Hi,

What are the unique risks associated with accepting Bitcoin payments and Bitcoin ownership that could lead to a material misstatement? What are the relevant financial statement assertions related to the identified risks?

Below you can find the context of the question:

You have been assigned to the audit of Johnstone Suppliers, a large online retailer. Johnstone has annual revenues in excess of 400 million from the sales of sports equipment and apparel at discount prices through their online platform. They have been primarily involved in ordinary retail activity that consists of purchasing inventory from their suppliers and selling it at a profit margin to retail customers online. Their major assets have historically consisted of the inventory held for sale and the property at which the inventory is warehoused. Accounts payable and accrued liabilities for their inventory purchases and operational expenses are their only major liabilities as they carry limited long-term debt from their historical purchase of property, plant, and equipment. In prior years, the audit has been a relatively low-risk audit with inventory balances and sales transactions being the focus of the audit team's work. In preliminary planning for the current year audit, and through communications during interim field work, it has come to the team's attention that Johnstone's operations underwent recent changes that may introduce new audit risks. To accommodate its customers' growing interest in paying for products with cryptocurrency, Johnstone recently began accepting Bitcoin as a form of payment. In addition, they have decided to hold a portion of Bitcoin as a speculative investment.

Module 1: Cryptocurrency Risks

Carin Schelleman, who is the engagement partner, asked you to join her meeting with Annelies Renders, Johnstone Suppliers' Chief Financial Officer, to get more details about the company's decision to accept cryptocurrencies for payment. Below is a transcript of that meeting:

Caren: Annelies, thank you for meeting with us today. We understand that your company started

accepting cryptocurrency payments this year. We wanted to get a better understanding of the nature of these transactions and your position in any cryptocurrencies.

Annelies: Yes Caren, you're correct. Starting March 1, 2017 we began accepting payments from our

customers using cryptocurrency. At this time, we are only accepting Bitcoin, specifically the more

mainstream version of Bitcoin that has the ticker symbol ''BTC,'' and we do so through our digital

wallet with Coinbase. We have also engaged a consultant, Mark Vluggen, who is a specialist in

implementing processes related to Bitcoin. He will work with Johnstone as we implement our Bitcoin

operations and is available to answer any questions your team has.

Caren: For your digital wallet with Coinbase, how do you store the private key? And to clarify, do you

have just one wallet?

Annelies: Yes, just one wallet for right now. We decided it made the most sense to have Coinbase store our private key, so then we could focus our efforts on controlling who at Johnstone has access to our Coinbase account, which at the time is just me. If and when the person responsible for the wallet changes, we would simply need to change the password to the Coinbase account rather than having to generate a new wallet.

Caren: I see. What portion of your sales have been collected in Bitcoin this year?

Annelies: We had total sales of 450 million this year and 20 million of that was collected in Bitcoin.

Caren: It sounds like this has been a pretty successful campaign. I've heard about individuals and

companies ''mining'' Bitcoin to try to win newly minted bitcoins. I've also heard this can be an

expensive undertaking. Is Johnstone doing any mining to try to win new bitcoins?

Annelies: Nonono, we leave that to others in the Bitcoin community.

Caren: Good, because I would have to research more on Bitcoin and blockchain if this

engagement included mining! Once collected, do you use Bitcoin in your normal operations? Are your suppliers accepting payment using Bitcoin as well?

Annelies: None of our suppliers are currently accepting Bitcoin. We hold a portion of the Bitcoin as a

speculative investment and the remainder we sell immediately through the Coinbase exchange. It has been a great investment for us. Since we started accepting Bitcoin on March 1, 2017 the price has increased from 1,200 to 12,500.

Caren: I remember reading the price reached a high of 16,000. I certainly wish I had invested in it

early this year. So, what were your holdings at December 31, 2017?

Annelies: We had 10 million in Bitcoin as of December 31, 2017. Our Board of Directors has approved us holding 25 percent of our Bitcoin receipts for investment. We held 5 million of the 20 million in Bitcoin received for payment, but with the price increasing, our holdings were substantially higher at year-end. In fact, it was actually over 14 million at one point in the middle of December.

Caren: The value certainly does fluctuate. Actually, the value fluctuations bring up another point I

wanted to touch on. I've heard that Bitcoin transactions aren't quite as instantaneous as many people believe, or in other words, the transactions don't always settle immediately. So for example, if the market value of one bitcoin is 10,000 and a customer buys something from you for 10,000, they would send you one bitcoin and you would immediately exchange it for 10,000 in cash based on your current policy. But, there are also backlogs of transactions on the Bitcoin network that don't get processed immediately for a variety of reasons, and sometimes it can take a few hours or even days for a transaction to settle. During this time, the value of that one bitcoin could drop, meaning by the time you are able to exchange it for cash it might be worth much less than at the moment you sold your product. Or, even if the transaction settles immediately, there is a chance someone at Johnstone might forget to exchange the bitcoin for cash, thus putting the cash value of the transaction at risk. What safeguards do you have in place to protect against these threats?

Annelies: You bring up excellent points, and to be honest, any Bitcoin price fluctuations we have

experienced during the settlement time so far have all sort of evened out. And as for the risk that

someone forgets to immediately exchange the bitcoins for cash, that rests on me. I closely monitor our wallet and am quick to exchange the bitcoins we receive for cash.

Caren: Along similar lines, what about revenue recognition? To me, it seems like there are three points in time at which you could make an argument to recognize revenue. First, you could recognize revenue as the market value of the bitcoins at the time of the sale. Second, you could recognize revenue as the market value of the bitcoins at the time they arrive in your wallet, meaning the transaction has settled. Or, finally, you could recognize revenue as the cash value for which you were able to exchange the bitcoins. If you recognize revenue as the market value of the bitcoins at the time of the sale, how do you treat any unexpected gains or losses in Bitcoin's value between the time of the sale and when you exchange the bitcoins for cash?

Annelies: We have been recognizing revenue as the listed sales price in Euros. At the time of the sale,

we calculate how many bitcoins the customer must send us to meet the dollar value of the sale price.

Again, so far, any fluctuations in Bitcoin's value have all sort of netted out and we haven't had many

issues in the difference between the sales price and what we ultimately convert to cash.

Caren: There's definitely a lot to think about with Bitcoin! Well, I believe we have enough information at this point. We just wanted to get a better understanding of your participation in this new market before we get started on the audit. I am sure we will have more questions for you and your staff as we begin fieldwork though.

Annelies: Just let me know if there is anything I can answer for you. Also feel free to reach out to Mark if you have any questions for her. Have a nice day.

After returning to the office Caren had a meeting with you and Leon Timmermans, the manager on the engagement. Below is a transcript of that meeting:

Caren: Leon, we just had a chance to speak with Annelies at Johnstone Suppliers. It sounds like they

have fully implemented the acceptance of Bitcoin this year, and even hired a specialist who is a fulltime employee to help. We need to really evaluate how this is going to impact the current audit. What are the preliminary materiality levels on the engagement?

Leon: Planning materiality has been set at 1 million, which was 5 percent of net income before taxes, and performance materiality is 500,000.

Caren: Do you remember what their Bitcoin collections and holdings were?

You: Annelies stated that they collected $20 million in Bitcoin and retained 5 million for investment purposes. It had a market value of 10 million at year-end.

Caren: Clearly this is material to their financial statements. I need you to gain a better understanding of what Bitcoin ownership consists of and how this is going to impact our risk assessment. Do some

research on it and get with John to work through the assessment.