Re-Evaluating the Audit Processes using Blockchain.
It's been a while since I penned down, and this thing which I wanted to share would be the best that I could think of sharing with you all.
Previously, the article on the blockchain, we saw what is blockchain and why is it an emerging technology from a layman’s perspective. So, now we will try and understand, the use case of blockchain on audit processes that will fetch you more clarity on this technology.
In the blockchain world, one party can send to another only the virtual digital currency (cryptocurrency). There are many cryptocurrrencies like bitcoin, ether dent, etc. If you guys are interested, then we will see the detailed explaination on cryptocurrency and how mining is done on the blockchain network. For now, we will go with the most well known cryptocurrency, bitcoin, and we will see how the transaction between two parties are done..
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For example, say, Arvind from India wants to pay 5 bitcoins (BTC) to Bharat in the USA. In order to process the transaction, the nodes on the network are also called the miners who will validate and authenticate the transaction to proceed. In the blockchain network, all the transactions since its genesis are being recorded.
In this case, to validate and authenticate Arvind’s transaction, the miners will go through each and every transaction in the digital distributed ledger and do solve some mathematical equations like adding the ones where Arvind was the recipient and subtract the ones where Arvind was the sender, so that it gives the total amount of money that Arvind holds in his account. Once this transaction is been being validated and verified, the miners will add the verified transaction to the previous verified block.
However, blockchain is not only restricted to money transactions, but can also store databases, contracts that can be embedded in the distributed ledger where they can be protected from deletion and tampering, etc. There are two major classifications of blockchain networks: permissioned blockchain and permissionless blockchain.
The only difference between these two is the determination of which parties are allowed to access the network for validating, and authenticating the records.
Permissionless blockchain: Here, blockchain is public, anyone can participate in the network as a node/miner by accepting that they will validate the transactions on their respective network. To say an example, bitcoin is the permissionless blockchain where people can participate in the network and validate the record.
Permission blockchain: Here, blockchain is private, only limited and restricted participation in the network is allowed. Permission blockchain solved some of the drawbacks of the public blockchain, but also lost some of the potentials of the permissionless blockchain. Permission blockchain sacrificed some of the potential properties like decentralized transactions, distribution of the ledger, etc.
Smart Contracts:
Smart contracts are nothing, but the code on the blockchain network that helps to perform certain actions under specified circumstances. Basically, it automates the task that is been performed manually for years. Smart contracts reduce operational errors and speed up the process efficiently. Ethereum is the platform that introduces the smart contracts which could deploy and execute on the distributed ledger. Smart contracts are the methods that automate the contracting process, and enable the monitoring with minimal human intervention.
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For example, say, Arvind and Bharat sets up a smart contract between thier businesses. Arvind wants to buy x number of products from Bharat. In order to success the transaction, the codes on the network are called the smart contract that will validate and authenticate whether Arvind received all the mentioned number of products from Bharat. The transaction will proceed further, if it is yes, or the transaction will not proceed, if the mentioned number products are not yet received.
What potential impact that blockchain can do on the audit processes?
Audits can be categorized into various forms like security audits, financial auditor compliance, and regulatory audit. In the traditional audit processes, audits like account reconciliations, trial balances, supporting spreadsheet files are provided to the auditor in a variety of electronic and manual formats where it will require significant time to invest while planning for an audit. Instead, in the blockchain network, the auditors can have real-time access to the data by having read-only nodes on the blockchain network. Basically, the blockchain removes the labor-intensive works, audit preparation activities, and avoiding manual data extraction.
The positive impacts of blockchain in the audit processes:
1. Cost-effective process: By speeding up the audit preparation activities, the lag between the transaction and the verification process can be removed. This gives the opportunity to increase the efficiency and effectiveness of the financial reportings.
2. Continuous real-time assessment: The auditor can easily verify the transaction on a publically available blockchain network on a real-time basis. The population of transaction usually take days for substantive testing but in blockchain within period with observation. Instead of assessment at the year-end, audit firms will be in the position to assess real-time of all the transactions.
3. Preventing duplicate transactions: In the blockchain world, the entry of duplicate transaction is very difficult because it has, its timestamp for each and every record that is added to the network. The duplicate record will be rejected by the nodes of the network.
4. Transparency and immutability: When more blocks are added to the chain then, the related transactions are immutable. Blockchain is transparent, because what all changes have been made in the network can be viewed by the people in the network.
Challenges that blockchain brings to the audit processes:
Even though blockchain offers inherently secure properties, it is human that will be coding the necessary software related to technology that helps to integrate and interface with the blockchain. Without an independent assessment, the user blockchain technologies face the risk of errors and vulnerabilities. For this, the auditor may need a new skill set that understands the functionalities of the blockchain with some technical programming language. A few of the major challenges are:
1. There’s no way to reverse the transaction: For instance, the user accidentally sends the money to someone’s account, then there’s no way to reverse the transaction. To solve this, the auditor needs an eye over all the events that are taking place in the network, which is a tad more complex.
2. No reporting authority: In the blockchain world, there is no involvement of any higher officials, so no one can report any mishaps to anyone. It is up to the people in the network, how they solve the issues among themselves. In this scenario, the only purpose of the auditor is to make sure that the process is operating effectively.
3. It’s Impossible to recover the account if the private key is lost: If the private key is lost then the user cannot access their virtual account. To transact any amount, the user needs private and public keys as it’s discussed earlier. The money will remain inaccessible and it becomes quite complicated for the auditors to prevent this occurrence if the user lost their private key.
So, what I am trying to say here is:
The auditor requires an additional skill set to satisfy the expectation of the shareholders and the entity owner. There is a rise in the adoption of blockchain technologies where the auditor needs to provide complex assurance services in a more agile manner. Furthermore, the independent audit trails increase the trust which is vital for the efficient functioning of the global audit firms. Recently, EY releases a new tool that helps to analyze and explore the transactions on the bitcoin. However, it will take some time to replace the entire financial reportings, but the blockchain has already started to nurture the audit firms.
Blockchain is a tad more complex. Even, if it is little that you learned from this article, then the purpose of writing is done.
Thank you!
If you could suggest to me, how I can explain them in a more simple way, I would take that as constructive feedback, so that, in the end it would help everyone.
Do give your constructive feedbacks here.
Thanks again!
