Blockchain, its impact on the audit profession
Blockchain has been referred to as the next internet or rather the internet of value. It is defined as a distributed ledger that provides a unique function to perform peer-to-peer transactions without any intermediary. Conventionally, organisations documented transactions manually in their ledgers. These ledgers would be kept separately to protect integrity and accuracy and each company would have its own ledger.
At its core, blockchain is a ledger but with a difference. It has what we call “the built-in trust”. Parties must agree to definite rules, rules to which transactions will be authenticated and vetted within the blockchain ledger. If a transaction is to occur, it is vetted and validated according to the agreed protocols and then accepted and posted in the system. Once posted, the transaction cannot be reversed.
Blockchain has these unique characteristics:
Distributed ledger — it has a public ledger that contains history of all transactions that have ever occurred. In addition to being efficient, the blockchain has other unique characteristics that make it a breakthrough innovation. It is considered reliable because full copies of the blockchain ledger are upheld 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. (Block Chain Technology, CPA, 2017)
Near real time settlement — it allows settling of transactions in real time and this prevents the risk of the other party fudging the transactions.
Peer to peer — individuals can transact directly without involving any third parties. This helps in improving the time in which transactions are cleared and has an impact of reducing transaction costs that are charged by the third parties.
Irreversibility — it contains the recording of every transaction and these transactions are immutable i.e. one cannot edit, delete or reverse. No single party has the right to modify the contents of the transactions. This makes it a more effective way of record keeping, reducing the risk of fraud or manipulation of data.
Smart contracts — Blockchains contain smart contracts, an agreement made amongst participants in advance and stored in the blockchain which executes contracts based on specified instructions agreed by the parties. For instance, a smart lease contract would enable the automatic payment of rentals. It could be modified further to automatically transfer the assets in the event of a default. Since the contracts are immutable this gives confidence to the various actors in the network that everyone is playing by the rules.
Why focus on audit?
The introduction of blockchain has caused a lot of world-shattering impacts on almost every industry, to the extent that some have suggested that the technology will completely replace the audit profession. To suggest that blockchain will replace the need of an auditor is a statement that is flawed and a reflection that the proponents of this theory do not appreciate the role and the purpose of the auditor.
This is because the transaction recorded in the blockchain may still be unauthorised, fraudulent or illegal, it may be executed between related parties or incorrectly classified in the financial statements. Hence, the auditor will still be needed to provide assurance on these. The technology will unquestionably have some impacts on the way the auditor delivers and conducts his duties. It will come with challenges, but however, where there are challenges, opportunities are not far behind. The technology will have an impact on the audit profession mainly because of the following:
• Business model — The blockchain technology will metamorphosise the traditional business model that we are used to. This then means that the auditor needs to have a new and revised understanding of the business models. New business models come with both new audit and business risk.
• Internal controls — the new business model will come with new controls which will be principally automated over the financial reporting process of the organisation. This will demand a new set of procedures and skills to appropriately test the new controls
• The technology will present new ways of transacting, recording, keeping, and reporting the financial information. The current audit procedures may not be adequate to address the risks that come with the blockchain technology.
Impact of blockchain
Subsequently, most of the ways businesses operate will be automated. The auditor would need new skills. The BCT comes with new business models and this presents new audit risk. The auditor would need to have a new understanding of the business model. Failure to do that would make the auditor’s role redundant. You can only provide appropriate assurance to a business model that you comprehend. Moreover, since most controls would now be automated, the auditor would need to have a comprehensive appreciation of the general information technology controls (GITCs). This then suggests that the audit firms need to invest in data analytics as BCT will remove the audit paper trail that we are used to.
The cumulative impact of blockchain on industries and on internal controls over financial reporting also means that audit methodologies will need to evolve, since the technology will introduce new risks related to the reliability of the blockchain, automated controls, and related-party transactions. The current audit of financial statements needs to comply with International Standards of Audit (ISAs). It will be very problematic to change the audit procedures and approach without first changing the nature of International Auditing Standard, the current ISAs need to change to address this, as the procedures are mainly manual substantive procedures, they need to be revised in order to address the new risks.
Some would then suggest that the auditors do not need new skills because they can always place reliance on the work of IT auditors, however, in this case it would be different because the greater part of the transactions would be automated. This then suggests that the skill set possessed by the IT auditors would require major changes for the auditors to fully place reliance on the work performed by the IT audit specialists who will be engaged with the audit team.
Composition of audit team
One of the key attributes of BCT is that the transactions that are processed through BCT are irreversible and immutable, a function that you can place reliance on. This then suggests that the vouching of invoices is one of the functions that would become redundant, as the transactions can all be tested using GIC S. Such improvement will affect the composition of the audit team as the junior staff that mainly perform the vouching of invoices would become redundant. The skills that would be in demand would be more of analytical skills and professional scepticism, the skills that are mainly possessed by the senior staff. This then proposes that the training offices will require more analysts and more auditors with IT expertise. Embracing new technology will require mainly less manpower, and this would affect junior staff.
Continuous monitoring system
The blockchain would give the auditor the opportunity to have real time access to the client’s system. This may allow an auditor to obtain information required for the auditing in a consistent and timely manner. For instance, if a transaction occurs in blockchain, it would be possible for an auditor to develop a system that continuously audits the transactions as they happen. This could eliminate manual extraction of data and audit preparation activities that are time consuming.
Hurtling up audit preparation activities could have the benefits of lessening the delay amid the transaction and verification dates — one of the major disparagements of financial reporting. Reducing lag time could offer the chance to increase the effectiveness and usefulness of financial reporting and auditing by empowering management and auditors to focus on riskier and more complex transactions while conducting routine auditing in near real time (Blockchain technology, CPA 2017).
However, this could present an independent challenge, as the auditor could end up placing reliance on client systems, thus reducing the independence of the auditor, which could even affect the way both stakeholders and shareholders will accept assurance offered by auditors.
Absolute assurance
An auditor customarily provides reasonable assurance when it comes to auditing of financial statements. This is mainly because trying to provide absolute assurance would be near to impossible as it involves voluminous transactions. This would be costly and would entail a high amount of time. Since most transactions will be automated, rather than manually examining a sample of transactions, auditors can take advantage of AI methodologies to scrutinise whole populations of transactions in a much quicker time. As a substitute for spending their time on manual labour, auditors will be able to put their professional skills to better use on high-value tasks by focusing their efforts on the elucidation of the results.
However, it is undesirable for auditors to offer more assurance other than reasonable assurance as this increases the risk on the auditors. It is also important to consider other issues that may affect the auditors’ ability to provide a higher assurance. Such issues will include increased risks over data integrity which increases with the increased use of automated transactions.
Conclusion
Blockchain has not yet been ingrained in the minds of the organisational leaders and its triumph will only be realised if the leaders move from blockchain tourism and get to put the technology into use.
The blockchain technology is no longer an experiment, it is now a true agent of change. This completely applies to the auditors, they need to be ready and well-versed in order to embrace the opportunities that comes with blockchain technology, it’s no longer a matter of asking if blockchain will disrupt the audit profession, it’s now a matter of when and will the auditor be ready when that profusely manifest.
Chimhofu is an audit senior assistant at Deloitte and Touché, Harare. — nigelchimhofu@gmail. com or www.nigelalbert.co.zw