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Bitcoin's blockchain technology could remove paper trailsFDA

Back in the late 1990s the cryptographer Nick Szabo predicted the paper-era techniques of auditing and accounting would be dramatically augmented by, and eventually integrated into, smart contracts.

The last year or two has seen lots of opinion about the extent to which distributed ledger technology, combined with real time audit potential proven by cryptocurrency, would impact the transfer of value and trust located within centralised database systems.

Some have said auditors, for instance, fall squarely in the gun-sights; others believe large professional services firms could be the ideal conduits of disruptive technologies, assessing and aligning value derived from them with their clients across the supply chain.

Regarding the bald execution of digital code, it's worth remembering that an audit is an opinion provided on the financial statements of a company based on pre-determined accounting guidelines (most commonly International Accounting Standards). The role of the auditor is to provide the trusted voice that states that opinion.

The large accountancy firms are all getting their heads around this technology at this time. Matthew Spoke of Deloitte is one of the leaders of the Rubix Project, tasked with delving into distributed ledger offerings such as Ethereum, Eris, Ripple and Hyperledger, in first instance, to assess their pros and cons.

Spoke told IBTimes: "The first proof of value we are looking at is essentially in the auditability of information, so applying a blockchain database infrastructure to processes that traditionally do not have easy to follow audit trails.

"There is a lot of great research coming out of all of the big four and other consulting firms as well. My team is trying to differentiate ourselves a little bit - in addition to trying to understand this technology and telling people what we have learnt, we think we could be in an interesting position to start implementing and testing some of these technology solutions.

"So we are taking a little bit of a leap into the actual building of technology solutions with the focus on our own industry firstly."

Spoke acknowledges shortcomings with today's technology and the audit process itself. For example, the audit concept today is essentially to provide reasonable assurance that there is no likelihood of a material mis-statement on the financial statement: there is no concept of 100% guarantee.

A big problem is that information being relied on is stored on traditional database structures.

Matthew Spoke
Matthew Spoke, the leader of Deloitte's Rubix Project

"It seems the more we move in to this cloud-based era, the more we rely on centralised databases, and the more we realise we still have an inherent problem with corruptibility of data," he said.

"Centralised databases still allow for the possibility for someone to change entries, to affect what the outcomes of certain calculations are in systems. So there is this kind of over-arching problem that you cannot guarantee the status of data that you rely on."

Spoke said blockchain is interesting, not only in respect of numerical data entries on an accounting system, but also because auditors go back and look at paper trails, contracts that support transactions, or old paper invoices - the types of documents where accuracy can be compromised, where there is a risk of fraud.

Following the Enron scandal of the early 2000s, the Sarbanes Oxley Act demanded that top executives sign off on audits knowing they would be held criminally responsible if the books had been cooked – something of a Catch 22 in compliance terms, since they have no way of guaranteeing that what they are signing is 100% accurate.

"We are looking at how to add incrementally, looking at little pieces of the audit. How do you add over time more and more ability to guarantee the status or the outcome of a financial statement audit.

"Most immediately we see value in what we call substantive testing of transactions and the process that auditors often go through which is called third party confirmations.

"This is where they have to reach out to a trading partner of their client to confirm that the status of an account, or an account payable, is X dollars on this date.

"We also think there is an ability to add incorruptibility to the types of documents that auditors would rely on.

Silicon Valley accounting, finance and digital assets specialist Libra is a distributed ledger focused start-up with companies like Ernst & Young on its advisory board. Libra CEO and founder Jake Benson is known for declaring that double entry accounting has been increased to triple-plus entry, thanks to the blockchain.

Benson believes distributed ledger has the potential to hugely disrupt traditional auditing and accounting. He said the big four have taken a long time to get into blockchain, considering the technology is several years old now.

Benson told IBTimes: "You'd be hard pushed to find some actual implementations out there, where anyone is say, keeping their books in blockchain format, or actually find examples where digital assets are kept on the balance sheet in any large form."

Although it's difficult to put a time-frame on this, he said we will be looking at "a massive reduction in the human resource that we would need to keep books in order, so basically just computers and the automated accounting systems just kind of taking over a lot of the manual effort that still gets done today.

"When it comes to transparency for accounts, instead of digging and asking for reports and finding the right people in the organisation who have that information - it's as simple as, 'go to this address on a blockchain and everything is there with as much detail as anybody could ask for.

Jake Benson
Jake Benson, CEO and founder of Libra

"It's just removing a lot of the legacy of standard accounting work, and when it comes to audit there will be a lot less time wasted on collecting documentation. It will just be there automatically."

In terms of how a blockchain system could be integrated into existing systems, Benson said this "could take shape as a new ERP or an add-on to SAP that now links it up to a financial cloud source, where that's your distributed ledger. I don't think anyone knows exactly.

"Since this is all kind of revolving around cryptography, these ledgers are now super-encrypted. So encrypted that there are now several levels of this encryption where I could share with an auditor some kind of like read-only key to my books and it reveals a certain type of transaction, or only the nature of transactions that they want to be able to reveal.

"Then a regulator could have a certain key type that only reveals some layer of their books. So I think that's another exciting thing - sharing your books might be as simple as giving someone one of these read-only keys and they could be designed in such a way that they only get to peruse what you configure that for."

Libra is looking at ways to build in tax reporting functionality into digital transactions and its next step is focused on forex to provide a "dropbox for traders with built-in accountant".

"This is all just one big programme anyway, so if a central bank wanted to create their own digital currency they could programme the tax rules into the digital currency.

"If I had it my way you could completely automate the tax system, where inherent in every transaction, independent of party A and party B and the nature of that transaction, tax would just be automatic.

"I mean that is truly possible now. The question of whether the central bank of government would be savvy enough to go and build a system like that - who knows?

"But it's something a lot of other crypto-anarchists would hate but I personally would love because you could cut down the fat on the tax profit so that it's instant and automatic and you wouldn't have to do any paperwork at the end of the year; it'd be pegged in to the digital transaction itself," said Benson.

Sigrid Seibold, a managing director at Accenture, who recently co-authored a report on Blockchain's disruptive potential, confirmed that the big auditing firms are looking into this and trying to understand it, but that adoption would be gradual while regulators are still trying to catch up on Bitcoin1.0

She told IBTimes: "I see great potential but I don't think it will massively change in the next two years - people still produce tons of paper and must do this to fulfil regulatory requirements.

"If you look at the speed of how quickly regulation catches up on technology - maybe the two year time zone horizon is not realistic."

Sigfried Siebold
Sigrid Seibold, managing director at Accenture, likes blockchain

She said in three or four years adoption of the technology will lead to "a ring-fencing of individual products solutions for some of the instruments and we will see massive cost benefit analysis".

In respect of a streamlining of the auditing industry, Seibold agreed this was imminent: "I'm sure it is. And honestly I would very much look forward to it. Whatever comes out of it is great business for us as we help our clients explore the impact."

Rubix leader Spoke added that from a resource perspective, he could not comment on how this could impact the number of staff you need to execute on an audit.

He said: "The more we sat down with auditors we started realising there is significant amount of complexity and judgement that goes into audits.

"At least in the short term, I don't see us being able to impact a significant role that auditors play, in terms of judgement and the oversight they have on financial statements. I think there definitely will still be auditors in five years.

"There is always going to be a need for someone who deeply understands the business and the industry of the company that is being audited and can pull out insights that we may not in the short term be able to solve with software."

Spoke concluded in the broadest terms that far in the future – leaving aside issues of competition – there could come a time when the most meaningful impact on the audit industry would be complete collaboration among its main players.

"Because it is very regulated and everybody has to follow the same standards and rules, no one player could decide unilaterally to do things differently. So that could be the future of this," he said.

IBTimes reached out to the other big three players - KPMG, PwC and EY - but they declined to comment on blockchain technology at this time.