Blockchain technology is a decentralised electronic ledger, which was first introduced as the technology associated with cryptocurrencies, such as Bitcoin. The wide appeal of blockchain technology can be attributed to its use of peer-to-peer network technology combined with cryptography, which enables two parties to conduct transactions securely between one another without requiring the services of a traditional trusted intermediary in the form of a bank or payment processing network.
Each transaction added creates another block on the chain. Each block is timestamped and once validated, entries cannot be deleted or altered and so it is not possible to cheat the system – therefore making it a verifiable and auditable record of each and every transaction in the ledger.
Blockchain technology may impact all recordkeeping processes of a business beginning with initiating a transaction, to processing, authorising, recording, and reporting, thereby providing transparency, efficiency, and cost savings for businesses because of its ability to create the secure, real-time communication networks with partners globally.
Sectors where blockchain technology can be applied
All businesses need to track information and therefore face the challenges involved in reconciling data with counterparties. The first prominent adoptions of blockchain may transform business processes and legacy systems that are arduous to maintain. For example:
- Transfer of value or assets between parties is currently cumbersome, costly and requires one or more intermediary organisations.
- Securities settlement – involving multi-day clearing and settlement processes between multiple financial intermediaries.
- Financial services industry – by automating many of the activities currently performed by humans such as trade finance, cross border payments and other banking processes.
- Industrial or consumer companies – Digitising and tracking the origins and history of transactions in various commodities.
- Healthcare organisations – Securing data integrity and protection of electronic medical records, medical billing, claims, and other records.
- Regulatory authorities are considering blockchain to support asset registries for land and corporate shares.
The probable effect of blockchain on the financial statement audit and the assurance profession
Currently the auditor has to be provided with financial information such as trial balances, reconciliation of account balances, adjusting journal entries, extracts of sub-ledger, and supporting spreadsheets in electronic and manual formats. Auditors have to spend a substantial amount of time obtaining supporting documents and information and schedules for the purposes of planning and performing the audit.
The adoption of blockchain will allow auditors to access information in real-time through read-only nodes on blockchains and conduct online assessments throughout the period under audit instantly. The auditors will no longer need to request and wait for clients to provide data as they will be able to obtain audit evidence directly through blockchains.
Financial statement auditing
Auditors are highly regulated and follow strict guidelines and professional codes of ethics and auditing standards. Auditors are required to obtain independent, relevant, and reliable audit evidence to enable them to provide assurance on an entity’s financial statements and report whether they are free of material misstatement and that a company’s internal controls over financial reporting are operating effectively.
Independent auditors need to understand the technology implemented by their clients and the impact on the audits, as organisations continue to explore the use of private or public blockchains. Auditors will have to adopt to automation, analytics, and machine-learning capabilities, as supporting documentation, such as contracts, agreements, purchase orders, and invoices could be encrypted and securely stored or linked to a blockchain. Therefore, auditors will have to develop procedures to obtain audit evidence directly from blockchains.
One of the important aspects of the audit is to verify the financial statement assertion – occurrence of a transaction. Recording a transaction in a blockchain may provide sufficient appropriate audit evidence for this assertion (e.g., an asset recorded on the blockchain was transferred by the seller to a buyer). However, it may or may not provide, sufficient appropriate audit evidence related to the nature of the transaction. For example, a transaction recorded in a blockchain can be fraudulent and not approved by an authorised official or be unlawful.
While the audit process may become more continuous, auditors will still be required to:
- Apply professional judgment when analysing accounting estimates and other judgments made by the management in the preparation of financial statements, even if the transactions are recorded in a blockchain.
- Test-check internal controls for data protection and data integrity of relevant financial information.
- Consider the risk of fraud or error and this will especially be more challenging because a blockchain may not be controlled by the entity being audited.
- Review the general information technology controls (GITC) to understand and assess the reliability of the consensus protocol for the specific blockchain. Also consider whether the protocol could be manipulated.
- Accounting policies for digital assets and liabilities adopted by management will have to be evaluated as these are not covered in International Financial Reporting Standards
- Customise audit procedures taking into account both the benefits and risks of blockchain.
There will be new challenges and opportunities to the audit and assurance profession
Auditors will be required to provide assurance to their clients, who use blockchain technology because of their skill, independence, objectivity, and expertise.
The auditor may be appointed by the contracting parties to validate that the smart contracts have been implemented with the correct business logic as these can be inserted in a blockchain to automate business processes.
Users of blockchain technologies require an independent evaluation, of the risk of unidentified errors or vulnerabilities. Therefore, an auditor will require a new skill set, including understanding technical programming languages and the functions of a blockchain. This raises important matters for the auditing profession including:
- Identifying the types of skills required.
- Understanding other elements that would have an effect on assurance engagement risk.
- Assessing the continuing responsibility once a smart contract is released into a blockchain.
There are tremendous opportunities for both internal and external auditors to adopt and implement distributed ledger technology. The current auditing process is transforming due to adaptation of blockchain technology. Even though blockchain promises secure transactions and provide clearer audit trails, there could be instances of scams and non-compliances.
Technology and innovation will continue to evolve and impact the auditing and accounting process. Audit firms will also benefit from this transformation because they will have an opportunity to evolve, learn, and take advantage of their ability to adapt to the requirements of a swiftly changing business world.
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Date: March 2021