The blockchain technology brings in yet another revelation, this time in accounting principles. Enter the Triple Entry Accounting system. Compared to the traditional double entry accounting, triple entry brings in another dimension in the accounting process. In this article we will first clarify what is double entry accounting and how blockchain technology introduces the triple entry accounting.

To gain a better understanding of this article, I recommend you to go through the previous articles on:

Asymmetric Cryptography, Public Key, Private Key and the RSA Algorithm

Digital signatures? Signing and verification – Relevant Indian Laws

Bitcoins, cryptocurrency and the blockchain – what is so different than fiat money?

How blockchain is changing the legal industry: Smart Contracts

 

Double Entry systems

Modern accounting originated about 500 years ago in 1494 through Luca Paciolo. Paciolo was a close aide of Leonardo Da Vinci and a Franciscan by religious order. Paciolo developed an accounting equation which in its simplicity means:

Assets = Liabilities + Equity
– Luca Paciolo

In other words for every transaction there has to be a credit and debit. Two accounting books need to be maintained for every transaction. At the end of a financial year the accounting procedure would make sure the debit balances the credit. Any mismatch in the two ledgers would tell the managers that they should not trust their own books.

Double Entry Bookkeeping or double entry accounting (‘DEA’) meant this system of maintaining two books for every transaction. It marked the Renaissance in accounting procedure compared to earlier, when only one ledger maintained accounts under the single entry system. Accountants needed to go through the entire accounting period counting every transaction to ascertain accuracy. DEA did away with this trouble, if the debit and credit balances matched it meant proper accounting.

 

The issue of ‘trust’

However, even with the introduction of DEA the quagmire of human accountability did not seem to resolve. Although the DEA kept company managers confident about their own books, outside stakeholders, such as investors, lenders and the state could not still trust the company’s books. Why would they? It was very easy to make bogus entries and still keep the debit and credit balanced.

PwC Satyam scam (7800 crore in 2009), five independent auditors, all affiliates of PwC, were guilty of collusion.1

DEA saw the appointment of a so called ‘independent auditor’. The company appoints and pays the auditor as a legal requirement, and he makes sure that the accounting is proper for the benefit of the stakeholders. The auditor donned the role of an independent guarantor of financial information.

If a company has prepared inaccurate financial statements and has a good story to support them, it becomes very difficult for auditors to detect the misstatements (even if the auditors were not collusive).

A big issue in law of agency arise out of this: Do auditors work for the company who appoints and pays them or for the outside stakeholders who rely on their integrity in order to make decisions?

Even if auditors do their work with full integrity, the amount of accounting ranges from obscene to astronomical. The accounting bill in itself causes a displacement of lakhs of rupees in even a medium sized enterprise.

All of these elements together places a lot of ‘trust’ in the company and the auditor. Consequently, it often proves to be detrimental to the general public.

 

Enter the Triple Entry Accounting system

The global popularity and massive circulation of bitcoins and the blockchain enabled technologies is solely because of this new method of accounting. New vistas have opened in trade both domestic and international. The element of trust is surgically being discarded.

In comparison to the traditional two columns maintained in the DEA, the triple entry accounting (‘TEA’) requires managing a third column. In the coming paragraphs I will explain the job of this third column.

 

The blockchain network

It is important at this juncture to understand how the bitcoin and blockchain works. I would recommend you to go through my earlier post on What are bitcoins / cryptocurrency / blockchain – what is so different than fiat money?

In jargon-free simple terms bitcoins are numbers stored on a public database. One can send bitcoins to another by digitally signing the transaction. Digital signatures ascertain authenticity of the sender’s identity. Furthermore, every transaction is stored as an immutable block in a linear chronological fashion called the blockchain. Finally, reading the blockchain would ascertain who owns how much bitcoins.

 

The third column

Remember how the DEA is a representation of two accounts? Now take these two accounts and give them a wallet address. Every movement of value debits one wallet and credits another. The account sending the value digitally signs the transaction, and this digital signature is stored in the third column. Consequently, the third column forms the blockchain and the integrity of every transaction is ascertained by reading the blockchain.

 

More Security

If you know about digital signatures and how they work,2 you would understand the role of a Digital Signature Certificate Authority (‘DSCA’).

The job of the authority is to maintain a public database of all public keys or encryption keys of digital signatures along with their legally identified owner. To effect this, the state legally enables only the DSCA to issue digital signature certificates.

All transactions which happen on the TEA requires a public key and a private key to digitally sign the transaction, the DSCA may now verify the identity of the signatory every time.

All of it creates an undeniable, immutable and future proof record of transactions. No matter how voluminous the transactions of a company have been, reading the very last record on a blockchain based TEA system would draw a clear picture every time.

 

Legal validity of Triple Entry Accounting

In India the Companies (Indian Accounting Standards) Rules, 2015 specify accounting standards. The Ministry of Corporate Affairs issued G.S.R. 111(E) making the Indian Accounting Standards (Ind AS) a mandate to be followed by various classes of companies. The Ind AS in turn heavily relies on Double Entry Accounting.

While, no country has made Triple Entry Accounting a mandate. Reports of Credit Suisse in 2016 on Blockchain3 and Delloite 4 explain and show how blockchain can be used in financial auditing through the TEA. They also place reliance on the current ongoing practices at the Big4 to show their future applicability.

Seems like it is only a matter of time nations across the world appreciate the Big4 practices and accord legal recognition to it.

  1. SEC Charges India-Based Affiliates of PWC for Role in Satyam Accounting Fraud
  2. What are digital signatures? Signing and verification – Relevant Indian Laws
  3. Credit Suisse – Blockchain – 2016
  4. Blockchain Technology: A game-changer in accounting?

Posted by Donnie Ashok

Donnie Ashok is a freelance technology advisor, cyber security advisor and a final year law student studying B.A.LL.B at Gujarat National Law University. IndiaTechLaw is an initiative by Donnie Ashok.

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