By Genevieve Hancock, CPA
The concept of blockchain, the hyped network of interlinking underlying data that has no need for third-party assurance or even approval of transactions, has recently seemed to dwindle within the accounting world. For years, the accounting profession has been hearing and attempting to understand the impact that blockchain will make on the day-to-day lives of accounting professionals, but recently the discussions seem to have diminished.
Is blockchain the next step, or is it not likely to take off with a large population of companies? While the latest lull in how much accountants have been bombarded with blockchain may seem like it is dying out, this is not the case. Blockchain is likely here to stay, even with a potential slowdown in widespread implementation due to the current health and economic environments, as well as regulatory statutes on the topic being debated and published. Next up: A crash course in the basics of blockchain.
What is blockchain?
To lay a base for more in-depth discussion, you first need to understand how cryptocurrency and blockchain are inter-related. Blockchain technology is, at its core, a decentralized ledger or database for transactional processing among multiple entities. This means that a transaction that includes a supply received and a bill/cash transfer would no longer need a second party on the other end to approve the payment as all of the information from one entity to another would already be there and communicating between entities.
How it works: When a transaction is identified, a request (usually initiated by a person) is sent out on a “peer-to-peer” network — or likely, entity-to-entity network. Once the request is received, the other entity’s algorithms confirms the request by validating the information as correct. The transfer of information (or cryptocurrency, see below) occurs — this can be anything from records or contract requests to payments to other information. Once this is complete, the set of information and transactions is used to create a unique, permanent and unalterable new block of data that is added to the existing blockchain ledger — which can be visualized as a literal chain of blocks linked together. At this point, the transaction is complete. This can also be known as a distributed ledger technology.
Cryptocurrency and the blockchain
Cryptocurrency is a currency of exchange, such as the U.S. dollar, which is created and stored electronically within blockchain technology. It has no intrinsic value like the U.S. dollar, as it can only be transferred electronically where accepted. While cryptocurrency is inherently correlated to blockchain technology, we’re going to stay away from talking too much about cryptocurrency as it relates to blockchain, so the only things to remember are 1) cryptocurrency is created by using encryption techniques (mined) by the blockchain functionality and 2) it is used to validate the transfer of funds in blockchain technology.
Tax impact with the recent IRS ruling
Revenue Ruling 2019-24 was a decision by the IRS in reference to one type of cryptocurrency transaction, “hard fork,” which can be followed by an “air drop” of cryptocurrency, but not always. The ruling was in relation to inclusion in gross income for each of these types of transactional cryptocurrency. The examples given in the ruling are very principles-based, when it comes to whether or not the units of currency are able to be used or creates an increase in wealth for the taxpayer. A hard fork, for instance, without an airdrop, is generally a creation of a new cryptocurrency by the occurrence of an existing cryptocurrency in the distributed ledger technology resulting in a permanent change from the existing ledger. As this is essentially only a transaction, and there is no wealth which the taxpayer can access and increase their own position, so there would be no gross income inclusion.
Adversely, given the same fact pattern as laid out above, the second example diverts in that an airdrop of cryptocurrency follows the hard fork occurrence, resulting in the taxpayer being able to access cryptocurrency and increase their own wealth as they can direct the use of and dispose of the units of cryptocurrency after they are air dropped. This would result in an inclusion in gross (ordinary) income, at the fair market value of the new units as of the date they are air dropped.
Impact on financial statements
Due to the real-time nature of accounting, financial information will move toward becoming timelier as the distributed ledger technology becomes more continuous. Operational information and up-to-date cash flow data will be available nearly at the drop of a … pardon the malaphor … block. This creates avenues to be able to analyze data in real time versus historical periodic reviews as are still being completed now. This is aligned with the recent implementation of accounting standards such as the Financial Accounting Standards Board’s Current Expected Credit Losses (CECL) standards, Revenue from Contracts with Customers and Leases, which are more forward-looking for comparability and consistency within the financial statements.
One of the theorized reasons for the delay in change happens to be not only the complexity and change management associated with implementation of blockchain, but also the implications to the workforce needed in accounting post-implementation. Once the system is working efficiently, it becomes a change in needed labor from managing and recording support for transactions, which would now be housed in the system, to a need for analysis around making the entity and business more profitable based on the data that is being recorded, and further implementation or updates.
The need for a workforce that posts entries for approval and billing departments, as well as reconciliations from the general ledger (non-distributed) to any outstanding balances, would be nearly eliminated under distributed ledger technology. Blockchain may fundamentally change our workforce needs at the foundation. This is not to say that this would be a reduction to the workforce, but rather a need for training around new skillsets to mold the workforce into what it needs to become.
In distributed ledger technology, there is a level of transparency that entities would not be able to achieve otherwise because the data, or blocks, are immutable, irreversible and extremely costly to hide based on the economic rules built into a ledger that is distributed and across multiple entities. If you have ever been on an assurance engagement assigned to a company, you know that this is going to be viewed as both positive and negative, potentially on the same day for the same topic, and possibly by the same person. This makes documentation of anything that could be controversial for assurance or investment purposes all the more valuable to either include within the block or outside of the block within a timely manner.
The impact on auditing?
While many would love to believe that blockchain technology will decrease the assurance needed across organizations for auditing — both in a substantive testing and internal controls environment — we honestly won’t know for sure until auditing a blockchain environment is more common. What is likely to occur is a high level of assurance needed over the migration to a blockchain environment, then slowly identifying the need for higher assurance around the IT environment and transactional flow in more complex ways.
Regulatory implications are also still unknown and have yet to be written. Further, there will likely be more of an emphasis on data analytics within the audit and assurance world to ensure correlations make sense for the business being audited, which requires a more focused skillset by assurance teams. As the American Institute of CPAs (AICPA) has noted in previous publications, distributed ledger technology does not eliminate illegal, fraudulent, related party, side agreement or incorrectly classified transactions within the ledger itself, and this will need to be heavily validated for accuracy as more entities adopt and move forward — both by auditors and the entity.
In conclusion, blockchain will be both an astronomical increase in efficiency and functionality for businesses but may fundamentally change our workforce needs for the accounting and finance professions. As more regulatory reporting requirements are issued, we will start to understand the strategy and impact of blockchain a bit better. We’ll likely start seeing the technology adoption life cycle exit the early adopter phase and enter the early majority time frame, when most entities start assessing the impact and adoption of distributed ledger technology. The complexities of auditing blockchain are still yet to be perfected, especially as more regulatory guidance is issued.
Here are the main takeaways: Don’t be afraid of the technology. Prepare for the changes coming. Understand whether, and potentially when, blockchain may be right for your company.
Technology is making many advancements in the accounting field, so embrace inevitable changes by ensuring that you understand the impact. More advancements are afoot in the next few decades, including the already popular concept of applications of machine learning. Just as the adoption of the internet in the late 20th century, and the rapid change of computer processing and personal computers fundamentally altered the way accountants operate, assurance engagements document, and business partners and networks communicate, changes in technology are inescapable.
Blockchain is not going anywhere, and becoming an expert in a new and challenging area of accounting will create a higher level of credibility and trust with your business partners as they also try to wrap their heads around this new technology.
Genevieve Hancock, CPA, is the director of technical accounting for Brown & Brown Insurance in Daytona Beach, Fla. Genevieve is passionate about developing leadership skills and mentoring accounting students and young professionals and is a member of the VSCPA Disclosures Editorial Task Force and the Young Professionals Advisory Council. Find her on LinkedIn.