Blockchain and the Future of Accountancy
Blockchain technology is an innovative distributed ledger system that records and stores digital data across a secure network of computers, creating a tamper-proof record of transactions. A peer-to-peer network administers the blockchain. This technology has been used to revolutionise many industries, from finance to healthcare, and most recently it has been gaining attention in the field of accounting. This article will explore how blockchain technology is being utilised in the accounting industry, its potential applications, and some implications for the future of accounting professionals.
Triple-Entry Accounting
Triple-entry accounting is a concept developed by an accounting professor, Yuji Ijiri, in 1989 which suggests that accounting records should maintain an extra entry, therefore expanding the double-entry accounting system to three entries, which is based on distributed ledger technology (DLT). This is a digital system for recording, copying, and sharing data across multiple entities or nodes in a network.
The third entry is a cryptographic signature stored on the blockchain records. The decentralised ledgers in blockchain technology serve as the impartial third party or intermediary that validates and verifies the transaction. The triple-entry aspect is the inclusion of the blockchain as an automatic, decentralised intermediary that confirms and records each transaction, providing added transparency and security.
Triple-entry accounting is related to smart contracts and blockchain technology in that smart contracts are self-executing digital programs that automatically verify and enforce the terms of a contract. Smart contracts can be programmed to execute triple-entry accounting, with the inclusion of the blockchain records providing the third entry in addition to the traditional debit and credit entries. This adds an extra layer of verification and immutability to accounting records, making them more secure and transparent.
Overall, triple-entry accounting, smart contracts, and blockchain technology provide a framework for a more transparent, secure, and efficient accounting system, ensuring that trust is maintained within the accounting field while reducing business risks.
Key Blockchain Features: Immutable and Decentralised
Immutability refers to the fact that once a transaction has been recorded on a blockchain, it cannot be modified or deleted. This is because each block in the blockchain contains a unique cryptographic hash that is generated based on the contents of the block. This creates a chain of blocks where each block is linked to the previous block in the chain by its unique hash. If someone tries to change a transaction in a block, it would change the hash of the block, and this would cause a discrepancy in the blockchain’s ledger. The other users in the network would detect it as an invalid transaction and disregard it. This makes the blockchain tamper-proof, ensuring that all transactions on it remain secure and transparent. This immutability feature is particularly useful in accounting and financial scenarios where it’s essential to have a permanent and incorruptible record of financial transactions.
Decentralisation refers to the fact that there is no central authority controlling the blockchain. Rather than being stored on a central server, the ledger is distributed across a network of computer systems. Each participant in the network has a copy of the entire ledger, which adds to the transparency and security of the blockchain. With decentralisation, there is no single point of failure, making the blockchain far less susceptible to cyber-attacks or other malicious activities.
Decentralisation also allows the network to operate autonomously, with transactions being validated by the network rather than by a central entity. This leads to reduced costs associated with intermediaries such as banks, brokers, and clearinghouses, making the blockchain a popular tool in the accounting profession.
How Will Blockchain Technology go beyond financial accounting and expand conventional bookkeeping?
Blockchain technology has the potential to revolutionise the accounting industry by changing the way that accounting information is stored, managed, and analysed. As blockchain technology continues to be incorporated into various business activities, there is a growing demand for accounting software that can integrate with blockchain transactions. As an example, Xero has partnered with several blockchain platforms, including Veem, to enable seamless integration of blockchain transactions with accounting records. Implications of blockchain technology could affect the accounting industry covering several aspects:
Increased Transparency: Blockchain technology provides increased transparency, which is essential for accounting. The technology can record transactions securely and transparently, which means that all parties involved in a transaction can agree on a single version of the truth. This technology ensures that accounting data is tamper-proof, with all parties in the network having access to the same records, providing transparency and accountability that can increase investors’ and regulators’ confidence in reported financial data
Reduce the Risk of Fraud: Blockchain technology can reduce the risk of fraud in the accounting industry due to its immutability and transparency features. Using blockchain, accounting records are recorded in real-time and cannot be manipulated, making fraudulent activities difficult to execute. Additionally, blockchain technology can help track transactions across different systems, creating a more holistic view of accounting data and identifying any discrepancies.
Increased Efficiency: Blockchain technology can improve the efficiency of the accounting profession. With blockchain technology, transactions can be recorded in real-time, eliminating the need for intermediaries to record and verify transactions. Automating accounting processes with blockchain technology also reduces the time spent on manual data entry, freeing up time for accountants to focus on higher-level strategic analyses.
Simplified Auditing Process: Blockchain technology can simplify the auditing process by using smart contracts that can validate transactions automatically. Additionally, since blockchain technology creates a permanent and immutable record of all financial transactions, the overall audit process can become more simplified and faster.
Sustainable Accounting: Blockchain technology provides an opportunity for sustainable accounting practices. One of its advantages is the capability to create an immutable ledger to record environmental sustainability initiatives and report on ESG metrics. Blockchain technology can help organisations monitor and report on such initiatives while ensuring accuracy, transparency, and data security. Currently, there are no specific accounting standards that cover blockchain technology. However, as the use of blockchain technology increases, standard-setting organisations are beginning to consider the implications of blockchain for accounting and financial reporting.
Use cases of blockchain technology in Accounting Firms
The Smart Contract
A smart contract is a self-executing contract that is encoded on a blockchain. It is designed to automatically execute and enforce the terms of the contract and does not require human intervention once it is set up. In accounting blockchain technology, smart contracts can play an important role in streamlining accounting processes and reducing the occurrence of errors or fraudulent activity. Below are some examples of how smart contracts can be used in accounting blockchain technology:
Automation of Accounting Processes: Smart contracts can be used to automate accounting processes such as invoicing, payment processing, and record-keeping. For example, an invoice may be created and sent using a smart contract that automatically records the transaction and payment on the blockchain, eliminating the need for intermediaries and manual input.
Real-Time Financial Reporting: Smart contracts can be used to automatically update financial records and reports in real time. This allows for greater transparency and accuracy in financial statements and records, which can enhance partnerships between businesses and their investors.
Fraud Prevention and Detection: Smart contracts can be used to prevent and detect fraudulent activities such as double-spending, identity theft, and false invoicing. For example, a smart contract may enforce certain rules and conditions regarding the creation and submission of invoices, which can help detect fraudulent activity.
Decentralised Auditing: Smart contracts can also be used for decentralised auditing in which an independent third party uses a smart contract to verify transactions and validate financial records. This can provide greater transparency and reduce the risk of errors or inconsistencies in financial reporting.
Automatic Tax Reporting: Smart contracts can be programmed to automatically calculate and report taxes based on predefined rules and taxation regulations. This can reduce the time and resources required by businesses to keep up with regulatory compliance and can reduce the potential for errors or late filings.
Streamlined Auditing
Blockchain technology can make auditing more efficient and streamlined. Since all transactions are recorded on the blockchain, auditors can quickly verify the authenticity of a transaction by reviewing the relevant blockchain data. This saves time and money since auditors don’t have to manually gather and reconcile data from different sources.
Let’s say that a company wants to audit its financial statements. In a traditional auditing process, the auditor would collect various financial documents from the company, such as bank statements, invoices, and receipts, and manually verify each transaction. This can be a time-consuming process that is prone to errors.
All financial transactions are recorded on a decentralised and distributed ledger. This means that the auditor can access the blockchain to view all transactions that have occurred within the company’s financial system. The auditor can quickly verify the authenticity of each transaction by reviewing the blockchain data, which includes information such as transaction date, time, amount, and parties involved.
Since blockchain technology offers a tamper-proof and immutable record of all transactions, the auditor can be confident that the financial data is accurate and has not been altered. This not only saves time and money for the auditor but also improves the integrity and reliability of the audit process.
Enhanced Data Security
Blockchain technology offers enhanced data security for accounting records. All transactions are encrypted and stored in a decentralised database, making it difficult for hackers to tamper with the data. This ensures the integrity and accuracy of financial records, thereby reducing fraud and errors.
Let’s say that a company stores its financial records in a centralised database. In this scenario, financial data is vulnerable to attacks by hackers who could potentially steal or manipulate the data. For example, an attacker could gain access to the company’s database and modify financial records to hide fraudulent activity.
However, with blockchain technology, all financial transactions are encrypted and stored in a decentralised ledger. This means that even if a hacker gains access to a single node in the network, they cannot modify the data as it is immutable and stored on multiple nodes in the network.
In addition, blockchain technology uses cryptographic algorithms to ensure that only authorised parties can access and modify financial data. This significantly reduces the risk of unauthorized access and ensures that financial records are secure.
Faster Settlements
Blockchain technology enables faster and more efficient settlements, which can save time and money for businesses. Instead of waiting for third-party intermediaries to verify transactions and process payments, blockchain technology automates the process and reduces settlement times significantly.
In traditional financial systems, settlements can take several days to process because they usually involve multiple intermediaries, such as banks or payment processors. Each intermediary charges fees for its services, and the entire settlement process can be time-consuming, costly, and prone to errors.
With blockchain technology, settlements can be near-instantaneous and automated because transactions are processed and verified by the network without the need for intermediaries. This reduces transaction fees and the time required for settling accounts.
For instance, let’s say that a company based in the United States wants to make a payment to a vendor in Japan. Instead of using a traditional payment system that requires intermediaries, the company could use a blockchain-based payment network that allows them to send and receive payments in digital currencies.
The payment would be processed within a few seconds, and the vendor would receive the payment almost immediately. The transaction would be recorded on a blockchain and verified by multiple nodes in the network, ensuring its security and immutability.
By leveraging blockchain technology, settlements can be faster, more efficient, and more secure than traditional payment systems. This can provide significant benefits for businesses that rely on fast and reliable payment processing.
Compliance and Regulatory Requirements
Compliance with existing accounting standards is crucial. This includes ensuring that transactions are properly recorded, classified, and reported in accordance with generally accepted accounting principles (GAAP) and other applicable regulations.
Protecting client confidentiality is also a critical consideration for accountants. The use of public blockchains can potentially compromise client confidentiality, while the use of private blockchains requires careful consideration of access controls to prevent unauthorised disclosure of client information.
Compliance with anti-money laundering (AML) and know-your-customer (KYC) regulations is another important consideration as the decentralised nature of blockchain technology can potentially facilitate money laundering and other illegal activities. Therefore, accountants must ensure that they comply with AML and KYC regulations.