Accounting has a vital role in the running of any business. Financial reports produced by bookkeepers and accountants are an essential support to the management in making the most informed business decisions. The profession has naturally evolved since its start thousands of years ago during the Mesopotamian era, but today’s systems are still subject to fraud and lack the components for a real-time audit.
Until the Renaissance period, merchants relied on a one-sided accounting entry that would be very hard to examine for accountability. Nowadays, accounting has moved to a double-entry system, in which the companies maintain records that reflect what they own and owe. In other words, today’s standard accounting formula is Assets = Liabilities + Equity.
For example, let’s take a business that places an order of $1000 to its supplier for goods. The assets are recorded on the first entry of the book as a debit of $1000, and with a credit of $1000 to record the debt on the second entry. By documenting those two opposing entries in its book, the business can ensure that the ledger is in balance.
Yet, the system is not free of security failures. Even if the book displays the debits equalling the credits, it is still possible to do so falsely or misleadingly. Companies record their transactions privately and independently, giving the possibility for malicious actors to manufacture fake transactions. This likelihood of fraud requires accounts to be audited regularly. It is a costly and time-consuming process, which doesn’t remove all the risks, as it is often impossible to audit all records.
With the help of blockchain technology to enhance the double-entry system, triple-entry bookkeeping presents itself as the solution to the current accounting points of failure. The concept was first introduced by Yuji Ijir in the 1980s, revisited in 2005 by Ian Grigg, but only became implementable when a public and immutable ledger, the blockchain, was created.
Using this technique, all parties can agree on one objective economic reality. Here, all accounting entries involving external parties are encrypted and sealed by a third entity. By recording the receipt of the transaction on the blockchain, thus having immutable proof that some transaction took place, the authentication of the two double entries in separate legal entities can be enforced by a smart contract. The different books are then linked together by this third entry, which can be viewed for external audit purposes. The verification can be done on all transaction activity, with real-time access to data, thus reducing the opportunities for fraud.
Moving away from double-entry accounting will remain tricky and take time, as it complicates the current structures. It is important to note that triple-entry accounting is currently not used in significant ways.
Still, this new method holds some great potential, and it is exciting to follow the progress of companies developing this type of solution.