The history of accounting has only known two major inventions. All further accounting research is trivial in comparison. Until now. I will explain.

The first invention in and practically the inception of accounting as a field is the invention of counting. A hand goes up to 5, both count 10. This sounds simple and it is, yet this is where accounting birthed. 1 cow could be traded for 8 hens in ancient Mesopotamia 7000 BC or for 16 bronze Folles in the 6th century Byzantine Empire. Transactions could be accounted for, books could be kept.

The second revolutionary invention that changed accounting for good is the concept of double-entry bookkeeping. I believe this is one of few awesome contributions European Medieval times gave us. In the 15th century the concept originated that for every inflow there is a corresponding outflow and/or creation of value, and vice versa. Every debit must have a credit.

This changed accounting to the point where cash accounting could be supplemented by accrual accounting, meaning costs could be decoupled from expenses and receipts from revenue. For example, expected future cash inflows belonging to a present sale can now be booked as revenue. In short, revenues and expenses can be ‘matched’ to the period they belong to.

What the matching principle caused is that books can be kept to a greater accuracy. Why is this important? Because we can now properly assess the financial position of a business or individual. A supplier, money lender, government or tax authority can check the creditworthiness and of a business which greatly reduces transaction costs through the reduction in uncertainties (by mitigating financial information asymmetry). Accounting contributed enormously to an economic prosperity the world had never seen.

Yet in some way double-entry bookkeeping was not the end-station. Yuji Ijiri, a renowned Japanese Accounting researcher, knew this and dedicated much of his academic life to finding the next step in the way we keep our books. His theory of “triple-entry bookkeeping” has nothing to do with the revolution this article is about, yet the name of his theory will be in the books forever. Until his death in early 2017 he will not have foreseen how much of an impact triple-entry bookkeeping will have on the accounting profession. A paradigm shift is at hand…

The third invention

Now, to understand the third invention you have to understand the two biggest shortcomings of modern day accounting. The first is the moral hazard problem related to the preparation of financial statements. A company may choose to present statements the way they want and, despite the IAS and IFRS rules which I hold in high regard, accounting is the perfect tool for white collar crime. Management has enough discretion to influence the truth they want to signal.

The second inherent problem of modern day reporting can be found in the time it takes to prepare (and audit) financial statements. Listed firms are required to present statements every quarter. Quarter OF A YEAR that is. This means that NO timely figures available to public decision makers. Never. In this modern ever faster paced world economy where reality can go fast, accounting cannot keep up. This means that millions of decisions worldwide are based on untimely and backward data. The current way of reporting falls short.

"Millions of decisions worldwide are based on untimely and backward data. The current way of reporting falls short."

Both abovementioned shortcomings, the manageability and untimeliness of figures can (at least to a great extent) be solved by the implementation of a third invention in accounting. Imagine, an economy where decisions can be made on the basis of real-time and confirmed accounting figures. Please realize that the invention I write about is going to save billions of [insert currency here] per year. And the best thing is, the technology making this possible has already been invented!

Blockchain technology will definitely change accounting

This is where cryptography comes in. On Christmas day 2005 Ian Grigg published a paper that was ahead of his time entirely. The concept he proposed (and, like Ijiri, called “triple-entry bookkeeping”) was by then far from feasible, yet… It was theoretically sound! Next to a debit and credit entry, Grigg proposes a third entry: A cryptographic signature. This signature contains all information on the transaction that is needed to verify its existence and authenticity. It proves that both parties on the transaction signed it, and it is checked against parameters set for valid transactions. This third entry is what verifies a transaction.

Now, a third entry makes no sense unless (part of) it is made publically visible. Blockchain technology enables this. For those who do not know what blockchain is I will explain it shortly. The best way to do so is by calling it a public ledger. This ledger registers the ownership of X. Where X could be a digital currency, or a digital representation of any asset - tangible or intangible - for that matter. All transactions registered to this ledger must be confirmed by peers in the network. Once enough peers confirm transactions (bundled in blocks) a block is added to the chain. And once a block is added to the chain the state of ownership changes.

Without going too much into details about the technology we can still see the potential of Griggs third entry. Provided that ledgers can be kept and verified in a public and decentralized blockchain as I just explained, this third entry might be just what we need to overcome both the untimeliness and unreliability of modern day accounting figures.

Real-time financial reporting

What Blockchain or Distributed Ledger Technology (DLT) does is it registers the ownership of assets and makes both the state of ownership and the changes in this state visible for anyone to see through Simplified Payment Verification (SPV). Since all financials in the end come down to states and changes in states, all financial information of a firm could theoretically be registered on a multiple of blockchains. The end user can ultimately use software to “read” out of the blockchains all information that would normally be reported in a financial report. By that time, regulation should require companies to make all necessary accounts available to comply with relevant accounting standards. This should be possible without compromising a firm’s competitive position by giving away strategic investments (auditors or audit software might have a role here).

“Since accounting in the end comes down to states and changes in states, all financial information of a firm could theoretically be registered on a multiple of blockchains."

The here advocated transition to real-time reporting might be more smooth than one would think. Information technology has improved massively over the past years. Lots of accounts are already kept in a real-time manner within entities (companies, government bodies, etc.) using ERP or other entity-wide information systems. Many internal decision makers already rely on this information in their everyday jobs. External decision makers however are still left to use backward data of quarterly reports.

What about auditing?

To what extent can we be certain that the information the blockchain provides is complete, correct and reliable? Due to the immutability property of DLT it verifies transactions and thus proves the existence of assets and transactions therein, yet it won’t be able to take over all audit functions. The audit profession will not die, but at least it will not be such a seasonal job anymore. The auditor should be able to perform an audit at any time, without the company expecting it. In fact, DLT could give rise to constant real-time auditing. The strength of this is that it mitigates ex-ante managing of earnings because of known reporting dates.

As a matter of fact, the incentives for earnings management might even decrease radically since external parties are watching over your shoulder at any time. Asset states , transactions and market prices could be monitored real-time, which might to a great extent mitigate misrepresentation in asset ownership, related party transactions and fair value estimates. Acknowledging this, the reliability of real-time figures will be higher than in quarterly or yearly reports.

Time to revolutionize Accounting

Not long from now a blockchain-based solution will be possible to deliver real-time updated figures for external use, without compromising the competitive position of the firm (by giving away strategic investments) or the reliability of the figures (if unaudited).

It is time to reinvent accounting to the point that not only internal but also external parties are supplied by adequate information streams. Once the big firms realize this and the first-movers experience a positive market reaction, it will not take long for the rest of the market to follow. By that time many of the current information asymmetries between the entity and the users of its external reports are gone and the financial economy will be more streamlined than ever.

tldr: Distributed Ledger Technology (DLT) will definitely change accounting. Next to a debit and a credit entry, a third entry in the blockchain can provide confirmation of existence and correctness of a transaction. This enables reliable real-time reporting.

Suggested further reading:

Ian grigg, 2015. Triple-entry accounting. url: http://iang.org/papers/triple_entry.html

Satoshi Nakamoto, 2008. Bitcoin: A Peer-to-Peer Electronic Cash System. url: https://bitcoin.org/bitcoin.pdf

About the author:

Wim Maas MSc. is a lecturer at the Department of Accounting at Tilburg University. His research interest fields are financial accounting, auditing and Distributed Ledger Technology.