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What You Need to Know about the Blockchain

“The Blockchain” – What is it and how will it impact the accounting world?

You are bound to have seen headlines about blockchain technology and/or bit coin digital currency.  Countless pieces on the new phenomena have been popping up recently in news publications and social media.  Most people I come across are familiar with the term blockchain but they have trouble describing what it is and how it will impact us.  I found myself in the same predicament.  Here is a summary of the blockchain and its potential impact on accounting and finance:

Background

The blockchain is a technology that produces a shared ledger between companies or people that can either be public or private.  The most common application of blockchain today is the bitcoin exchange.  This is an example of a public blockchain system.  The shared ledger is a collection of a long stream of transactions or journal entries depending on what the blockchain system is tracking.  Imagine the blockchain as a spreadsheet, where each row is a transaction, and each column represents the participants or entities in the blockchain.  Each row must equal zero.  We mentioned bitcoin, but other units of value could be tracked as well such as real estate, stock, payables and receivables.

There are six properties that make up the blockchain technology:

1 – Synchronization

All the participants in the system have the same view of the data in real time (a shared ledger)

2 – Indelibility

Meaning once a transaction is initiated by the “unit” holder you can’t undo that transaction.  This allows for an air-tight trail of transactions.

3 – Determinism

Meaning the system will not allow you to transfer a unit to more than one recipient.  Also, new transactions require validation by more than one user (a consensus) before being accepted and shared universally.

4 – Single Use

Each unit can only be used one time; similar to Determinism but slightly different

5 – Security

A unit holder is the only person that can transfer what they hold (or someone with that unit holder’s credentials) and the security of the system is strengthened by its collaborative nature.  “ In theory, it cannot be hacked because that would require overpowering all the computers that contribute to and update the ledger network – a feat akin to hijacking the entire internet,” Lou Carlozo, a freelance writer based in Chicago, said in the June issue of Journal of Accountancy.

6 – Speed

Current Blockchain systems have a resolution time of ten minutes.  If that seems like a long time, think about current automated funds transactions.  ACH’s take 2 or 3 days and wire transfers take a few hours.

To summarize, the blockchain technology is a real-time shared ledger that facilitates transactions in a secure environment that cannot be manipulated.  Once a transaction is recorded on the blockchain it will not go away.  If an erroneous transaction is entered, a reversing entry will need to be made to correct it.

The blockchain technology has held up well in the trading of bitcoin.  The only weakness noted has been related to #5 above, relating to the concept of user credentials.  Since there is no regulation and no authority to a blockchain system, if you lose your credentials, then there is no way to retrieve them.  There have been cases where users have lost up to $1mm in bitcoin value because they lost their blockchain credentials.  There is nowhere to turn if this happens, such as customer service.

How will it be relevant to the accounting world?

 You may wonder why or how this is relevant to accounting.  We hear that it goes hand in hand with bitcoin, but many of us do not foresee our clients or our employers switching to bitcoin in the near future.  We need to remember that the tracking and payment of bitcoins is just one application of blockchain technology.  Blockchains supporting other applications can be set up to reap the benefits of this technology, which include as we mentioned, speed, recordkeeping, and security.

Let’s take the Accounts Receivable and Accounts Payable process for example. If we think about the current systems in place, there are many laborious steps to this process that involve manual data entry and exchanging of paper documents between companies (think receipts of Purchase Orders, Invoices, and the data entry of these items).  Then, the auditors come in and attempt to confirm accounts receivable directly with the customers, which causes additional time, paperwork and back and forth between the two companies and the auditor.  This is an area that is waiting to be automated and blockchain technology could be a great fit.

So, in this example, how could we replace the manual AR/AP process between two companies with a blockchain system?

A private system could be set up where the two companies’ ERP systems would allow a private blockchain between the two entities.   The recording of the Purchase Order, Bill of Lading, and Invoice would be automated and agreed upon by the two entities in real time and would be immediately reconciled.  If integrated with a public bitcoin blockchain, the payment could also be facilitated through this private blockchain.  When audit time comes around, the auditor would be able to rely on the blockchain transactions as corroborating evidence since these transactions are real time and authorized independently by both parties.

Other accounting areas could also be drastically streamlined through the use of this technology.  Manual reconciliations could be eliminated all or in part with blockchains.  Imagine not having to reconcile a set of intercompany accounts.  There are many other areas of accounting and finance where we can envision the blockchain saving time and money and providing more valuable real-time data (Streamlining settlement activities, tracking ownership, facilitating supply chain financing).

When could this become a reality?

 Blockchain’s popularity and use continue to accelerate.  “No one was talking about it before 2008,” L. Gary Boomer, CPA/CITP, CGMA, Strategist with Boomer Consulting, said in an interview with Journal of Accountancy.  “Then in 2013, we started to see the rise of bitcoin, a blockchain consortium in 2015, and proof of concept in 2016.”  Boomer expects that blockchain may begin to replace legacy accounting systems around 2023.

So now is a great time to learn all you can about this exciting new technology which can change how companies operate and how financial audits are performed.

Have questions about this topic? Stephano Slack LLC is here to help. Contact myself of your trusted Stephano Slack advisor for assistance.

 

Contributed by:

Michael P. Jones

 

 

October 27, 2017