How Blockchain may diminish/change the role of Auditors and Accountants

As an accountant, there are very few technologies that have scared me (and excited me at the same time) and caused me to think: “Is my job at stake…?…”. Most of them over the years have made my job as an accountant and Internal Auditor..much easier and faster. However Blockchain as a technology could significantly change my role as an accountant/auditor.

While the rest of the world’s focus is on Bitcoin, Ethereum, Ripple etc. its underlying technology (i.e. Blockchain) is a cause of concern for me as an accountant and auditor  – and how it will affect my specific skills.

The word ‘disruptive’ technology is used very frequently nowadays. However in the last 2 years, along with Artificial Intelligence and 3D manufacturing, Blockchain to me will change our lives as accountants and auditors – the profession as we know it will change….

Understanding Bitcoin and Blockchain for me a professional accountant has not been very easy and by far the easiest explanation I have found is included in this article.

However while the focus of most of the world’s attention is on Bitcoin and other related cryptocurrencies, the development or dare i say ‘invention’ of Blockchain technology is the real disruption.

At its heart Blockchain is distributed ledger. Think of it as a ledger or accounts book that is maintained by me, you and everyone else. Any transaction that causes it to get updated causes it to get updated in everyone’s ledger – so that if one ledger is lost/destroyed, the others are still there. However, what is the proof that the data is accurately updated every where….and that it is the original update? The proof of the ‘stamp’ is the ‘digital’ ‘cryptic’ signature.

Here we enter techspeak…to the extent I can understand and explain it..:The Block ‘chain’ is a distributed ledger that contains ‘blocks’. Each of these ‘block’s contains a time stamp and a link to the previous block using a digital finger print or digital signature. Each of these ‘blocks’ have data. This data can be land title deed records, purchase records, ownership information, a transaction record, bitcoin etc.

Herein comes the usefulness and innovative disruption feature of Blockchain.

In today’s world of double entry bookkeeping, each company or trader, updates her transactions in her books of accounts or her ledger. However for participants of a distributed ledger technology, the same transaction is simultaneously recorded in the distributed ledger or Blockchain  that is a distributed or shared ledger. Accordingly all transactions are recorded in real-time, time stamped and stamped with a unique crypto-signature- everywhere.

A few characteristics of the ‘block’ should now probably be mentioned – the data has a timestamp, cannot be changed and is accurate- some of the very characteristics of Information we as auditors look for.

The introduction of double entry book keeping was revolutionary as it brought about rigidness, structure and a way to ensure the accuracy of accounting records- ensuring that ‘all’ or both sides of a transaction is captured. However once the transaction is captured there is a requirement for stakeholders to have access to financial reports or records based on these accounts. At this point auditors come in to ‘check’ the accounting records and the financial statements and give their ‘reasonable assurance’ on the information being reported.

As accountants (in financial statements and other financial information) we tend to look for certain assertions in our financial information, these are:

  • Completeness- financial information and records are complete
  • Existence – of assets and liabilities are true and accurate
  • Rights and obligations- what our rights are and what is owed to others is captured accurately
  • Accuracy – information is accurately captured
  • The records or information has not been tampered with or is ‘immutable’ or unchangeable

Blockchain through its various characteristics above solve all these problems to some extent.

A simple example would be, lets say a bank sells shares (its investment) to another company. The Bank would credit Investments and Debit Cash; and the Company would debit Investments and Credit cash. In a scenario where there is a ‘distributed ledger’ or Blockchain, the whole transaction would be updated on the shared distributed ledger simultaneously with a timestamp and a crypto signature/digital fingerprint.

Accordingly the Company cannot falsify its records to say it received more shares than it actually bought and neither can the Bank say it received more cash than it actually did. The records cannot be changed and cannot be manipulated on a back-dated basis. (however the issue of method of valuation in each ones books would have to be separately dealt with)

To extend this analogy further, a purchase contract signed with a supplier could be included as data in a ‘block’. Since the Blockchain can have protocols for smart contracts enabled, this can seamlessly transfer and be included for the purchase order details, for the receipt of the goods details, for the payment details etc. In other words the transactions are updated simultaneously at all these points and cannot be modified-all persons with access to the blockchain have access to this information.

All information of the contract, the purchase, the receipt of goods, the payment by the ‘Bank’ all being simultaneously updated and processed/enabled on the distributed shared ledger or Blockchain (which all participants including the supplier, the buyer and Bank) have access to at the same time. The information is accurate, cannot be changed and is accessible by all participants. The inclusion of all this additional information in blockchain transaction processing is even being called ‘Triple-entry‘ book keeping- as additional information over and above the two sides of a transaction are being encoded.

The use of Blockchain in the Banking system is being studied, implemented and tested by a large many Banks and financial intermediaries (such as SWIFT). Precisely because Blockchain and Bitcoin are a disruption technology. If they don’t become part of the change, they will get left behind. The technology can be applied to payment processing, transaction processing, trades settlement etc.

Now lets say your company as a participant for a Blockchain solution has financial/Bank transactions to be processed – as an accountant you have to record all payments and receipts in your bank accounts in your ‘books’, carry out reconciliations of your books with the Bank statement etc. All these steps get thrown out of the window in the Blockchain era. This will be an an era without Bank reconciliations and the need for auditors to check the reconciliations.

Taking the analogy of a purchase transaction mentioned above, in a distributed ledger or Blockchain environment, there is no need for the auditor to check whether the purchase was recorded correctly or whether a balance confirmation needs to be sent out, followed up, received and matched to the company’s accounting records.

The world of the accountant and the auditor accordingly undergoes a 365 degree change- as certain processes are no longer required.

For the asset management industry there are significant changes and benefits. Take the example of the number of intermediaries and support providers in the asset management industry, there are the administrators, the registrars, the custodians etc. In a process in which a secure Blockchain is used; customers could potentially deal directly with Fund Managers as all necessary information can be securely stored on the Blockchain. Transaction processing from a clients order to settlement date would be almost instantaneous due to smart contracts built into the Blockchain solution.

Even the transactions by the Fund manager, say a purchase of shares, disbursement of necessary funds by the custodian, settlement of the transaction, update of records by the administrator could all get simultaneously updated on a distributed ledger or Blockchain. The benefits of the same are immense and include shorter or very sort settlement times, removal of redundant processes (e.g. such a daily reconciliations), removal of certain intermediaries, lower operation costs (as intermediaries may get eliminated) etc.

Theoretically, this could mean in an environment in which Blockchain is widely used; the Fund Net Asset Value (NAV) would be calculated and updated in real time.

The same analogy would apply for financial records and reports – in an environment in which Blockchain is widely used financial reports may be real time.

As an auditor, the focus of audits may then shift from carrying out repetitive non-value add activities to review of the blockchain technology controls, the controls for use of the wallets etc. The role of the auditor may shift from periodical year end auditor to real time auditor. Focus of the audit may change to:

  • Confidence in the ‘system’ – e.g. the digital signatures
  • Time spent on audit activities that are repetitive and automated under Blockchain will need to be reconsidered
  • Systems and software auditing will have to be included

However a number of challenges to the widespread adoption of Blockchain include the adoption of such technology across sectors and across geographies, definition and acceptance of standards by all industries and participants, acceptance by all relevant regulators, establishment of security for all aspects of transaction processing etc.

Whatever are the challenges, the world for accountants and auditors is changing and the question to be asked of ourselves is: Are we ready?

The above article is an introduction to the topic only, please let me know your comments if any on the above information and if I have described any technical concepts incorrectly. These are my personal views and not in any way connected to my place of employment.