sheet.

IFRS: Judgement is required and we might take reference from IAS 32.

The two basic requirements of IAS 32 are that offsetting is applied if, and only if, an entity:

1. currently has a legally enforceable right to set off the recognised amounts; and
2. intends either to settle on a net basis or to realize the asset and settle the liability simultaneously.

i.e. When the offsetting requirements are met, customer crypto assets need not be on the balance sheet.

Should the revenue of OTC Brokers be presented gross /net in the financial statements?

TL;DR -  It depends

In accordance with IFRS 15 ‘Revenue from Contracts with Customers’, an entity is a principal (and, therefore, records revenue on a gross basis) if it controls a promised good or service before transferring that good or service to the customer. An entity is an agent (and, therefore, records as revenue the net amount that it retains for its agency services) if its role is to arrange for another entity to provide the goods or services.

Judgment is required in determining control. Some factors that the exchange can consider include:

1. If the exchange controls the cryptocurrency before it is transferred to the buyer and as such carries the custody risk;
2. If the exchange sets the price for the transaction;
3. If the exchange is responsible for the fulfillment of the sale.

Example of journal entries for Gross:

• Dr COGS (cost based on valuation method)
• Cr Inventory
• Dr Cash / Digital Asset (Consideration)
• Cr Revenue

Example of journal entries for Net:

• Cr Inventory
• Dr Cash / Digital Asset (Consideration)
• Cr Revenue (Amount Earned)

Accounting Treatment at the time of purchase and valuation used for cryptocurrencies found on OTC Brokers

TL;DR -  USGAAP: Fair Value, IFRS: Usually Fair Value.

USGAAP: Newly-codified ASC 350-60 requires all crypto intangible assets in its scope to be measured at fair value after acquisition.

IFRS: The various ways one could recognize digital assets in terms of accounting treatment include; intangible assets, inventory, and financial assets.

At the time of purchase of the crypto, the crypto is recognized on the balance sheet.

Example of journal entries:

• Dr Digital Assets (fair value)
• Cr Cash 

The Elven software valuation module allows the valuation of digital assets acquired to be easily accounted for under ‘lots’, to facilitate the identification of the transaction under their cost method.

Accounting Treatment at the time of Sale and valuation method used for COGS measurement for OTC Brokers

Different valuation methods can be used such as WAC (weighted-average cost), FIFO (First In First Out), LIFO (Last In First Out) or specific identification.

At the time of sale, the crypto is derecognized and consideration is recognized as revenue.

Example of journal entries:

• Dr COGS (cost based on valuation method)
• Cr Inventory
• Dr Cash / Digital Asset (Consideration)
• Cr Revenue

The Elven software valuation module allows the disposal of digital assets to match with digital assets purchased for FIFO/ LIFO and Specific Identification.

Accounting Treatment at the end of the period and crypto reconciliation

At period end, the crypto on hand is fair-valued.

Example of journal entries:

• Dr/Cr Digital Asset (Change in value compared to the previous period)
• Dr/Cr Unrealised gain/loss

The Elven software Roll Forward is produced automatically at every period end to differentiate an increase in crypto versus an actual increase in quantity and an increase in fair value.

The Elven software reconciliation module allows all transactions including an internal trading system to be matched with journals to ensure 100% reconciliation.

Achievement Unlocked

Congrats, you have just learned Accounting Treatment 101 for Crypto OTC Brokers using Elven, assisting you with the completeness and accuracy of the financial report.