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Technology

Bitcoin Questions May Lead to Blockchain Financial Reporting Answers

Recent statements have thrown into question bitcoin trading and ecosystems but despite the negative press, accounting and financial reporting professionals are pressing ahead with exploring incorporating its underlying blockchain technology within financial statements. FEI is working with Deloitte to undertand the impact of this disruptive technlogy for senior-level financial executives.
 
“Bitcoin could disappear tomorrow and it would not affect the future of blockchain technology,” says Campbell Harvey, Professor of Finance at Duke University’s Fuqua School of Business. “One theoretical application of blockchain is to financial reporting and this exactly the point in time to discuss advantage and disadvantages.”
 
The past week brought powerful criticisms surrounding bitcoin, a “crypto currency” that is traded by investors and used by consumers to purchase goods and services.  
 
On Monday JPMorgan CEO Jamie Dimon called bitcoin a “fraud” and compared the rise of the digital currency to the “Tulip Mania” of 17th Century Holland that is considered one of the first speculative investment bubbles.
 
“It won't end well. Someone is going to get killed," Dimon is reported as telling the audience.
 
Separately, and more relevant to financial preparers, U.S. Securities and Exchange Commission Chief Accountant Wesley Bricker told an audience at an accounting industry conference that the regulator is reviewing the way “Initial Coin Offering” firms are reporting (or not reporting) their activity within financial statements.
 
“The SEC’s registration requirements, including for securities offerings, include various requirements for filing of audited financial statements,” Bricker said. “An organization should consider applicable accounting and reporting guidance, for example in U.S. GAAP, when preparing financial statements.”
 
Harvey argues that the despite the recent criticisms of bitcoin, financial executives should not get distracted from the underlying benefits of the technology that allowed for the digital currency’s rise to prominence.
 
“Blockchain is a very general technology and it effects many different things, and many of FEI’s member firms will be impacted in one way or another, and one particular way will be financial reporting,” Harvey says. “The main mistake people make is that when you start talking about blockchain they morph the discussion into bitcoin.”
 
At its core, blockchain technology allows for the creation of a “distributed ledger” that records transactions between parties with transparency using a secure system that immediately verifies data permanently. While bitcoin is the most common form of transaction this is currently employing blockchain, the technology is agnostic to that data that can be recorded. That means everything from customer orders to fleet costs can be incorporated into a financial system using distributed ledger technology.
 
The primary benefit of blockchain on the financial statement can be summed up in one term, according to Harvey: real time.
 
“We currently use this model that relies on reporting numbers from the past within annual, semiannual and quarterly reporting,” Harvey explains. “What blockchain allows you to do is create a ledger that would be maintained by the internal audit team that is receiving immediate and secure data from the business lines, which then can be potentially validated by external auditors in real time.”
 
In addition, companies would employ a “private distributed ledger” (as opposed to bitcoin’s public ledger) that would allow external parties to only see what is in the typical financial report, but also allow financial executives and leadership to view information in much more detail.
 
Creating a private, real time ledger would also, theoretically, remove the risk of earnings management from financial reporting since all transactions are validated and recorded as they happen, Harvey adds.
 
“When you go to real time you actually eliminate all the negative incentives that are made at the end of quarter to make the numbers look good… because there is no end of quarter,” Harvey says, adding that a recent survey by Duke revealed 78 percent of CFOs admit to “destroying” value within their own firm in order to managing these investor expectations at quarter end.
 
“Many companies don’t hire, don’t advertise, delay valuable projects around the end of the quarter since it could impact investors’ sentiment even though it would be the correct business decision,” Harvey says. “With real time reporting, those incentives disappear. Firms will focus less on managing their earnings and more on managing the expertise to grow value.”
 
Several questions remain to be answer regarding blockchain and financial reporting, not least of which is the impact on accounting policy and regulation. But Harvey remains optimistic.
 
“There are certainly accounting items that are not cash flow based, which can come in lumps, and decisions need to be made based on that,” he says. “But when you have a system that is complexly transparent, that value should be explored.”