Blockchain – a game-changer in accounting and auditing?

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This article is on something entirely different from those we published previously, mainly about IFRS. We have had the opportunity to attend a conference (Exchange Summit 2016 – http://www.exchange-summit.com/) in Barcelona, organized around interesting topics like the future of E-Invoicing, Supply Chain Financing etc. Among the many interesting topics Blockchain was a key theme again – this post is to provoke some thoughts on how it might impact compliance in general, or accounting and audit in particular; an area to which each CFO and financial expert should pay attention.

What is Blockchain?

Short answer – the technology behind bitcoin, the first cryptocurrency in the digital world. Of course the real answer is more complex. Blockchain is a database type, a “distributed ledger” – means that data (or blocks thereof) are validated by the users of that ledger. Each new block of data entered by one of the users is linked to the previous block by a special algorithm, a hash, which is then synchronized across the full ledger, that is, across each copy thereof stored by each of the users. That is where the name comes from – blocks are linked one after the other, forming a chain of blocks. The full database is secure, consensus based, with no central administration or third party validation needed.

Couple this so far unseen level of security with the scalability and customizability of who can have access to the data (public and private ledgers), add the advantage of real-time transaction processing, and you might see why blockchain was called one of the six megatrends shaping the future of societies on the World Economic Forum a year ago. Distributed trust, powered by blockchain is accompanied by Artifical Intelligence & big data, social media, cloud computing, Internet of Things (IoT) and 3D printing on this “Mega6” list.

Implications? Just think about what that means for any kind of data or database which is currently subject to third party validation. Personal administration data, shareholding, land registry, and tons of that sort of stuff, bridging regulators, companies and customers.

Current thinking and stream of investments is going towards transaction-based financial services, mainly payments. There is an ongoing rivalry and rush between large banks, pouring USD billions into blockchain based solutions (some of which we will see coming onboard from 2017), and agile, fast fintechs offering dynamic and flexible financial services. All other uses of blockchain are under testing or in proof of concept phase. Just an interesting use case in beta-version – verification of product origins, like gems, which, beyond improved efficiency and usability will also enhance fight against “bloody diamond” trade.

Triple-entry accounting?

With regards to financial processes, accounting can be profoundly impacted. The current canon of double-entry accounting was created in the Reneissance by Luca Pacioli, a francian monk (did you know that 10 November was the International Accounting Day, being the anniversary of his book in which double-entry accounting was first discussed?). It focuses on having a transaction recorded on both sides of the balance sheet (asset, liability or equity). Next step in evolution could be having the transaction recorded by both parties, simultaneously and identically. It is not about uniform accounting debits and credits (though that would also be beneficial – finally we are coming back to IFRS, aren’t we?), but recognition of a single transaction by each counterparty with the same content at the same time. With blockchain, this so-far theoretical objective could become a real alternative.

An additional key output of this is that the performance of the transaction and the recording thereof would happen at the same time, leading to real-time accounting. All types of regulators and authorities could benefit from this, provided, of course that they adapt to and properly govern blockchain based transactions.

Audit Profession – Disrupted or Reloaded?

Thinking it further, if blockchain does have the capacity to ensure public trust, then it challenges the audit profession in general, since that public trust is the auditor’s ultima ratio, the essence and objective of what, how and why they are doing. Take out the public trust placed on any audited financial information, and what remains is an obligatory, low-added value post-mortem exercise for a very, very expensive signature. Even if that is taken aside for a while (the world will definitely not get there soon), this new piece of technology could fundamentally change how audits are conducted, for several reasons:

  • First, validated data on transactions are available on a real-time basis, meaning audit process could shift away from a year-end (or rather pre-filing) period of work towards an on-line, also real-time approach. It becomes a question of tools and process how it can be leveraged – but the opportunity is there.

  • Second, the traditional audit verifications might change. Why do we need counterparty confirmation letters if transaction data are written into blockchain? Why tick & tie of paper documents is needed on samples from existing balances to test controls or to do a substantive audit on a proper coverage of items when we have the full analytics available from the blockchain?

  • It means that the audit tests performed to verify a) existence / occurrence, b) accuracy and c) timeliness of sales or purchase type of transactions can be greatly reduced. Good bye, confirmation letters… and many other procedures.

All this leads to lower efforts and therefore costs on the audit side, and potential savings on the client side. At the same time, it is a major opportunity – together with process improvements (especially RPAs, robotic process automations), they are in a very good position to advise their clients. No wonder that each of the Big4s have set up their own blockchain centre of excellence and are actively seeking opportunities in this area. It also means that the auditor teams of the future will not only contain accounting professionals, but also staff who is proficient in IT as well, especially cyber- and software-security experts.

CFO challenges ahead

Adapting to this trend has its own challenges, of course, both for CFOs and audit firm executives. The first, most fundamental question is the same asked already in ancient Rome, “Quis custodiet ipsos custodes”, that is, who is guarding the guardians? Governance and policies will be needed for such consensus-based, decentralized databases, especially since public compliance is the main objective.

To adapt and benefit from blockchain, the current processes, even the most fundamental ones, such as procure-to-pay and order-to-cash are to be revised, accommodated and simplified, along with the underlying systems. It is very important to emphasize that utilizing blockchain is not an IT-only topic, exactly the same ways as implementing IFRS is not an accounting-only project (and here we are again…). Capabilities in any finance team must be expanded to include the necessary level of system and IT knowledge. It obviously has a price, but at the same time it elevates the role of finance to a more strategic level – moving away from the role of exercising controls over regulatory and financial compliance, passing it partly or fully to blockchain based solutions resources are freed up to support the business.