Blockchain Technology and Its Potential Impact on the Audit and Assurance Profession
Posted in CategoryEmerging Technologies-
IIheonu Nkechi Gloria 2 years ago
What Is Blockchain Technology?
A blockchain is a digital ledger created to capture transactions conducted among various
parties in a network. It is a peer-to-peer, Internet-based distributed ledger which includes all
transactions since its creation. All participants (i.e., individuals or businesses) using the shared
database are “nodes” connected to the blockchain,5
each maintaining an identical copy of the
ledger. Every entry into a blockchain is a transaction that represents an exchange of value
between participants (i.e., a digital asset that represents rights, obligations or ownership). In
practice, many different types of blockchains are being developed and tested. However, most
blockchains follow this general framework and approach.
When one participant wants to send value to another, all the other nodes in the network
communicate with each other using a pre-determined mechanism to check that the new
transaction is valid. This mechanism is referred to as a consensus algorithm.6
Once a trans-
action has been accepted by the network, all copies of the ledger are updated with the
new information. Multiple transactions are usually combined into a “block” that is added to
the ledger. Each block contains information that refers back to previous blocks and thus all
blocks in the chain link together in the distributed identical copies. Participating nodes can
add new, time-stamped transactions, but participants cannot delete or alter the entries once
they have been validated and accepted by the network. If a node modified a previous block,
it would not sync with the rest of the network and would be excluded from the blockchain.
A properly functioning blockchain is thus immutable despite lacking a central administrator.
What Are the Benefits?
A major advantage of blockchain technology is its distributed nature. In today’s capital
markets, the transfer of value between two parties generally requires centralized transaction
processors such as banks or credit card networks. These processors reduce counterparty
risk for each party by serving as an intermediary but centralize credit risks with themselves.
Each of these centralized processors maintains its own separate ledger; the transacting par-
ties rely on these processors to execute transactions accurately and securely. For providing
this service, the transaction processors receive a fee. In contrast, a blockchain allows parties
to transact directly with each other through a single distributed ledger, thus eliminating one
of the needs for centralized transaction processors.
In addition to being efficient, the blockchain has other unique characteristics that make it a
breakthrough innovation. Blockchain is considered reliable because full copies of the block-
chain ledger are maintained by all active nodes. Thus, if one node goes offline, the ledger is
still readily available to all other participants in the network. A blockchain lacks a single point
of failure. In addition, each block in the chain refers to the previous blocks, which prevents
deletion or reversing transactions once they are appended to the blockchain. Nodes on a
blockchain network can come and go but the network integrity and reliability will remain
intact as long as it is being used. In this way, no single party controls a blockchain and no
single party can modify it or turn it off.
Where Can Blockchain Be Applied?
Blockchain technology offers the potential to impact a wide range of industries. The most
promising applications exist where transferring value or assets between parties is currently
cumbersome, expensive and requires one or more centralized organization. A specific activ-
ity attracting significant interest is securities settlement, which today can involve multi-day
Clearing and settlement processes between multiple financial intermediaries. Certain financial
services experts believe the financial services industry is on the verge of being disrupted:
advances in innovative technologies such as blockchain are expected to transform the Indus-
Try and its workforce by automating many of the activities currently performed by humans.
The table below illustrates industries where interest in blockchain technology and it's potential
transformative benefits have been high, as demonstrated by significant investments from both
venture capital firms and large enterprises.
Financial
services
Several stock exchanges around the world are piloting a blockchain platform that
Enables the issuance and transfer of private securities. Additionally, multiple groups
of banks are considering use cases for trade finance, cross-border payments, and
Other banking processes.
Consumer
and industrial
products
Companies in the consumer and industrial industries are exploring the use of
blockchain to digitize and track the origins and history of transactions in various
Commodities.
Life sciences
and healthcare
Healthcare organizations are exploring the use of blockchain to secure the integrity
of electronic medical records, medical billing, claims, and other records.
Public sector Governments are exploring blockchain to support asset registries such as land and
Corporate shares.
Energy and
resources
Ethereum is being used to establish smart-grid technology that would allow for
surplus energy to be used as tradable digital assets among consumers.
Since all businesses track information and face the challenge of reconciling data with coun-
Parties, blockchain technology, have thee this initial relevant to everyone. The first major
adoptions, however, may transform business processes and old legacy systems that are
Cumbersome to maintain.
Financial Statement Auditing
The public looks to CPA auditors to enhance trust in the audited information of the compa-
nies they audit and help a multi-trillion dollar capital markets system function with greater
confidence. CPA auditors practice under strict regulations, professional codes of conduct and
auditing standards, and are independent of the entities they audit. They apply objectivity and
professional skepticism to provide reasonable assurance about whether an entity’s financial
statements are free of material misstatement and, depending on the engagement, about
whether a company’s internal controls over financial reporting are operating effectively.
Some publications have hinted that blockchain technology might eliminate the need for a
financial statement audit by a CPA auditor altogether. If all transactions are captured in an
immutable blockchain, then what is left for a CPA auditor to audit?
While verifying the occurrence of a transaction is a building block in a financial statement
audit, it is just one of the important aspects. An audit involves an assessment that recorded
transactions are supported by evidence that is relevant, reliable, objective, accurate, and
verifiable. The acceptance of a transaction into a reliable blockchain may constitute sufficient
appropriate audit evidence for certain financial statement assertions such as the occurrence
of the transaction (e.g., that an asset recorded on the blockchain has transferred from a
seller to a buyer). For example, in a bitcoin transaction for a product, the transfer of bitcoin
is recorded on the blockchain. However, the auditor may or may not be able to determine
the product that was delivered by solely evaluating information on the Bitcoin blockchain.
Therefore, recording a transaction in a blockchain may or may not provide sufficient appro-
priate audit evidence related to the nature of the transaction. In other words, a transaction
recorded in a blockchain may still be:
• unauthorized, fraudulent or illegal
• executed between related parties
• linked to a side agreement that is “off-chain”
• incorrectly classified in the financial statements.
Furthermore, many transactions recorded in the financial statements reflect estimated values
that differ from historical cost. Auditors will still need to consider and perform audit procedures
on management’s estimates, even if the underlying transactions are recorded in a blockchain.
Widespread blockchain adoption may enable central locations to obtain audit data, and
CPA auditors may develop procedures to obtain audit evidence directly from blockchains.
However, even for such transactions, the CPA auditor needs to consider the risk that the
information is inaccurate due to error or fraud. This will present new challenges because a
blockchain likely would not be controlled by the entity being audited. The CPA auditor will
need to extract the data from the blockchain and also consider whether it is reliable. This
process may include considering general information technology controls (GITCs) related to
the blockchain environment. It also may require the CPA auditor to understand and assess
the reliability of the consensus protocol for the specific blockchain. This assessment may
need to include consideration of whether the protocol could be manipulated. As more and
more organizations explore the use of private or public blockchains, CPA auditors need to
be aware of the potential impact this may have on their audits as a new source of informa-
tion for the financial statements. They will also need to evaluate management’s accounting
policies for digital assets and liabilities, which are currently not directly addressed in inter-
national financial reporting standards or in U.S. generally accepted accounting principles.
They will need to consider how to tailor audit procedures to take advantage of blockchain
benefits as well as address incremental risks.
How Audit and Assurance Might Evolve with Blockchain
Despite these complexities, blockchain technology offers an opportunity to streamline
financial reporting and audit processes. Today, account reconciliations, trial balances, journal
entries, sub-ledger extracts, and supporting spreadsheet files are provided to a CPA auditor
in a variety of electronic and manual formats. Each audit begins with different information
and schedules that require a CPA auditor to invest significant time when planning an audit.
In a blockchain world, the CPA auditor could have near real-time data access via read-only
nodes on blockchains. This may allow an auditor to obtain information required for the audit
in a consistent, recurring format.
As more and more entities and processes migrate to blockchain solutions, accessing infor-
mation in the blockchain will likely become more efficient. For example, if a significant class
of transactions for an industry is recorded in a blockchain, it might be possible for a CPA
auditor to develop software to continuously audit organizations using the blockchain. This
could eliminate many of the manual data extraction and audit preparation activities that
are labour intensive and time consuming for an entity’s management and staff. Speeding
up audit preparation activities could help reduce the lag between the transaction and veri-
fication dates — one of the major criticisms of financial reporting. Reducing lag time could
offer the opportunity to increase the efficiency and effectiveness of financial reporting and
auditing by enabling management and auditors to focus on riskier and more complex trans-
actions while conducting routine auditing in near real time.
With blockchain-enabled digitization, auditors could deploy more automation, analytics and
machine-learning capabilities such as automatically alerting relevant parties about unusual
transactions on a near real-time basis. Supporting documentation, such as contracts, agree-
ments, purchase orders, and invoices could be encrypted and securely stored or linked to a
blockchain. By giving CPA auditors access to unalterable audit evidence, the pace of financial
reporting and auditing could be improved.
While the audit process may become more continuous, auditors will still have to apply
professional judgment when analyzing accounting estimates and other judgments made by
management in the preparation of financial statements. In addition, for areas that become
automated, they will also need to evaluate and test internal controls over the data integrity
of all sources of relevant financial information.
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JJasica 13 hours ago
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