Blockchain and Advancing Analytics [Libra]

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“We’re not there yet, but in less than ten years, I believe that the technology behind bitcoin will transform the accounting profession entirely. What is the technology?  Blockchain.” says Ryan Lazanis, the founder of XEN Accounting, an accounting firm based in Quebec, Canada in an article called How Technology Behind Bitcoin Could Transform Accounting As We Know It.

Lazanis’ article was published four years ago, and after reading it, I was hooked on the concept of the blockchain. I have since read many articles and books on the blockchain (BC) ledger. Since then, after joining the Audit Advisory Board of a progressive software firm Libra and discussions with the faculty at Rutgers University CAR Lab Advisory Board, which includes CaseWare IDEA, we have learned much more about the control advantages and vulnerabilities of the BC.

So how is the technology behind bitcoin going to transform accounting?

In the 2015 article, it was described as follows, “The blockchain is a public, decentralized, distributed ledger that is capable of storing and confirming the transactions that pass through it. This means that the ledger is not owned or controlled by any one party. Instead, the control of the network, or protocol, is distributed among the network’s users. As transactions hit the blockchain, they are confirmed as true and accurate by the network’s users called miners.”

This sounded like a self-auditing system, and many corporate accountants started to think of it as a new world order for auditing. As a CPA, I was drawn to the word ledgers and thought this innovative ledger technology would replace all accounting ledgers.

However, we have learned there is more to discover. Moreover, while the transaction confirmation process that is executed by miners is acceptable for Bitcoin,  it is one of the key assertions that is still being studied.

The blockchain is a distributed ledger (DL) system existing on multiple computers with some new tech controls features; they are a logical evolution based on new computer capabilities. These critical new features, along with other attributes like the elimination of intermediaries in transactions will drive the expanded use of this new technology.

Specifically, this technology also contains information that could support auditors when assessing the evidence of recorded transactions. As we know, an audit requires evaluating that transactions are supported by evidence that is substantial, relevant, and accurate. This audit evidence could be produced when accepting a blockchain transaction such as when the transaction occurred. For example, when making a purchase using bitcoin the transfer of funds is recorded on the blockchain. However, not all appropriate evidence may be produced, such as confirming if the product was delivered.

As with many articles about the blockchain, this article started with and focused on the bitcoin BC. This is only logical since the BC technology was first launched as part of the now infamous bitcoin, a digital or cryptocurrency. These are two separate but related subjects! DLs existed before the bitcoin blockchain. Since bitcoin is a new currency, and trust was essential along with eliminating intermediaries, the founder started with a DL technology where trust is added by many users having a copy of the ledger. This system makes transactions immutable – plainly speaking, they cannot be changed. This is accomplished by having a unique hash for each transaction captured in an integrated log, and many other control features.

These controls initially lead many to assume an audit would not be necessary.  However, that may not be true. Although blockchain can record relevant information, the transaction may also be unauthorized, incorrectly classified in the financial statements or linked to a side agreement that is “off-chain.” Even if the transactions are recorded in the blockchain, auditors will still have to perform routine analysis of the financial statement audits.

Blockchain may not remove auditors from assessing transactions, but it can transform the way auditors perform financial statement audits. The evidence that comes with blockchain will allow auditors to perform more analytics, automation, and leverage machine-learning capabilities. This can include automatically flagging unusual transactions in real-time. Blockchain can also be used to generate and send confirmations and store any supporting documentation, such as contracts, agreements, bank statements, purchase orders, and invoices. If auditors are given these technical capabilities, the length of the whole financial reporting and auditing cycle could be improved.

Simply put, we will need new types of audits, and existing traditional accounting ledgers will be around for a long time, but eventually, the introduction of a DL aspect will have to be adopted to take advantage of the newly added control features.

How we audit in the DL future is still being studied. However, it is sure to include the use of analytics and continuous monitoring. I believe BC controls are likely to involve existing analytics from expert software companies like CaseWare IDEA. So, analytics and continuous monitoring become even more valuable and all you active users will be well positioned. Stay tuned for more on blockchain auditing.

Written by Michael Cangemi, originally published on CaseWare Analytics.