The Impact of Blockchain Technology on the Audit Industry

Abstract

This paper explores the impact that blockchain technology has on the auditing industry by analyzing how current audit procedures measure up to the abilities of blockchain. As a result of this technology, this paper further examines the necessary technological advancements and the roles that accountants will play in the future. Top players in the industry such as the Big Four accounting firms and the AICPA were evaluated as to their participation and forecasts in regards to blockchain. Research has shown that blockchain will play a major role in not only the future of accounting but many other industries as well.

The growth in popularity will force firms to adjust audit procedures, develop blockchain auditing systems, and incorporate new roles to maintain relevance with clients.

Introduction

As of August 2018, PwC surveyed 600 executives from 15 different territories, which reported that 84% of their organizations had at least some involvement in blockchain technology (Davies & McNamara, 2018).

Based on Gartner’s business forecast, PwC predicts that by 2030, 10-20% of the global economic infrastructure will be running on blockchain-based systems (Davies & McNamara, 2018). So, what is blockchain and why is it having such an impact on not only auditors, but the entire world? Blockchain, invented in 2008 by a man named Satoshi Nakamoto, is an open, digital ledger that records cryptocurrency transactions between two parties in an efficient, verifiable, and permanent way (Iansiti & Lakhani, 2017).

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The appeal of this technology is the transparency and permanence of the records. As stated in the Harvard Business Review’s article The Truth About Blockchain, “every agreement, every process, every task, and every payment has a digital record and signature that could be identified, validated, stored, and shared” (Iansiti & Lakhani, 2017). This technology’s revolutionary capabilities have reached beyond just cryptocurrency transactions; it is now being developed and utilized in the entertainment, retail, automotive, supply chain/logistics, insurance, healthcare, real estate, and nonprofit industries. An example of this transition is going to be seen in the food and beverage industry, specifically in tracing food-borne illnesses. Blockchain technology will help companies improve the transparency and efficiency of tracking down what food is contaminated and at what point the supply chain was corrupted (Marr, 2018). If the popularity of this technology continues on this trajectory, accounting firms are going to have to adjust their current techniques and processes to efficiently audit companies utilizing blockchain.

The first impact to consider, with an immutable ledger of transactions, is what is the purpose of an audit? Blockchain offers a lot of valuable capabilities that eliminate the need for an accountant to audit the transactional level of assertions. Although that may be true, it does not consider other elements that are involved in the processing of transactions. For example, whether a product has been delivered to the customer. It is an important portion of an audit to verify the occurrence of a transaction, but that is only one aspect. An audit also involves an assessment of the evidence that supports a transaction to validate that it is relevant, reliable, objective, accurate, and verifiable (Piscini, Basir, Datardina, Stratopoulos & Gorgi, 2017). As more and more companies adopt this technology to fit their specifications, auditors will need to adapt their procedures to capture the entirety of the company’s processes. Secondly, not only will there be a need for adaptation of audit procedures, but the development of a corresponding accounting system will be necessary to audit transactions in real-time. Prior auditing methods, such as the point in time method, will be rendered obsolete regarding blockchain. Finally, due to the lack of regulation and inexperience companies have with this type of technology, it is crucial to look deeper at the role auditors will play in the future. For example, companies will be looking to CPAs for help in auditing Smart Contracts and Oracles (Piscini, Basir, Datardina, Stratopoulos & Gorgi, 2017).

In an extensive look into the auditing processes of blockchain, it was found that the old way of auditing transactions is rather outdated. The capabilities of this technology eliminate the need for auditors to perform testing on the occurrence, completeness, cutoff, accuracy, and valuation assertions. Not only that, but with the use of blockchain capabilities, auditors will be able to test an entire population of transactions within a specific period. This new process will reduce the time it takes auditors to perform sample testing and with the ability to audit a whole population, the level of assurance will drastically improve.

The ability of blockchain technology to process a high frequency of transactions and how it records and stores that information, requires the need for auditors to develop systems that can run a continuous audit in real-time. The Big Four firms have taken extensive steps to incorporate blockchain technology into their business strategies, that address not only the auditing of transactions but also predictive mechanisms that can anticipate issues in the future and recognize long-term patterns. These systems will be an integral part of the blockchain audit procedures and will open up opportunities for firms to take on roles beyond just auditing.

With the audit process being automated and traditional testing being nearly eliminated, blockchain technology has turned the auditing industry upside down. As one door closes on the old way of auditing, this technology has opened a new door in which accountants will supply services such as consulting on the development of blockchain services, auditing of Smart Contracts and consortium blockchains, blockchain administrator, and arbitration. These roles will require the standards and skill sets of accounts to evolve to meet the expectations of clients.

By using processes and evidence gathered by Certified Public Accounting firms, I will evaluate the impact blockchain technology has had on the audit process. I will compare the prior process of auditing transactions to the adopted process developed out of this technological revolution. I will then assess the need for firms to develop new auditing software for blockchain technology and look at the benefits that will arise from these developments being made by some of the largest firms in the world. Lastly, I will evaluate the new roles that will emerge for accountants in the future due to the lack of experience and regulation surrounding this technology.

Audit Procedures

Currently, the audit process consists of the seven-different assertion tests to verify the quality of financial information being provided by a client. The first test is on classification, in which auditors are deciding whether transactions were classified correctly in all accounting records. This can be done by reviewing purchase records to see if the assets were classified in the correct account. Secondly, the completeness test examines all transactions to determine whether there are any transactions not recorded in the books. For example, the client’s bank statements can be reviewed to see if there are any payments or cash receipts that were not recorded. Auditors will then make sure that these transactions were recorded on the correct period in which they took place, also known as the cutoff test. To ensure transactions are recorded in the correct period, auditors will analyze the shipping logs or bank statements to see when the transactions took place and then verify that the books match the supporting documentation. The fourth step in the audit process is to determine whether transactions that have been recorded, have actual auditory occurred. This for example could be a client supplying supporting documentation such as obligations about invoices, sales ledgers, or shipping documentation to validate that the transactions that have been recorded in the books happen. This is followed by the test of existence which verifies whether the asset in the transaction actually exists. The existence test can be completed by observing inventory on hand and orders being fulfilled. Upon testing its obligationsexistence, auditors will also examine the rights and obligationsabout of the asset to determine whether the client owns the asset. Auditors will inquire aboutcan the inventory to identify if the client does indeed own the assets instead of them being held on consignment from a third party (Bragg, 2018). Finally, auditors will complete the valuation testing of transactions by inspecting the client’s books to determine whether their assets and liabilities are recorded at the correct value.

According to PwC’s 2017 Digital IQ Survey, 36% of financial services executives said their organizations are planning to make significant investments in blockchain technology over the next three years (Smith, 2018). Blockchain technology, as mentioned, is a distributed digital ledger that provides consensus, provenance, immutability, and finality of all recorded transactions and contracts (“Unlocking the Real Benefits of Blockchain Through Its ‘Sweet Spot,” 2017). As this technology continues to build traction in not only the financial industry, but the supply chain/logistics, retail, real estate, and health care industries, it will be integral for firms to reassess and restructure their audit processes to fit the current technological advances. As stated previously, this technology can provide appropriate audit evidence for specific financial statement assertions such as the occurrence of a transaction (Piscini, Basir, Datardina, Stratopoulos & Gorgi, 2017). For example, if a client buys a product with cryptocurrency, that currency’s blockchain will record the transfer of those funds in exchange for whatever goods or services were rendered. Due to the nature in which blockchain technology validates transactions, auditors can depend on its reliability. Auditors can trust that the transaction has occurred, which reduces the need for them to perform the occurrence test. The completeness will also disappear because all transactions being made in the ledger are verified, and the integrity of financial records is guaranteed (Baron, 2017). Each transaction has a time stamp timestamp and links to all previous related transactions or blocks in the chain, creating what is called a “fingerprint” (Baron, 2017). The ability to have all transactions time-stamped in real-time makes the cutoff test also obsolete, in that all transactions will have been recorded in the correct period due to them being recorded at the time that they were transacted. The abilities of this technology allow it so that any new transaction will only be accepted for posting if all computers in the network achieve a consensus as to their validity, which reduces the likelihood of errors (“Unlocking the Real Benefits of Blockchain Through Its ‘Sweet Spot,” 2017). These capabilities eliminate the need for auditors to test the accuracy and valuation assertions because this technology essentially does that for them. As for the remaining assertions, classification, existence, rights, and obligations, these will still be a major part of the audit process because blockchain does not provide sufficient audit evidence relating to the nature of transactions (Piscini, Basir, Datardina, Stratopoulos & Gorgi, 2017). Auditors will still need to verify, for example, whether a product was delivered, if the company has ownership of the asset, and if the client correctly classified it in the financial statements.

Overall, I think that the impact of blockchain on the audit process will be extensive. The responsibilities of auditorthe will auditorswillauditors be completely transformed to fit the needs of blockchain technology. First, the time spent on testing will be cut in half, if not more, due to about half of the assertions being rendered obsolete. Auditors will no longer need to request confirmations from third parties or supporting documentation such as bank statements because transactions can be verified through the blockchain ledger (Psaila, 2017). Secondly, the level of assurance will be improved drastically due to the functionality of blockchain technology allowing auditors to audit an entire population of transactions (Saifi, n.d.). Ultimately these changes will reduce the time and cost of the audit while increasing the efficiency and quality.