Accounting—the measurement, processing, and communication of financial information—is up for profound changes. It performs a critical function in today’s economy. However, the implementation of accounting methods must catch up with the modern era and the blockchain revolution. First, the current regime relies upon managers to swear that their books are in order. This places often undue challenges on responsible executives. Additionally, dozens of high-profile cases—Enron,
AIG, Lehman Brothers, WorldCom, Tyco, and Toshiba—show that management doesn’t always act with integrity. Greed too often gets the best of people. Cronyism, corruption, and false reporting precipitate bankruptcies, job losses, and market crashes, but also high costs of capital and tighter reins on equity.[i] Second, human error is a leading cause of accounting mistakes, according to AccountingWEB. Third, new rules such as Sarbanes-Oxley have done little to curb accounting fraud. Fourth, traditional accounting methods cannot reconcile new business models. Take microtransactions. Most audit software allows for two decimal places (i.e., one penny), useless for microtransactions of any kind.
Blockchain opens up vast new possibilities that need exploration. Modern financial reporting is based on a simple concept called double entry bookkeeping—for every transaction, both a debit and credit are recorded and in the end they must balance (hence the term, “balance sheet”). Blockchain offers the promise of a new paradigm in accounting: where a third entry recorded to a distributed ledger becomes instantly accessible to those who need to see it—the company’s shareholders, auditors, or regulators. Imagine that when a massive company like Apple sells products, buys raw materials, pays its employees, or accounts for assets and liabilities on its balance sheet, the ledger recorded the transaction and published a time-stamped receipt to a blockchain. The financial reports for a company would become a living ledger—auditable, searchable, and verifiable. Generating any up-to-the-minute financial statement should be as simple as a spreadsheet function, where the click of a button gives you an immutable, complete, and searchable financial statement, free of error.
The idea is tantalizing, but how does it get implemented and what questions should managers be asking? Companies have a right to trade secrets but also a duty to disclose important information. So, to whom should these records be exposed? How does triple entry accounting reconcile with non-cash items that rely on management discretion?