Evolution in audit with Blockchain Technology

Background: What is blockchain technology?

Blockchain technology is basically the creation of a distributed ledger to capture transactions conducted amongst various parties in a network. It is an internet based, node-to-node connected distributed ledger which includes all transactions since its creation.

In simple terms, a blockchain can be considered to be a distributed ledger which contains complete and relevant details for every transaction that has ever been processed. The validity and authenticity of each transaction is has been processed by each node in the network.

In blockchain, there is no central administration and anyone can process transactions using the computing power of specialised hardware (nodes/miners).

Understanding the functioning

When a transaction is initiated from one node, all the other nodes in the network communicate with each other using a pre-determined block-chain mechanism to validate and authenticate the transaction. Once such transaction is accepted by the network, all copies of the ledger is updated and saved for future reference. This is known as consensus algorithm.

The network nodes can add new transaction after being time-stamped and validated by the network, but cannot delete any transaction that has once been validated and accepted by the network.

Implementation Options of Blockchain

• Private Blockchain:

It is quasi-decentralised and Consensus algorithm is controlled by preselected nodes.

The allowed participants (nodes) are pre-defined and only read option is accessible to them.

• Permissioned Blockchain:

Centralised requiring trusted entities and such nodes are pre-defined through consensus algorithm.  Write permissions are centralised to one entity and read access to all participants.

• Public Blockchain:

It is decentralised and transparent.  Anyone can read, perform transactions and participate in the consensus process.  Access permission is not required.  Anyone can become a member of the network without conditions of admission.

Opportunities blockchain technology bring to the Audit procedures:

The auditing procedures would evolve drastically with introduction of blockchain technology into audit environment.

The way we look at audit as the detection tool would be changed to a corrective tool which would in turn increase its effectiveness.

Some of the areas where blockchain technology would change the picture of traditional audit are as below:

1) Audit trail

Inherently, blockchains are designed in a way that it is resistant to modification of any stored data.

Functionally, a blockchain is an open, distributed ledger that can record transactions between two parties which is accepted by all nodes in the network which means its authenticity is sufficiently verified in the process itself, Also it is permantly stored in the system which is highly useful to the  auditor for providing complete end-to-end audit trail.

2) Accessibility

Blockchain can be used as a source of verification for reported transactions.

Many of the audit procedures is made easy due to real time verification and authentication of transactions

For example:

• The audit procedure of obtaining bank statements from the client can be performed directly by use of block-chain technology where bank statements are available on public domain.
• The audit procedure of checking negative bank balance can be performed on real-time basis by setting up a control on node which throws back the transaction that affects negative balance in bank, through which bank transactions are processed.

3) Increase in coverage of audit procedures

In current audit environment, auditors mainly depend on selected samples due to high volume opf transactions.

With the integration of blockchain into auditing procedures, the whole population of transactions will be covered for audit. This extensive coverage will drastically improve the level of assurance gained in affected audit engagements.

4) Quick and effective

In blockchain, a transaction of low value currently takes approximately 10 minutes to be validated as a single block verification is deemed appropriate.

Typically a high value transaction will take approximately 1 hour to be verified (6 blocks). The traditional financial transactions, where information needs to be collected, might take up to a month or more to be cleared.

5) Real-time audit

For a typical audit, the transactions are verified at the end of the year, when the transactions have already occurred, so auditor is not in the position to correct the incorrect transations.

Whereas, the use of blockchain technology enables the auditor for real-time assessment throughout the period under audit.

This enables the auditors to not only detect the frauds but also correct the same.

This could be a very much-needed revolution is auditing environment

6) Reliabilty

When evaluating a blockchain for its data reliability, the focus is on the potential ability for the blockchain to be manipulated or altered.

Blockchain technology is the most reliable one because it utilizes a concept called a consensus mechanism that dictates how parties reach agreement on the transactions to be added to a blockchain.

As an auditor is evaluating a blockchain’s data reliability, the auditor should evaluate the susceptibility of a blockchain’s consensus algorithm to attacks.

7) Accuracy of the data

Since a blockchain is immutable—it cannot be edited—the processing of data is significantly more accurate than a typical database.

The auditor gets the unfiltered audit trail which can be used for various analysis to draw the required conclusions.

Provided that comfort over data reliability is obtained, the auditor could be in a position where there is reduced risk over the accuracy of information related to digital assets.

Fundamental shift in audit design

Blockchain technology at its core is a new, encrypted digital accounting system.

The transparency that blockchain provides requires a fundamental shift in how we think about auditing.

A blockchain has the ability to record the supporting documentation, the authorizations, the journal entries, and execute the value transfer for both sides of a transaction all on the same platform. Therefore, this could minimize the need for confirmations or reconciliations, as this can be done in real time on a blockchain if all parties are utilizing the same blockchain.

The audit design then shifts from a retrospective or forensic, point-in-time effort to an ongoing real-time monitoring effort. The underlying foundations of audit and internal control become part of the nature of each transaction.

Conclusion:

With the evolution in technology, blockchain has opened innumerable opportunities for CA and CPA which would in turn increase the effectiveness of the audit procedures with decreased period of time and efforts.