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Blockchain in Audit

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Farjad Noor
Farjad Noor

Blockchain technology offers opportunities to streamline the audit process. With blockchain, auditors could have near real-time access to consistent financial data through read-only nodes. This would eliminate manual data extraction and allow auditors to focus on riskier transactions. Documentation like contracts could be securely stored on blockchain. While automation may increase, auditors still need to apply judgment and test internal controls over blockchain data integrity. However, challenges include assessing controls over irreversible transactions, responding to attacks without a central authority, and accessing data if private keys are lost.

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BLOCKCHAIN IN AUDIT PRESENTED BY: FARJAD NOOR
Agenda What is Blockchain Technology? Blockchain platform Qualities How Audit evolve with Blockchain Implementation options of blockchain What challenges does blockchain bring to the audit process?
What Is Blockchain Technology? A blockchain is a digital ledger created to capture transactions conducted among various parties in a network. It is a peer-to-peer, Internet-based distributed ledger which includes all transactions since its creation. All participants (i.e., individuals or businesses) using the shared database are “nodes” connected to the blockchain, each maintaining an identical copy of the ledger. Every entry into a blockchain is a transaction that represents an exchange of value between participants (i.e., a digital asset that represents rights, obligations or ownership).
Cont.. When one participant wants to send value to another, all the other nodes in the network communicate with each other using a pre-determined mechanism to check that the new transaction is valid. This mechanism is referred to as a consensus protocol. Once a transaction has been accepted by the network, all copies of the ledger are updated with the new information.
Cont.. Multiple transactions are usually combined into a “block” that is added to the ledger. Each block contains information that refers back to previous blocks and thus all blocks in the chain link together in the distributed identical copies. Participating nodes can add new, time-stamped transactions, but participants cannot delete or alter the entries once they have been validated and accepted by the network. If a node modified a previous block, it would not sync with the rest of the network and would be excluded from the blockchain. A properly functioning blockchain is thus immutable despite lacking a central administrator
Blockchain Platform Qualities Blockchain technology is a step towards modernisation of digital infrastructure and allows the reorganization of data and assets. Blockchain solutions across industries are helping solve complex problems with use of its platform and technology qualities. Decentralised: Blockchain can operate independently of any intermediary or authority i.e. it can be managed by participating nodes in a network on peer to peer basis and not necessarily operated by one central authority or entity. Distributed: The ledgers of blockchain are distributed and replicated amongst the participating nodes of blockchain, hence all the participating nodes maintain their own identical copy of the ledger. Validated: Transactions executed in blockchain are validated by the participating nodes against the defined validation rules before it is linked to older blocks, making a chain of blocks that show every transaction made in the history of that blockchain. Traceable: Every ledger entry of blockchain is linked to the previous transaction so that it is retraceable across its full history, hence providing an audit trail of the underlying transactions. Immutable: The transactions performed in blockchain are immutable as transactions which are validated cannot be replaced, reversed or altered, and, are permanently recorded across the network nodes. Verifiable: Transactions performed in blockchain are broadcasted to the participating nodes of blockchain where the nodes can verify the ongoing transactions and history of the transactions.
How Audit Evolve with Blockchain Auditing is the process of conducting an independent examination of an organization’s accounts, books and/or documents in order to determine whether the organization’s financial statements present a fair view of the business. Blockchain technology offers an opportunity to streamline financial reporting and audit processes. Today, account reconciliations, trial balances, journal entries, sub-ledger extracts, and supporting spreadsheet files are provided to a auditor in a variety of electronic and manual formats. Each audit begins with different information and schedules that require an auditor to invest significant time when planning an audit. In a blockchain world, the auditor could have near real-time data access via read-only nodes on blockchains. This may allow an auditor to obtain information required for the audit in a consistent, recurring format.
Cont.. As more and more entities and processes migrate to blockchain solutions, accessing information in the blockchain will likely become more efficient. For example, if a significant class of transactions for an industry is recorded in a blockchain, it might be possible for a auditor to develop software to continuously audit organizations using the blockchain. This could eliminate many of the manual data extraction and audit preparation activities that are labour intensive and time consuming for an entity’s management and staff. Speeding up audit preparation activities could help reduce the lag between the transaction and verification dates — one of the major criticisms of financial reporting. Reducing lag time could offer the opportunity to increase the efficiency and effectiveness of financial reporting and auditing by enabling management and auditors to focus on riskier and more complex transactions while conducting routine auditing in near real time. With blockchain-enabled digitization, auditors could deploy more automation, analytics and machine-learning capabilities such as automatically alerting relevant parties about unusual transactions on a near real-time basis. Supporting documentation, such as contracts, agreements, purchase orders, and invoices could be encrypted and securely stored or linked to a blockchain. By giving auditors access to unalterable audit evidence, the pace of financial reporting and auditing could be improved. While the audit process may become more continuous, auditors will still have to apply professional judgment when analyzing accounting estimates and other judgments made by management in the preparation of financial statements. In addition, for areas that become automated, they will also need to evaluate and test internal controls over the data integrity of all sources of relevant financial information.
Implementation options of blockchain
What challenges does blockchain bring to the audit process? To provide the necessary level of assurance, the Audit processes need to shift further towards the assessment of operating effectiveness of the internal IT controls. To give some concrete examples: • If an entity’s employee accidentally or deliberately sends bitcoin to a wrong or unauthorised address (recipient), there is currently no way to reverse that transaction. • If an entity experiences a phishing attack, there is no fraud department to which to report such an incident since in blockchain there is no central administration. This situation can also translate into a risk of fraud. • If a private key is lost (e.g. through a software or hardware malfunction) the entity loses access to data or information that is associated with this private key. The data will no longer accessible to anyone on the network; they are effectively out of circulation, forever. Although blockchain technology offers inherently secure properties, it is humans that will be coding the necessary software to integrate and interface with blockchain.
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Blockchain in Audit

  • 2. Agenda What is Blockchain Technology? Blockchain platform Qualities How Audit evolve with Blockchain Implementation options of blockchain What challenges does blockchain bring to the audit process?
  • 3. What Is Blockchain Technology? A blockchain is a digital ledger created to capture transactions conducted among various parties in a network. It is a peer-to-peer, Internet-based distributed ledger which includes all transactions since its creation. All participants (i.e., individuals or businesses) using the shared database are “nodes” connected to the blockchain, each maintaining an identical copy of the ledger. Every entry into a blockchain is a transaction that represents an exchange of value between participants (i.e., a digital asset that represents rights, obligations or ownership).
  • 4. Cont.. When one participant wants to send value to another, all the other nodes in the network communicate with each other using a pre-determined mechanism to check that the new transaction is valid. This mechanism is referred to as a consensus protocol. Once a transaction has been accepted by the network, all copies of the ledger are updated with the new information.
  • 5. Cont.. Multiple transactions are usually combined into a “block” that is added to the ledger. Each block contains information that refers back to previous blocks and thus all blocks in the chain link together in the distributed identical copies. Participating nodes can add new, time-stamped transactions, but participants cannot delete or alter the entries once they have been validated and accepted by the network. If a node modified a previous block, it would not sync with the rest of the network and would be excluded from the blockchain. A properly functioning blockchain is thus immutable despite lacking a central administrator
  • 6. Blockchain Platform Qualities Blockchain technology is a step towards modernisation of digital infrastructure and allows the reorganization of data and assets. Blockchain solutions across industries are helping solve complex problems with use of its platform and technology qualities. Decentralised: Blockchain can operate independently of any intermediary or authority i.e. it can be managed by participating nodes in a network on peer to peer basis and not necessarily operated by one central authority or entity. Distributed: The ledgers of blockchain are distributed and replicated amongst the participating nodes of blockchain, hence all the participating nodes maintain their own identical copy of the ledger. Validated: Transactions executed in blockchain are validated by the participating nodes against the defined validation rules before it is linked to older blocks, making a chain of blocks that show every transaction made in the history of that blockchain. Traceable: Every ledger entry of blockchain is linked to the previous transaction so that it is retraceable across its full history, hence providing an audit trail of the underlying transactions. Immutable: The transactions performed in blockchain are immutable as transactions which are validated cannot be replaced, reversed or altered, and, are permanently recorded across the network nodes. Verifiable: Transactions performed in blockchain are broadcasted to the participating nodes of blockchain where the nodes can verify the ongoing transactions and history of the transactions.
  • 7. How Audit Evolve with Blockchain Auditing is the process of conducting an independent examination of an organization’s accounts, books and/or documents in order to determine whether the organization’s financial statements present a fair view of the business. Blockchain technology offers an opportunity to streamline financial reporting and audit processes. Today, account reconciliations, trial balances, journal entries, sub-ledger extracts, and supporting spreadsheet files are provided to a auditor in a variety of electronic and manual formats. Each audit begins with different information and schedules that require an auditor to invest significant time when planning an audit. In a blockchain world, the auditor could have near real-time data access via read-only nodes on blockchains. This may allow an auditor to obtain information required for the audit in a consistent, recurring format.
  • 8. Cont.. As more and more entities and processes migrate to blockchain solutions, accessing information in the blockchain will likely become more efficient. For example, if a significant class of transactions for an industry is recorded in a blockchain, it might be possible for a auditor to develop software to continuously audit organizations using the blockchain. This could eliminate many of the manual data extraction and audit preparation activities that are labour intensive and time consuming for an entity’s management and staff. Speeding up audit preparation activities could help reduce the lag between the transaction and verification dates — one of the major criticisms of financial reporting. Reducing lag time could offer the opportunity to increase the efficiency and effectiveness of financial reporting and auditing by enabling management and auditors to focus on riskier and more complex transactions while conducting routine auditing in near real time. With blockchain-enabled digitization, auditors could deploy more automation, analytics and machine-learning capabilities such as automatically alerting relevant parties about unusual transactions on a near real-time basis. Supporting documentation, such as contracts, agreements, purchase orders, and invoices could be encrypted and securely stored or linked to a blockchain. By giving auditors access to unalterable audit evidence, the pace of financial reporting and auditing could be improved. While the audit process may become more continuous, auditors will still have to apply professional judgment when analyzing accounting estimates and other judgments made by management in the preparation of financial statements. In addition, for areas that become automated, they will also need to evaluate and test internal controls over the data integrity of all sources of relevant financial information.
  • 10. What challenges does blockchain bring to the audit process? To provide the necessary level of assurance, the Audit processes need to shift further towards the assessment of operating effectiveness of the internal IT controls. To give some concrete examples: • If an entity’s employee accidentally or deliberately sends bitcoin to a wrong or unauthorised address (recipient), there is currently no way to reverse that transaction. • If an entity experiences a phishing attack, there is no fraud department to which to report such an incident since in blockchain there is no central administration. This situation can also translate into a risk of fraud. • If a private key is lost (e.g. through a software or hardware malfunction) the entity loses access to data or information that is associated with this private key. The data will no longer accessible to anyone on the network; they are effectively out of circulation, forever. Although blockchain technology offers inherently secure properties, it is humans that will be coding the necessary software to integrate and interface with blockchain.