Blockchain Technology and Triple Entry
A game changer in accounting
Blockchain, one type of Distributed Ledger Technology (DLT), is being touted as a game changer that will provide verifiable trust amongst decentralised peers for myriads of applications from healthcare to energy grids, to registries and digital rights management. Blockchain and DLTs will also disrupt and provide new ways of undertaking business related tasks, including but not limited to transparent voting mechanisms for boards and automating internal business processes. One such business process that could greatly benefit from such a system is accounting. In this article we will first introduce what Blockchain, DLTs and smart contracts are and then highlight how blockchain technology could revolutionise the accounting practice.
Consider how services have been offered since as long as we can go back. Service providers such as banks act as middlemen enabling clients to make use of their services — but require that their clients have trust in them. This is a perfectly acceptable requirement for many services. After all, if you do not trust the service provider to undertake the respective service, then you would have to perform the service yourself. Say you would like to transfer money to a friend. You would need to first trust the bank with your money and thereafter send the bank instructions to undertake the transfer of funds as required and trust that the bank will perform the transfer. However, you may not want to reveal the details of your transactions to a third party — and rightly so banks do not allow for transactions to take place when sufficient information is not provided, in effort to minimise money laundering, funding terrorism and other fraudulent activities. Decentralisation is useful not only because one might not want to reveal information or trust the central authority in question, however is also useful due to its massively redundant mechanism — each node in the network will have a copy of the data. Consider what would happen if a certificate registry was destroyed (and associated data servers) — no one would be able to prove their education, marriage status, etc. Besides redundancy decentralisation provides more transparency to users which will help build more social trust in the system — so many service providers are moving towards decentralised solutions to build more trust with their clientele. Building a decentralised ledger though is no easy task.
Blockchain achieves this by allowing for each peer in the network to have a full view of the decentralised ledger — in which any peer in the network can add transactions and transfer funds from their account (and not from other accounts). Since any peer in the network can alter the distributed ledger (in respect to the resources they have access to), there needs to be a means of ensuring the validity and integrity of the ledger such that no one can tamper with the data. This is achieved using cryptography and a consensus mechanism (of which often takes the form of a proof-of-work mechanism).
A Blockchain implementation was first proposed for use in Bitcoin. However, blockchain systems have since evolved to provide not only a decentralised ledger, but also a verifiable and decentralised means of executing digital processes by providing a smart contract or dApp (distributed application) on top of a DLT. Smart contracts enable for the automatic execution of code that is guaranteed to do what the original uploaded smart contract was coded to do — this therefore can be used as a means of enforcing and automating obligations of various parties that have entered into an agreement.
How can blockchain be used within the Accounting World?
The hype surrounding Bitcoin resulted in many attempts to replicate its success. Which followed with a surge of Altcoins (alternative coins to Bitcoin and the major cryptocurrencies) introduced to the crypto market last year. Thereafter, focus shifted to applying the technology in banking institutions and also to registry keeping.
A more recently emerging Blockchain application is that of Triple Entry. This concept challenges the fundamental assumptions of the double entry system, which has been relied upon for hundreds of years ever since it was developed by merchants in Venice in the 1400s to enable a more effective and efficient trade system. Before this period, trade was limited to a few merchants and single entry accounting — a list of who owes the trader what without providing additional information to the merchant.
The double entry mechanism effectively manages to capture all the transaction details required to balance the books of any business and provide a complete picture of all the assets, liabilities and income generated at any particular point in time. However, its application is limited to just one business at a time since business bookkeeping is done independently of other businesses with which the company trades.
Analysing the double entries involved in Business to Business (B2B) transactions, one can note a similar pattern throughout the transactions. The separate double entries recorded in the books of two individual businesses are mirror image to each other. The revenue of one company is to be considered as the expense of the other company. Similarly, what is to be considered as a payable for one company is to be considered as a receivable for the other company. For this process to perform, each company requires its own accountant. One accountant would record the transaction in the books of his employer and similarly, the other accountant would record the transaction in the books of his employer. Two accountants recording the two sides of the coin albeit being identical.
B2B transactions recorded on the blockchain using triple entry implies that once a transaction is recorded on the blockchain by one of the two accountants, the other party can extract the particular double entry, review it, and have it recorded automatically in its books in the classical double entry bookkeeping system.
The future of bookkeeping could be potentially revolutionized. Blockchain accounting can potentially halve the double entry transactions recorded. Accountants can now start focusing on more value-added roles within the profession. Rather than looking at the past to record the transactions, accountants can help businesses grow and improve. Gone are the reconciliation days.
Distributed ledger attributes, enhanced with the immutability characteristics often associated with blockchain technology, provides for a common ground amongst businesses as there is no reliance on any centralised data server. Blockchain technology when applied to accounting manages to provide credibility and trust in real time and replicates in essence part of the trust provided when financial statements are audited a couple of months after year end. To top it all, recording the transactions on the blockchain will not require any specialised programming skill. Companies (such as The Accounting Blockchain) are already investigating and providing easy to use software capable of integrating with various accounting applications that enable accountants to record the transactions on a blockchain.