Blockchain and Accountancy - 2021
Blockchain gained phenomenal recognition with the proliferation of Cryptocurrencies. The technology is revolutionary with the concept of decentralized database and distributed trust. The revolutionary technology is just around the corner to impact each aspect of our life – Banking, Finance, Legal, Healthcare, etc. For example, Ethereum provides an ideal solution for managing royalties in the music industry by distributing tokens that represent ownership rights that facilitate automated and seamless distribution of royalty payments. Ethereum projects working in the music industry include Ujo, Mediachain, and the Open Music Initiative. It’s just a matter of time that this incredible technology will take the winds of accountancy. Keep reading as we deep dive into the core concepts of Blockchain, its components, and the benefits it provides to the accountancy profession along with a review of existing applications utilizing its power.
What is a Blockchain?
Blockchain technology, elucidated in simple words, means a digital and decentralized database that stores assets and transactions across a peer-to-peer network. Blockchain technology is a unification of two familiar words, blocks and chains. Visualize blocks of data in digital form chained together.
Breaking down Blockchain into its components
A block is like a page of a ledger book. It is a structure made of information stored chronologically but in digital form.
Digital signatures or hash
It is a unique identification of a block together with data stored in it.
Chaining is a technique of linking the blocks with each other using the hash. It makes the database immutable.
Proof of work
It is a mechanism that slows down the fabrication of new blocks.
Each participant (node) of Blockchain performs the job of an admin of the data block. Stringing new input along-with the existing block needs acceptance or authentication by most of its participants. This process is known as consensus.
What makes a Blockchain special?
We all have heard that Blockchain is a revolutionary technology. It becomes essential we investigate what makes it so promising.
Each block resembles a packet consisting of its data, its hash, and the hash of the previous block as its contents. Every new block added is immutably linked to the last block. The chaining of data brings into existence an audit trail making users trace back the data out of a big database with no effort. Data stored in blocks acts as a proof of ownership.
Changing or tempering data, any line, word, or even just a single digit in a block generates a new signature for the block. The latest signature is different from the initial hash stored in its subsequent block; this breaks the chain. The process creates an alarm for altered data to the users. Cautious users would reject this change and move back to the original record. The process makes data permanent and immutable.
For an alteration to stay undetected, the hacker will need to tamper all the blocks, then redo the proof-of-work for each block till the end of the chain and take control of at least 51% of the peerto-peer network. Only then the tampered block becomes accepted and reflected in the respective user’s Blockchain. Executing this is nearly impossible. As a result, data added can never be changed.
Decentralized and distributed ledger
Instead of using a centralized network, this technology operates on a peer-to-peer (P2P) network, permitting everyone to join the network. Each participant (nodes) joining the network receives a full copy of the data; gets access, verifies, and validates the data authenticity. Blockchain constructed on the concept of distributed trust requires duly convinced participants for alterations and additions to the Blockchain.
How can Blockchain impact Accountancy?
We frequently hear the term ‘Blockchain technology’ connected with cryptocurrencies. The use case of its application goes far beyond just trading cryptocurrency, impacting various sectors. Let us solve the puzzle of how Blockchain can impact accountancy. Blockchain reforms the reporting and recording of monetary transactions; through the medium of creating a a decentralized ledger. Permanent and immutable recording of transactions along-with real-time access by the users would have an immense impact on accounting. This permits for
- Security and Reliability
- Consolidated bookkeeping and real-time access
- Privacy of accessibility of digital data
- Efficiency in Auditing
To get a picture of the impact of Blockchain on accounting, we need to study and weigh each of the above points.
Security and Reliability
Transparency and immutability are necessary to avoid manipulation, fraud and offer trusted record-keeping by the accounting industry. Traditionally, storing data in a centralized server makes it effortless for hackers to access. The resultant makes data vulnerable to loss and could result in loss of valuable information.
Born with the talent to store information in a distributed manner at multiple nodes results in multiple copies of same data. The consensus mechanism acts as a defence for misrepresentation, tampering, and sew-up security. Further, the timestamp feature acts as a digital waxed seal. It contributes to wipe-out backdating; ensure data stored are accurate, authentic, and chronological. It eliminates the chances of any duplication of transactions or fraudulent activity.
Consolidated bookkeeping and real-time access
Blocks are digital custodians of data. Bringing to play this speciality of Blockchain gives the power to build a robust database by storing different types of information, maintaining its identity and individuality. Pieces of information stretch from the ledger to transactions, contracts, agreements, purchase orders, invoices, authorizations, and reports. Blockchain stores all these in one consolidated place but distributed to every participant making it easily accessible and impossible to mess around with by any user with wrong objectives. Data stored in blocks acts a proof of ownership. Transaction history pins down each participant’s rights and obligations; these are immutable. It behaves like a registry of who owns what and who transacts what. Its architecture permits a company to share its valuable records with other participants (nodes). A variety of participants, not limited to its employees, departments, suppliers, clients, banks, government authorities, shareholders, or the auditing company, get mileage out of the company data. The realtime element assures each participant that the data shared is dependable, not inflated, dubious, or of an older version. Hence, providing an actual picture of the company’s operations, liquidity, profitability, solvency, and risks at any point in time.
Privacy of accessibility of digital data
Blockchain in a private permissioned architecture works in a network of known and identified participants rather than an open network of unknown participants. Permissions to assign ‘who can see what’ within a distributed ledger is built by putting cryptography to work. Plugging technology into accounting bears positive implications. The technology improves the efficiency of money, asset, and data transactions by addressing privacy and security. We can understand more clearly with the help of the below usecases of financial data.
- Company management (managing director, CEO, and CFO) retains full access to all accounting data to make business plans and take decisions.
- Company departments have limited access depending on their functional requirements. The warehouse department deals with stock. They would see the stock records, tracking inventory forecasts and supply, and material inward/outward entries. The human resource department deals with the workforce, would have access to information about employees. Smart-contracts could monitor the working hours or holidays; automate the generation of payslips.
- External stakeholders such as shareholders would have access to financial statements, analytical information, and trends, using procedures like dataanalytics, which would lead to better-informed decisions.
- The government agencies would have access to data such as revenue, purchases, payable and receivable accounts, and tax filings could become automated.
- The Companies auditor would enjoy full access to ensure transactions are according to accounting standards and accounting principles.
One of the significant developments of Blockchain technology are Smart-contracts. These are self-executing; they handle everything from execution, management, performance, payment, and the recording of transactions. The occurring of an event automatically triggers another event mentioned in the contract. Smart-contracts are terms of an agreement stored as code. They are masters in compliance with the contract terms that reduce any doubts or ambiguity in many situations. Participants benefit by automating tasks that traditionally occur manually through a third-party intermediary. The technology described above is an expert in speeding up business processes, executing complex transactions like an exchange of money, property, shares, or any asset, thus improving cost-efficiency. The simplest example to imagine, transfer of money to an overseas client on the delivery of goods. Traditionally, the barter materializes by a third-party intermediary. Taking advantage of Blockchain technology; reduces the number of intermediaries (e.g., banks) who settle the event manually. It self-executes the entire process from identifying trigger transactions and participants through clearing, settling, and record-keeping. The automated process makes settlements more efficient, faster, and cheaper by reducing high commissions and transfer charges. Let us make sense with another example. Two parties may join to run a smart-contract to kick off a derivative contract to hedge the price of an item X at the end of a year. Participators decide the contract terms, collect hedged funds, and tie in with Blockchain. At yearend, the smart-contract would execute the terms. It would start from gathering the price of item X from a dependable source, defined in the smart-contract, then compute the settlement amount, and end by transfer funds.
Efficiency in Auditing
Current auditing practice is costly, laborious, and timeconsuming. Blockchain works over the performance and productivity of the external audit. It amends the way auditors would trust the auditee functioning and management. Blockchain provides the auditor a whole story of the client’s business. Thus, the auditor can address crucial points pumping up labour and cost-efficiency. Thrown in together, they allow zoom-in their time and energy on designing procedures on risky, complex elements and internal controls and shun away from manual data extraction or screening and analysis of repetitive transactions. Blockchain teamed up with the AI procedures would profit auditors by gaining command over transactional analysis and material queries.
Blockchain souls a storehouse. Readily available encrypted and secured data allow auditors to complete the audit within the stipulated time and refines the quality of financial reporting. Real-time access to the data via read-only nodes enables them to obtain all required audit information in a consistent and standardized format.
The footmarks of the consensus characteristic aids minimize the need for confirmations or reconciliations. Distributed trust rubs out duplication and intentional omission of dataentry. It improves transparency in asset tracking and skilfully deals with the misappropriation of assets. This hallmark of Blockchain turns out good enough to provide comfort on the existence/rights and obligations assertion and certify the completeness of data.
False transactions, collusion, bogus and unauthorized entries, and accounting fraud are the main reasons for material misstatement and fraud. The timestamp feature produces a stable audit trail making it impossible to backdate records or tamper data. It retains a permanent record of data for the auditing unit, assuring true and fair presentation and disclosure of financial statements.
Auditors work in a diverse and dynamic environment. Blockchain with a programmable personality could greet the auditors with variegated modus operandi. The auditors could shoot to advise management on risks and controls of Blockchain blueprint functioning and processing. They could also land becoming a validator of bonafide participator to access the Blockchain.
No doubt, with the use of Blockchain, the audit process and procedure may become more continuous, real-time, effective, and efficient. Still, an auditor’s professional judgment needs to be applied to analyse accounting estimates and assumptions used by management in preparing financial statements. Further, automated processes; demand the auditor to evaluate and test internal controls to maintain the integrity of the financial information.
Exploring existing Blockchain developments
Having understood the vast impact Blockchain can provide on the accountancy profession, it would be unjustified to overlook the recent real-world applications developments which have aided and simplified accounting activities. Let us unfold the evolutionary outcomes against the variety of roles the technology plays.
Remittances, payment system, and bank guarantee
The master has given into existence a new virtual currency which speeds up and simplifies the cross-border payments by reducing the middlemen. Some applications which assist in this role are
- We.trade: an IBM product has the expertise to make cross-border trade easier. Leading banks of Europe have joined hands to raise global remittances and payment processes. The We.trade Blockchain platform reduces conflicts and improves the trading process for participating companies, creating trust for global trade. It has simple trading options and standard rules which decrease risk and increase trading opportunities for banks and SMEs.
- ABRA: is a cryptocurrency wallet. It enables buying, trading, borrowing, and earning interest on cryptocurrencies. It helps to track the balance in different currencies.
- Bitpesa: is a Blockchain payments start-up and digital foreign exchange. It focuses on simplifying and polishing payments to and from African markets.
- Circle: builds a treasury infrastructure effectively for smoother global payments, pay-outs, and high-yield digital dollar accounts built on USD coin (USDC).
- Lygon: Blockchain platform is first-of-a-kind to digitize and transform the bank guarantee process for both financial and performance guarantees. It enables applicants, issuers, and beneficiaries for paperless, standardized, secure, and safe management legally binding guarantees.
Derivative and trading
There has been revolution in the process, transparency, and complexity of derivative contracts by providing real-time information on a decentralized distributed network. With proper regulations and controls, trading and short-term investment avenues have been opened. Some applications which assist in this role are:
- Chain analysis: are builds tools to help financial institutions and governments to understand, monitor, and comply with regulatory guidance of cryptocurrencies. It has an Investigating nature that detects fraudulent trading, monitors laundering and violations of compliances, and builds trust.
- Chain: using sequence a cloud Blockchain infrastructure provides for building safe and efficient financial services. It manages financial assets in token format and transfers them across public networks.
Supplier/customer KYC Management –
The technology helps build and retain the reliability of suppliers and customers. It serves to identify the parties to the contract are reputable, qualified, and with no fraudulent background. Some applications which assist in this role are:
- Trust Your Supplier: is an IBM Blockchain-based solution for identifying, onboarding, and managing qualified suppliers.
- KYC-Chain: provides services of individual and corporate KYC. They help in document identification, ID verification, and crypto funds screening. Thus, provides a check on customer and supplier identities
Supply Chain Management
The technology improves the tracking of the origin of manufactured goods from the stage of production to retail destinations, as a result boosting transparency and traceability for everyone in the chain curbing fraud and cheating. It aids in efficient inventory management by enabling accessibility of realtime inventory records by everyone in the network namely, supplies, distributors, or even retailers, thereby eliminating confusion, tampering, and excessive pricing and hoarding of goods. Blockchain enables digitally secure payment automatically on satisfying the credit terms and conditions. An applications which assist in this role is TradeLens, which is an IBM Blockchain that works on a permissioned network and serves as a digital shipment freight management tool. It provides real-time transport insight, quick access to immutable documents, reduces the cost, and improving security.
Blockchain manages false claims, misunderstandings, and fake products by bringing a better customer experience. The company also benefits from using Blockchain for the reconciliation of invoices and resolution of the dispute. An application in this regard is Pega which provides warranty solutions with faster and easy tracking of authentic transactions and claims settlements.
Taxation and Risk Management
Blockchain assists in early identification of risk and fraud and makes the audit and taxation process more continuous, real-time, effective, and efficient. There are different applications that have been developed to assist in taxation and risk management by some of the leading accounting firms.
The world of Blockchain is eye-catching and fascinating, drawing professionals towards its charm. The technology opens the road to bring in its expertise on many unknowns and undiscovered zones. Company management, accountants, auditors, IT professionals, and start-ups must focus on taking action to put ‘theory’ into ‘practice’ and make research and developments. The advantages urge to raise the curtain and capitalize on the rapidly changing technology to digitally transform the picture of accountancy but various other aspects of life.