Tax liability, there’s no avoiding it.
One of the challenges facing cryptocurrency accounting is knowing when to use the most advantageous accounting method to calculate one’s capital gains & losses. In this article, we will weigh the pros and cons of using the Cost Basis and Weighted Average Cost (WAC) accounting method for cryptocurrency.
Weighted Average Cost is a popular accounting method because it takes as the name suggests, the weighted average cost to determine what value goes into the inventory and COGS. For example, a company would use the WAC method by dividing the cost of goods available for sale by the number of units in inventory. In a cryptocurrency-focused example, the cost of goods available could be the acquisition cost of 5 Bitcoins and the number of units would be 5 because there are 5 Bitcoins in inventory.
If the acquisition cost varies because each Bitcoin was individually acquired at a different timestamp and subsequently at a different market price, now you have 5 different costs recorded for the same cryptocurrency. The sum of the 5 different costs for each of the 5 Bitcoins acquired divided by the number of units, in this case, 5 Bitcoins will produce a dividend that is the weighted average cost. With this WAC example, the 5 separate acquisition events for the 5 Bitcoins will be recorded with the associated average cost.
Periodic vs. Perpetual
It is important to make the distinction between WAC Periodic and WAC Perpetual. When the Periodic Weighted Average Cost is calculated, the total cost of goods available for sale is divided by the number of units. As the name suggests, these cost averages are done over a period of time. Perpetual weighted average cost, also known as the moving average cost, is calculated after each sale or disposition. Calculating a new weighted average cost after each sale suddenly makes the process laborious and time-consuming, it is often expensive for companies to use this method.
Going Cost Basis
Cost basis is another commonly used accounting method in the cryptocurrency space. In this accounting method, the capital gains tax rate is the difference between the crypto asset’s cost basis or acquisition price and the current market price after a disposition. When the crypto assets are acquired and only held, the capital gains tax rate is unrealized until there is a disposition event. For example, if an individual purchases 1 Uniswap token for $5 and sells it a month later at $8, the cost basis is the acquisition price of $5. This means the taxable capital gain will be (8–5)= $3.
FIFO & LIFO
The cost basis method is often calculated using FIFO or LIFO, first-in-first-out, or last-in-first-out. The FIFO method will mean the investor or company will have to go by recording the sale of crypto assets purchased first in time when calculating capital gains and losses. LIFO here would follow an opposite order than FIFO, going by a record of crypto assets sold most recent in time.
Leveraging WAC & Cost Basis On Cryptoworth
On Cryptoworth’s CAP, both the WAC and cost basis accounting methods are supported. Meaning calculations can be compared using both methods to determine the best tax-saving strategy when reporting capital gains & losses. Cryptocurrency ATM operators, exchanges, liquidity providers, and other crypto-focused service providers should always be pursuing the best tax mitigation strategy possible over their digital assets. If you are looking to solve your cryptocurrency accounting challenges, sign up here or send us a message at firstname.lastname@example.org and we’ll be happy to get back to you.