The death of accounting and auditing and what to do about it

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photo courtesy of iStockphoto

At the 4th CFO Innovation Indonesia Forum in Jakarta last week, the Asia Managing Director of a workflow management consulting company was in a pensive mood.

 “One might think that as long as humans trade with one another, we’ll have something like the invoice,” he said. “But in reality this is not going to be the case. It is very likely that technologies like blockchain would take away the need to send an invoice.”

But surely this will happen in the far-off future? It will be sooner rather than later, said the MD. “Obviously I don’t know the future, but it is likely going to happen in less than ten years.” His business will be seriously affected. Helping companies and shared services centers digitize and automate the invoicing process accounts for a significant portion of revenues.

The seriousness with which his company views blockchain is an indication of how close we are to adopting the technology for a variety of commercial transactions.

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Invoicing is only one of numerous applications. In this particular case, there would be no need to issue paper or digital invoices because the transfer and receipt of goods and services will appear on a digital ledger. The company will be prompted to pay the vendor – or a smart contract will self-execute payment after checking the ledger to confirm that the goods have been received and funds are available.

What blockchain can potentially do is make obsolete the double entry system that allows companies to trust that their books are in order.

Proofs of concept

The most high profile application of blockchain currently is in virtual currencies such as Bitcoin. But there are many other ongoing proof-of-concept projects, including one by start-up Everledger to track the movement of diamonds from mines to stores. Last year, Dutch bank ING worked on 27 proofs of concept around lending, payments, financial markets, bank treasury, compliance and identity, and trade finance and working capital.

For its part, the Monetary Authority of Singapore is partnering with blockchain technology company R3 and a group of international banks on a proof-of-concept project around inter-bank payments. And the Hong Kong Monetary Authority (HKMA) and the Hong Kong Applied Science and Technology Research Institute are doing proof-of-concept work around mortgage loan applications, trade finance, and digital identity management.

The Big Four accounting firms and the American Institute of Certified Public Accountants have met to discuss forming a consortium to explore how blockchain can be used in accounting and auditing. “It can be gradually integrated with typical accounting procedures: starting from securing the integrity of records, to completely traceable audit trails,” suggested Deloitte in a recent article. “At the end of the road, fully automated audits may be reality.”

Ending double entry

In simple terms, blockchain allows numerous parties to record their transactions in a digital ledger in their computers. Every transaction is time-stamped and linked to the previous transaction by a cryptographic algorithm known as a “hash”. Every user’s ledger is replicated and synchronized across the network of users regardless of where their computers are in the world.

 “It is essentially technology that supports networks of databases that enable participants to create, disseminate and store information in a secure and efficient manner,” explains the HKMA in a white paper.

“What makes [blockchain] special is that these networks of databases can operate smoothly and securely without necessarily being controlled and administered by a central party that is known and trusted by every participant.”

“Instead of keeping separate records based on transaction receipts, companies can write their transactions directly into a joint register, creating an interlocking system of enduring accounting records,” adds Deloitte. “Since all entries are distributed and cryptographically sealed, falsifying or destroying them to conceal activity is practically impossible.”

What blockchain can potentially do is make obsolete the double entry system that allows companies to trust that their books are in order. Currently, these books are externally audited to also build trust among investors and ensure compliance with regulations. It can take companies that rely on paper documents and manual processes weeks just for monthly closing, with audit engagements needing months to be completed.

Digitization and automation can speed up accounting and auditing. Blockchain can bring it up to the next level – indeed, the technology can end accounting and auditing as we know it. When companies can record transactions directly to the blockchain, which is updated and synchronized in real time even as it contains real-time transactions as well by subsidiaries and associates, they will no longer need double entry accounting.

The new accounting – and auditing

Monthly closing could be done in real time. Drawing on the blockchain data, the finance team (or software) can generate financial statements for internal and regulatory purposes faster, at a more frequent pace, and in response to ad hoc requests. Questions around the veracity of the transactions will abate. “Every transaction becomes ‘notarized,’” writes Deloitte.

But they will still need to be tracked and audited. A transaction may be genuine, but it may not comply with policies and regulations, and may not be the best use of the company’s resources. The same is true of internal and external auditing. The financial statements and other information in the annual report will still need to be reconciled with the transaction data in the blockchain.

Still, both processes will be much easier and faster to complete, and require smaller headcount. Which begs the question: What will happen to today’s CFO and finance teams, as well as to the teams of internal and external auditors?

Blockchain and finance

Blockchain will probably be not as disruptive to accounting and auditing as people might think. It will simply accelerate trends that are already in train today in terms of automation and standardization – and the expansion of the finance function’s remit from transaction processing, reconciliation and control to also include analytics, decision support, risk management, strategy and business partnering.

In other words, the de-emphasis of back-office accounting work and the heightened focus on value-added activities, already gaining momentum today, will quicken. Finance professionals who can better deal with this mind-shift and who have acquired the necessary skills and experience will thrive. Those that cannot navigate the shift away from double entry accounting may not survive. 

In auditing, the use of blockchain in accounting would allow the automatic verification of a large portion of the most important data behind the financial statements, says Deloitte. “The cost and time necessary to conduct an audit would decline considerably. Auditors could spend freed up time on areas they can add more value, e.g. on very complex transactions or on internal control mechanisms.”

As with accountants, it will be the auditor that can move beyond the transactional and checking parts of the role to higher value activities that would be well-placed in the blockchain world.

First published on CFO Innovation