Accounting
Accounting

ET received a email with the bizarre headline “Blockchain could replace banks and lawyers, says ICAEW“. This purports to come from a new report from the ICAEW (the Institute of Chartered Accounts in England and Wales), entitled ‘Blockchain and the future of accountancy’.

This headline is bizarre for two reasons:

  • the Report barely mentions ‘blockchain could replace banks and lawyers’
  • the focus, much more practically, is on the possible impact on accounting.

 

As David Lyford-Smith, Technical Manager, IT at the ICAEW (more encompassingly) says: “Blockchains mean organisations can work together without an intermediary, but no longer need to have institutional trust in one another. This is potentially a seismic shift in how we do business. It will have knock-on effects on everything from record keeping to supply chain management and accounting and audit. It could potentially remove middleman institutions, gain transactional certainty, reduce cost and bias and open up access to more participants.

David Lyford-Smith (https://www.accountingweb.co.uk/community/blogs/savia/icaew-excel-tips-modelling-is-a-risky-business)
David Lyford-Smith

Blockchain for accountants

The key features, from the Report, about blockchain are:

  • propagation: there are many copies of a blockchain ledger, and no ‘master’ copy; all participants have access to a full copy of the ledger and all copies are identical and equivalent; no one party has control of the ledger; new transactions can be posted quickly and will propagate to all participants’ copies
  • permanence: with each user having their own copy of the ledger, truth is determined by consensus; past transactions cannot be edited without the consent of the majority, meaning that blockchain records are permanent; the
    entire ledger is stored by each participant and can be inspected and verified
  • programmability: some blockchains enable storage of program code (as well as ledger entries) – thereby creating automatic journal entries that execute automatically when triggered; these are the so-called ‘smart contracts’.

As the Report states: “whether blockchain(s) are applicable in any particular business or sector will depend
on if these qualities are desirable alternatives to present methods. Good blockchain applications (will) centre on the cost and timing advantages of removing central parties from the system, and the increased security and certainty from having a system of consensus.”

The essence of what blockchain offers

“Conceptually, blockchain is a move from a point where the trustworthiness of a ledger derives from the central controller that maintains it, to one where it is derived from trust in the system that drives the recordkeeping. Furthermore, the potential for self-executing smart contracts allows for a programmable ledger that could fundamentally alter how all contracts operate. Assuming that all the technological barriers can disappear, blockchain has huge potential.

“If we consider just the capabilities of blockchains without smart contract functionality, a full implementation could lead to disintermediation of a large part of the financial system. Private blockchains between groups that often transact with one another could replace central authorities such as banks, clearing-houses and lawyers. With the ability to directly interact, and with only one ledger that never requires reconciliation, businesses could save on both the costs of paying the ledger owner, as well as efforts spent reconciling with their counterparties. Removing uncertainty benefits the economy by streamlining it, facilitating greater confidence in decisions.

“What’s more, where appropriate a tax authority, regulator, or similar oversight body could be granted view-only access to such a blockchain, and would be able to observe and monitor transactions in real time. This kind of insight could lead to a reduction in costs and increases in the efficiency of regulatory and compliance activities. The permanent record of a blockchain reduces the chances for financial crime, thus making records more trustworthy.”

Eliminating the quadruplication effect

The ICAEW makes one particular point. Most enterprises, the exceptions perhaps being small or cash businesses, operate Pacioli’s double entry bookkeeping. This involves creating debits and credits in such a way that all should balance out, thereby demonstrating the completeness of the entries (though not necessarily of the information therein – GIGO applies just as much to accounting as to computing).

When two businesses interact – one (say) buys from the other – the seller will record the sale with a debit and a credit. Similarly, for the buyer, there will be a debit and a credit. In other words, to embrace the whole transaction chain there is a need for at least four book entries.

This works, or has worked, for centuries. Indeed, one can argue that Pacioli’s epitome arrived with modern ERP systems from the likes of SAP, Oracle, NetSuite and a host of others. These provide accounting through automation of the double entry system – within each enterprise – but not between enterprises.

What the ICAEW Report argues is that blockchain technology could substantially alter this model. “By lowering the walls around each company’s internal accounting and making entries directly on the blockchain, the bookkeeping allows for the transaction to be recorded faithfully, verifiably and identically by each party. This might start as something for intragroup trading, but with time could grow to cross multiple entities, creating a kind of ‘universal entry bookkeeping’.”

It goes on to point out that: “fundamentally, any kind of asset ledger will have to be designed around the limitations of privacy that a blockchain creates. While the data in each transaction can be encrypted, if the provenance or ownership of assets is at stake, then prior transactions must be public to verify this. Finding a way to balance the competing priorities of decentralisation, privacy, and security is a current area of research among blockchain specialists.”

Possible impacts on auditing

Though the email headline is misleading, the Report articulates how blockchain technology can change the current approach to accounting and auditing. For example, in the latter instance, it rightly says: “Blockchain has applications in external audit. Performing confirmations of a company’s financial status would be less necessary if some or all of the transactions that underlie that status are visible on blockchains.” This proposal would mean a profound change in the way that audits work.

“A blockchain solution, when combined with appropriate data analytics, could help with the transactional level assertions involved in an audit, and the auditor’s skills would be better spent considering higher-level questions. For example, auditing is not just checking the detail of whom a transaction was between and the monetary amount, but also how it is recorded and classified. If a transaction credits cash, is this outflow due to cost of sales or expenses, or is it paying a creditor, or creating an asset? These judgemental elements often require context that is not available to the general public, but instead require knowledge of the business, and with blockchain in place, the auditor will have more time to focus on these questions.”

What does this mean

This ICAEW Report is worth reading in full. While neither comprehensive nor technical, it ‘locates’ future blockchain usage in a practical place. In that it is unusual.

In addition, it briefly (and unusually), explores the ‘database dimension’ and produces some practical guidelines: “Virtually any activity that would otherwise run on a database could be on a blockchain platform, but whether this is actually beneficial will depend on the circumstances. Many proposed blockchain applications could use a shared traditional database hosted by a trusted central party and would provide nearly identical results. A problem where blockchain might be an appropriate solution is one that has:

  • “a number of participants who don’t have institutional trust in one another;
  • “a desire to work without an intermediary (either because of cost or because one isn’t
    available); and
  • “a need for a complete definitive log of transactions.”

Where the Report is less convincing is about smart contracts. Its overall optimism overall about their applicability is possibly misplaced. As the Report in one place records: “While the process of executing a smart contract might be disintermediated, there may still be a need for a trusted professional – in this case, a programmer to create the smart contract. If institutional trust (and cost) moves from the lawyers drawing up the contract to the programmers encoding it, there is no real advantage to be gained.”

Finally, the Achilles Heel of blockchain, performance, comes in for mention by implication rather than explicit doubt. Current blockchains operate at tens or perhaps hundreds of transaction per second. IBM claims that it can deliver low thousands of transactions through its controlled, permissive blockchain. Visa delivers tens of thousands of credit card transactions per second. If blockchain advocates do not solve the performance issue, then much of what the ICAEW wrote about blockchain for accountants will be meaningless.

 

Previous articleCisco to share threat intelligence with INTERPOL
Next articlePraveen Asthana on marketing in Cybersecurity
Charles Brett is a business/technology analyst consultant. His specialist areas include enterprise software, blockchain and enterprise mobility tech (including metering). Specific industry sectors of interest and experience include finance (especially systems supporting wholesale finance), telecommunications and energy. Charles has spoken at multiple industry conferences, has written for numerous publications (including the London Times and the Financial Times). He was the General Chair of the bi-annual High Performance Systems Workshop, 2005. In addition he is an author and novelist. His Technology books include: Making the Most of Mobility Vol I (eBook, 2012); Explaining iTunes, iPhones and iPads for Windows Users (eBook, 2011); 5 Axes of Business Application Integration (2004). His published novels, in the Corruption Series, include: The HolyPhone Confessional Crisis, Corruption’s Price: A Spanish Deceit and Virginity Despoiled. The fourth in The Corruption Series - Resurrection - has is now available. Charles has a B.A. and M.A in Modern History from the University of Oxford. He has lived or worked in Italy, Abu Dhabi, South Africa, California and New York, Spain, Israel, Estonia and Cyprus.

LEAVE A REPLY

Please enter your comment!
Please enter your name here