Token Accounting in EU
On example from Accounting in Latvia
Let’s start with a discussion of a pre-seed round when the company uses its own funds to create tokens. They could include savings, borrowings, an increase in equity capital or retained earnings from previous years. Let’s divide token accounting into two phases. We will not take the scheme of the issue of сompany’s shares as a basis, since, in our opinion, it entails substantial differences.
As the State Revenue Service of the Republic of Latvia did not develop ICO token accounting methodology and the Cabinet of Ministers did not adopt the relevant regulation so far, we will follow our own practices and experiences.
1st phase: Creation of tokens.
Founders and financial directors of the company should set price for one token inclusive of VAT (see more details below) and quantity of tokens to be issued. Furthermore, they should identify types of tokens (Utility Tokens or Security Tokens). Token creation certificate, specifying all the above parameters, could serve as a source document. We also recommend indicating the purpose and description of ICO, including time-frames.
In most cases, the company will make pre-ICO (see more details below) and offer its tokens at discount prices. Therefore, this aspect should be also documented, entering financial indicators in the balance sheet of the company, since non-documented tokens at discount prices could cause unfavorable consequences: the State Revenue Service could doubt unreasonable decrease in prices of tokens.
Let’s study out an example: ABC company intends to issue its Utility Tokens in the quantity of 10000 pcs. at the price of 1 EUR per token. Within the framework of pre-ICO, it will issue 8000 more tokens at the discount price of 0,40 EUR per token.
Accounting will be as follows:
D1350-C5910–10000 EUR. Entering of tokens in the balance sheet. Tokens will be recognized in assets, account 1350 Long-term financial investments — tokens, in liabilities, account 5910 Deferred revenue. At the time of sale of tokens, this account will be debited and amount resulting from the sale will be recognized as net turnover. We recommend to recognize discount tokens on a separate account:
D1351-C5910–3200 EUR. Tokens charged for pre-ICO.
It is important to know that the value of tokens should be inclusive of VAT since income resulting from their sale is subject to value-added tax. For convenience, we will single out VAT, which is payable as a separate account 2391 VAT payable. The accounting entry will be as follows: D2391-C5910–2772 EUR.
The general situation after issuance of tokens is shown in the Table:
We have already mentioned that during a pre-seed round the company uses only its own funds. Let’s assume that the company has a loan in the amount of 15000 EUR. In this case, financial accounting will be as follows
Funds in the amount of 15000 EUR are recorded as the company’s assets (Bank), and long-term obligations in the same amount — as liabilities
2nd phase: Token pre-sale expenses (pre-ICO)
In the process of acquiring potential buyers of tokens, the company incurs numerous expenses, such as salary to employees, lease of premises, advertising, marketing, lawyer and other expenses, which should be also recognized.
For example, after issuance of tokens, ABC company used funds it has borrowed for the needs as follows: salary to employees — 4000 EUR, social tax — 850 EUR, lease of premises — 1800 EUR, advertising and marketing expenses — 2300 EUR, telecommunication expenses — 800 EUR, office expenses -500 EUR, legal expenses — 800 EUR, administrative expenses — 900 EUR. Total amount of expenses — 11950 EUR. Pre-tax of the company resulting after recognizing of invoices from the providers of services is 2509,50 EUR.
Financial reporting will be as follows
Analyzing this turnover balance sheet, we would draw attention to decrease in funds, which were expended for settlements with the providers of services (let’s assume that the company has no longer accounts payable), pre-tax on the account 5721 (debit) in the amount of 2509,50 EUR, which, if available during the reporting month, might be claimed back from the Tax Service, provided that all requirements of VAT law are observed. Moreover, expenses in the total amount of 11950 EUR appear on the operational accounts 7xxx of the group company, which at this moment could be considered as losses of the company, because the company has no income so far, namely, until the sale of tokens is started.
The company expenses could be reduced in view of the new start-up law (Jaunuzņēmumu darbības atbalsta likums), which came into force on 1 January 2017. If the company meets all the requirements of the law (for example, the company is younger than 5 years of age, 70% of employees hold a master’s degree or a doctoral degree, etc.), in this case, it is subject to a special tax regime, providing for a reduced tax burden. Part of taxes is payable at the expenses of the State or European funds.
3rd phase: Pre-sale of tokens (pre-ICO)
Let’s assume that pre-sale of tokens is successful and all of them are exchanged for the cryptocurrency. The company earns its first income in the amount of 3200 EUR (account 6110 — Net turnover appears), and reduces its pre-tax by 672 EUR (to make it easier, let’s assume that the company incurred expenses and pre-sale of tokens took place during the same reporting month, therefore, pre-tax is equal to 1837,50 EUR now). The amount of 3872 EUR (inclusive of VAT) appears on the active account 2111 — Cryptocurrency. Account 5910 Long-term investments are debited for the same amount. Accounting entries and financial reports are given below:
D2111-C1351–3200 EUR. Sale of tokens for cryptocurrency.
D2111-C2391–672 EUR. Token pre-sale VAT accounting.
D5910-C6110–3200 EUR. Income from sale of tokens.
D5910-C5721–672 EUR. VAT payable.
4th phase: Sale of tokens (ICO)
Let’s assume that the company has in fact succeeded in reaching the maximum amount of capital, which was planned within the framework of ICO — 9200 tokens or 92% of the total number of declared tokens. In terms of accounting, the accounting system for these tokens will not change drastically. Only instead of the account 1351 Tokens for pre-ICO there will be the account 1350 Tokens for ICO.
Accounting entries and financial reports will be as follows
Let’s analyze this turnover balance sheet in more details: the company’s assets include unsold tokens, which will be recognized on the balance sheet so far or will be liquidated. The company’s cryptocurrency is a bit more than 15000 EUR, which is enough to repay the loan or re-invest these funds. Funds on the bank account are enough to pay VAT in the amount of 94,50 EUR (liabilities). If to close all operational accounts (6ххх-7ххх), the company’s income as of the time of completion of ICO will be 12400 EUR -11950 EUR = 450 EUR, which it is reasonable to retain for the purpose of further development of the company. At the end of the taxation year, the cryptocurrency will be even re-valued, which could also essentially affect the income and financial indicators of the company.
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