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Accounting

Enron, WorldCom, Lehman Brothers and Satyam are all dark moments in corporate history, where, in some way or the other, they all cooked the books to hide their true financial position, at the expense of investors, customers, and taxpayers. These incidents made the global audit industry lose its most precious asset: public trust. Even though the rules have changed to limit the risk, the potential for auditor fraud, still remains. However, blockchain can put an end to corporate fraud.

 

CURRENT PROBLEMS

Today, auditors typically are only able to verify a small sample of transactions in a large company and approve the rest based on statistical probabilities

An auditor’s job is to be an independent third party who verifies the accuracy of financial statements, however, the inherent bias to protect the clients, because auditors are collecting fees to conduct the audit, cannot be ignored

Risk that the company’s management, for their own self-interest, cooks the books in a way undetected by the auditors, isn’t unheard of

When auditor issues an audit opinion stating that the financial statements were reasonably prepared, we trust the auditors and the financial statements assuming that all biases and self-interests have been put aside, but this is not always the case – sometimes bias gets in the way affecting the public, like the Enron scandal

 

This is where the blockchain can play an integral role…

BLOCKCHAIN SOLUTION

The double-entry book-keeping accounting and traditional audit processes involved have remained relatively unchanged for decades, with miniscule improvements to change the nature of information from paper to digital. The distributed decentralized ledger technology is well suited to address this scenario as it provides a globally distributed decentralized ledger that everyone has the exact same copy of and no one can tamper with. It gives the ability to compare accounting entries between two trading partners, while maintaining data privacy, thus significantly reducing the reliance on auditors for testing financial transactions. Once a match is posted to the blockchain, the transaction is time stamped and irreversibly recorded. Everyone agrees on consensus that those transactions actually happened, providing verification. Thus, we have the debit, the credit, and confirmation by the network.

A blockchain solution could also allow for automated third party verification by a distributed decentralized network to ensure that transactions are complete, accurate and unalterable.

E.g., Let’s say Company X wants to pay Company Y. Traditionally, both X and Y would rely on their accounting systems alone to describe this situation. In a blockchain world, both X and Y can share a “receipt” (the exact same copy), which is cryptographically signed.

Thus, in the above case, there are three parties, each holding a copy of the same receipt – Company X, Company Y and the mediator, which is the blockchain that verifies each transaction and issues the receipt. Thus, every transaction would have a corresponding entry that would have to be verified by the blockchain. Now every transaction is effectively recorded in three places.

The receipt above is itself strong because the payer cryptographically hashes it, and it is cryptographically signed by the mediator (at the least). It represents concrete corroboration that it is practically irrefutable.

Since all participants agree upon the distributed ledger and there are digital signatures to provide a degree of non-reputability, auditors can rely on this ledger, making their job easier.

Since all audit procedures entail confirming transactions and balances on a company’s accounting ledger, blockchain is an ideal solution, as it can do this by itself, without the use of a third party, like the auditor. Everything on the company’s books could occur on the blockchain.

Instead of employing its own auditors to examine the accounting, a company can log all transactions on an internal blockchain. Even external auditors or regulators can inspect the firm’s books in real time. Thus, this technology has value for even the accounting firms that make their money from auditing. Regulators can use this technology to stress-test the corporations and identify questionable practices.

ADVANTAGES

Data privacy – The value of a transaction can be hidden, so only authorized people can see its value, but it would be recorded in a public ledger, thus allowing accountants, auditors and risk managers to ensure that the books add up, even though they weren’t allowed to know the values. Thus, it makes sharing data between entities seamless without hampering privacy.

Complete, accurate and Unalterable transactions – ‘The transaction’ and ‘the record of the transaction’ are the same thing in blockchain. Thus, when a transaction takes place, the blockchain not only makes that transfer, but also provides an eternal, immutable record of the same, verified by the participants for the network which approves the transactions as they happen.

Integrity across all transactions – Merging the transaction and its record creates a comprehensive view of an organization’s transaction history.

Continual auditability – Auditors can perform a complete audit at any time as the record would always be complete and accurate up to the current point.

Instead of treating accounting as a separate process, it makes it an integral part of the business activity – translating an invoice into a ledger.

Tamper-Proof Record

Double-Entry + Cryptography

Validated, Secure & Private

Verification by consensus