Will External Audits Vanish in the Blockchain World?

R Vittal Raj, Partner, Kumar & Raj Chartered Accountants, India | November 2, 2017 |

No! At least not in the immediate future. But like many of the disruptive transformations taking shape around us with everything going digital, external audits cannot stand insulated.

Among emerging technological disruptions, bitcoin has been presented as a rather contentious alternative to money online. That aside, blockchain, a critical technology that powers cryptocurrencies such as bitcoin, is already finding popular application in many industry verticals, including, significantly, financial services as the accepted “trust protocol.”

If one scratches the surface, blockchain has its foundations in the distributed ledger concept and cryptology that promises transparency, immutability, security, auditability, highly cost-efficient and is “ever available.” More simply, it is like a copy of a digital ledger automatically maintained and synchronized with every party in a transaction chain that captures every transaction across all the parties as well as any modifications. Blockchain brings with it an inherent trust based on the technology and collective consensus, which is achieved by a network of administrative peers called miners.

With trust as an inherent feature, blockchain applications, such as those currently popular in the payments and remittance industry, are eliminating the need for trusted third party institutions such as banks. End consumers benefit from transactions taking place in a fraction of the time and at a fraction of the cost of current methods.

Why should accountants bother?

Blockchain technology is in an advanced stage of adoption in agriculture, international trade, healthcare, digital content, transportation and government, to name a few. In fact, blockchain is seen as a solution in every situation where there is need for a trustworthy record. And that is where blockchain’s next big disruption is: its potential application in inter-organizational records, including accounts management.

When it comes to business contracts and transaction execution, another add-on to blockchain is the technology of smart contracts. Smart contracts are a kind of blockchain application that enable automatic exchange of anything of value at agreed upon terms that are implemented automatically in a trustworthy, transparent and secure manner without the need of any inter-mediating parties. Smart contracts help define and configure the rules and the penalties relating to a contract or agreement and automatically enforce them when due. This would remove the need for maintaining separate books of account, reconciliations, confirmations and the like.

When it comes to external audits, investors look to auditors, as trusted third parties, for their opinion to assure that the financials an audited entity presents are a true and fair view. This the auditor achieves based on performance of audit procedures, as ordained in the relevant auditing framework. In the current framework, auditors are required to assert that:

- the financial statements are free from material misstatement, whether due to fraud or error;

-  are prepared in accordance with the requirements of the applicable financial reporting framework;

- effective internal control over financial reporting was maintained in all material respects;

-  the accounting estimates made by management are reasonable;

-  the information presented in the financial statements is relevant, reliable, comparable, and understandable; and

-  effect of material transactions and events on the information conveyed in the financial statements that achieve fair presentation.

If we play this out in the context of a blockchain-driven world where trust and transparency are built-in, audit trails become inherent to transaction execution and recording across the ecosystem:

- financial statements would inherently be free from material misstatements, errors and potential for fraud.

- smart contracts could ensure compliance with transaction recording and disclosures in compliance with stipulated financial reporting framework.

- the combination of blockchain and artificial intelligence solutions will enable near-accurate accounting estimates.

- by inherent design, blockchain technology has the potential to ensure internal controls relating to financial reporting.

Hence, in a mature blockchain and an artificial intelligence-driven world, investors could—in real-time—have a true and fair view of financials that are inherently trustworthy. This would eliminate the need for external audits in its current form, including all the associated audit procedures surrounding examination of records, assessing compliance with accounting principles, accuracy of accounting estimates, etc.

Does this really mean external audits would be extinct?

Not really. First, as it stands today, blockchain suffers from lack of clarity in its administrative framework, more specifically the network of miners who form the key trust bearers for maintaining distributed trust in the blockchain network. This is one of the few downsides of blockchain as a technology (although it has not stopped intense explorations for various cross industry applications as is). However, with blockchain’s benefits fast outweighing its downsides, the businesses would find a solution to these problems sooner than later.

In addition, the internal controls surrounding origination and creation points for transactions and configuration of smart contracts and mining may always be a cause of internal control concern and need to be audited. Besides, like most other areas, it is unlikely that the auditor’s human judgement could be completely usurped by emerging technologies, at least in the near future.

Transformation of external audit

One can say with some certainty that the external audits in a blockchain-driven world will need to shift focus from transaction based audits to audit of internal control design and change management. The transformation that analytics brings to transaction audit and audit risk assessment procedures may require auditors consider redefining audit objectives and use technology-driven approaches to achieve them.

The blockchain challenge to external audits is tangible and is a clear call for smart transformation in external audits. Blockchain, coupled with other emerging technologies such as artificial intelligence and the Internet of Things, is more likely to usher in changes for auditors in a transformed, smart world sooner than later.

  

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