Dec 09, 2019

Distributed Ledger Technologies Increasing Efficiencies of Audit Process

Mark Eckerle of Withum Smith + Brown is “bullish” on distributed ledger technologies. Why? As he says in our latest episode, these advances have the potential to greatly improve processes for auditing professionals.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor



Podcast Transcript

Blockchain has been around for a while at this point, but like any emerging technology, it is still, to a degree, shrouded in mystery. Today our guest, Mark Eckerle, manager with Withum Smith + Brown PC, will look to answer several of our questions about blockchain, including whether it is synonymous with distributed ledger technologies, how it increases the efficiency of the auditing process, and the difference between private and public blockchains.

Can you give us an explanation of what blockchains and distributed ledger technologies are?

[Eckerle] Blockchains are essentially a form of distributed ledger. Saying that a distributed ledger is essentially a database across several locations where multiple people or participants and users can all log in or participate, and it's spread out on various networks with no real central authority. The big thing that makes blockchains unique is that it utilizes a chain of blocks which are made up of a batch of transactions essentially in each block, and they're securely brought to the network for general consensus. When you have a block, it's brought and it builds on top of one another in order to create that chain of blocks that is approved by the entire network as a whole, and then it builds from there.

Basically a blockchain is a form of distributed ledger technology, but the two terms aren't synonymous. Can you give us one or two examples of other types of distributed ledger technologies, and how are they different from blockchain?

[Eckerle] From what I have come across, there are about three main types of distributed ledger technologies. There may be more, but that's just what I have seen so far. Basically it's made up of blockchain is the obvious one, then there is a directed acyclic graph, and then Hashgraph. And what a directed acyclic graph, or a DAG, I mean, because obviously that's very wordy. A DAG, the most common example is IOTA. IOTA is a cryptocurrency and they have this network which they call Tangle and it's basically, there's no blocks, there's no chains. The main purpose of that is each transaction, in order to get validated, has to verify two or three other transactions. It's just basically a group of transactions confirming one another and they're not really building on top of one another. It's just kind of like a web. Hence the word “tangle.”

And then Hashgraph. Hashgraph, I haven't seen any real use cases yet, but it is a patented technology, so it is almost like a permissioned or private blockchain. But the one big thing that Hashgraph kind of brings to market is it states and, again, there's no use cases to this, but it states that it can handle up to over 250,000 transactions a second, which is one of the issues currently that blockchain is facing, is their scaling problem. They cannot handle that amount of transactions. So that's one thing that Hashgraph kind of differentiates itself from the market and from blockchain.

Apart from the obvious descriptor, what are the differences between public and private blockchains?

[Eckerle] On a very high level, a public blockchain is one that is essentially a ledger or database open to the public to view at any point in time on the internet. It's constantly being updated. It's immutable with no central authority. The most common example of that is the Bitcoin blockchain, right? I can go onto the website and see transactions constantly being verified and uploaded to the blockchain in real time. A private blockchain is a database where it's essentially permissioned view only or edit-only access with a central authority or a creator.

So the way I look at it is there is basically someone, if you think of QuickBooks for an example – I know QuickBooks isn't a blockchain per se – but there is a central authority, there's someone with administrative rights, and they'll allow other users into that software. If you wanted to think of a private blockchain, one of the common examples to market right now is Corda, created by a company, R3. Basically they allow you to build a blockchain internally for business-to-business transactions that no ... like I can't, as an independent third party, go in and view those transactions like I can on blockchain. It's restricted to only those that have access.

How does the fact that a blockchain is public or private affect a CPA's auditing procedures?

[Eckerle] This is where I become a little bullish on blockchain because I think it's going to greatly impact my profession. When a blockchain is public, I can go in and view transactions in real time whenever I want, right? When it's private, I have to wait for a third party to give me access. For instance, right now if I wanted to go, if I had a client working and transacting in Bitcoin or Ethereum, I can go on and see that transaction happen whenever I want, right now, tonight, tomorrow. Whereas on private it's a little bit more difficult to find that and get that access.

The one real hiccup that kind of public versus private blockchains face is that the Bitcoin blockchain obviously is public and it's been approved and people have tested the code, I should say. Whereas a private blockchain, if I built an internal software for my own blockchain, you'd almost have to get like a SOC 1 or SOC 2 report in order to prove that the technology behind that is effectively working. Same thing with any other software that you may have, a payroll processor. It's in order for, as an independent auditor, for myself to get comfortable with that software, either we would have to test all the ins and outs or you'd have to have an independent SOC 1 or SOC 2 verifying that that software is working effectively.

What would you say the benefits are for CPAs auditing via a distributed ledger? And how would you say these technologies are going to significantly increase the efficiency of the auditing process?

[Eckerle] Right now if you're looking at the auditing process, like if you were testing an account substantively, you make selections, you request support, physical or electronic. When you're looking at bank statements, invoices, vouchers, you're looking at checks, whatever it may be, and the biggest hurdle with that now is it takes time for clients to pull that support. It could take days, weeks, depending on how much availability they have and it's a real difficulty that we're facing now because before we want to obviously make sure everyone's working as efficiently as possible. You don't want to be sitting out at a client or prepared during fieldwork where you have that hiccup and that kind of stop gap.

Where I think blockchain comes into this is that it's essentially like a public QuickBooks, whereas you can attach invoices, you can attach supports, bank statements, and you see the transactions happen in real time. If I wanted to go and do interim testing today through August for eight months, I could go in and just start testing those accounts, obviously assuming that the books are closed. But I could go in and test those accounts and see the support in real time instead of requesting from the client, waiting for them to pull it, where I think it could just really increase efficiencies for both us and the client so that they're not sitting there pulling invoices from a filing cabinet or whatever it may be.

What would you say the current growth level of auditing via distributed ledger is? Is it a practice that's becoming heavily accepted? Is it a slower adoption process? What do you think?

[Eckerle] There's two stances I have there. A lot of my clients working in crypto, they love the ease, the ease of use of blockchain technology, and that we can do it remotely. We can test transactions wherever we are. We don't always have to be on site. But for clients in this instance where they're adopting blockchain technology in their business as a whole, it's really been slowly adopted, I should say. I think as more people are beginning to understand the market and it's becoming more commonplace, I think it'll become more widespread, more widely adopted. But right now, as far as growth and everything, it's still in the early stages and people are still researching, understanding, and still seeing a full picture of what this technology can actually do for their business.

It's constantly changing, right? The Bitcoin blockchain has been around for 10 years. And there has been over a thousand other different currencies modeled off of Bitcoin and Ethereum and everyone's got their own little projects going on. And there's all these other types of blockchains. So I think it constantly is always changing. We're always finding new ways to enhance and better what we have. I just think it's, as people begin to understand this technology and see it more in their day-to-day lives, it'll become more involved and part of our auditing process.

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Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of PICPA officers or members. The information contained in herein does not constitute accounting, legal, or professional advice. For professional advice, please engage or consult a qualified professional.