Overview

In the current economy, global accounting practices/accounting standards and related technology solutions are built on top of a fundamental accounting principle known as double-entry bookkeeping. In the double-entry accounting system, at least two accounting entries are required to record each financial transaction.

In recent times, the limitations of these principles have led to rise in frauds and increasing dependency on the auditors to establish the accuracy of the entries. Time is apt for re-assessing the way the entries for all transactions are recorded and processed with a focus on building trust within the process and systems rather than putting undue pressure on regulators, auditors and assessment services.

In my opinion, one of the solutions is to use triple entry accounting. This is an enhancement to the traditional double entry system in which all accounting entries involving outside parties are cryptographic sealed by a third entry. However, there has to be a conscious move to technology and systems which enable triple entry accounting. The benefits overweigh the transformation challenges. By making use of the immutable data on a real time basis which can be assessed and incorporated into the decision making process, following use cases can be achieved:

  • Government bodies can use this technology innovation to facilitate diplomatic decisions in the global trade process and ease out the process of import and export documentation and delays associated with trade. 
  • E-invoicing and instant reporting of invoice by mandate can be considered as the first step towards triple entry bookkeeping where government tax departments act as the guardians of immutable ledger. In my opinion, this will usher in trust and reduce the chance of frauds not only with the participating parties in the trade but with the entire economy itself. 
  • Tax administration would be positively impacted where existing self-assessment will transform to tax determination. A combination of hardware and software enabled with the latest triple entry bookkeeping principles will help compute tax consequences and deliver tax receipt to the taxpayers like a postpaid mobile phone bill. This will contain all taxable transactions so that taxpayers can pay their tax obligations without the need of filing a tax return.

Double Entry Accounting/Bookkeeping

Double entry practices originated in Italy in 1211 AD where a bank in Florence used the system for managing their internal accounts. It became popular after 1490’s when a Venetian mathematician Franciscan friar Luca Pacioli published a book, Summa de Arithmetica, Geometria, Proportioni et proportionalita (Sum of Arithmetic, Geometry, Proportion and Proportionality).

Double entry originated at a time when humans were using paper based systems to record and transact data. Every transaction to an account requires a corresponding and opposite entry to a different account. The double-entry has two equal and corresponding sides known as debit and credit.

Double entry was effective for cross checking transactions and establishing trust and transparency between participating parties. But the associated stakeholders such as investors, auditors, tax authorities and financial institutions, are at the mercy of information disclosed by the participating parties. This is a fundamental limitation. As there is a chance that the disclosed information is not accurate or consistent. Most of the process inefficiency and manual work required by finance professionals like reconciliations, omissions and manual errors are due to the fundamental limitation of this accounting process.

Usually the self assessment tax compliance process is built up on double entry accounting principles. Fraudulent entities have been known to use the limitations as a loophole by falsifying the transaction volume, indulging organized financial crimes and disclosing fake transactions which cannot be currently prevented due to lack of relevant capacity or capability. Though there has been a conscious attempt to build both capacity and capability, it might take longer time than expected without moving to triple entry accounting.

Auditing is the only way to find out the defaults after the transaction has happened which again have been known to be prone to manual errors and frauds. Organised financial crimes in association with auditors have risen even though there has been higher vigilance and reviews from regulatory authorities. Wirecard fraud is one of the recent examples.

Triple entry accounting

 This system essentially creates a link between the two double entries where transactions are recorded at three levels by both participating parties as well as a common ledger (usually cryptographically secured) or public book. Usually a central government agency can be the guardian of this immutable ledger or public book, especially for public data such as trade transactions and resultant tax.

The Bitcoin network (with underlying blockchain technology) can be considered as the first successful implementation of triple entry accounting in the financial industry. It is a growing record of transactions which provides trust and transparency to every party in the network so that the network can automate the auditing process on a real time basis and nobody in the network will be able to lie/falsify data regarding the transactions.

Blockchain technology enables triple entry bookkeeping. A common entry is made using an immutable ledger which cannot be corrupted by any party including the administrator of the network. External stakeholders can have trust and transparency with transactions and they are no longer at the mercy of the participating parties for information disclosure. This subtle change in accounting practice will have a butterfly effect on the entire economy.

Fraudsters exploiting the loopholes of double entry accounting will no longer be able to manipulate transactions already registered over the ledger and this will ensure integrity that they should have inherently possessed without supervision. The current post transaction auditing will transform to real-time transactions auditing thereby reducing the risk associated with auditor frauds.

Impact and challenges

The transformation to triple entry book-keeping will have its share of challenges.

 

Area impactedImpactChallenges
Policy ImplicationsPolicy needs to be revised – especially to push the adoption of triple entry book-keeping. This includes accounting standards and governance policies. 

This might include incentivising the move to triple entry book-keeping by encouraging firms to look for technology solutions.

Capacity building for storing and processing data would have to increase which means investment from governments and private sectors over short and medium term.

Policy would have to push for standards creation and foreign investment in these areas.

Stakeholders might push back as the policy change would give rise to tighter controls and greater visibility on firms & individuals

Greater education needed among policy makers

Blockchain technology has been linked to cryptocurrencies in the past and has neutral to negative opinion among governments. However, governments would have to separate the technology itself from its use cases while forming policies.

TechnologyResearch and development needed to build solutions and services to cater to triple entry book-keeping.

Standards need to be developed for various stakeholders to be able to adapt to the changes.

Transformation needs to be phased out and gradual instead of a one-time change.

Current technology might not be able to support the transformation. There might have to be a combination of Artificial Intelligence, IOT, Blockchain and others to drive this transformation across different use cases.

No single solution might be able to meet the needs. There have to be multiple components built to solve the problem. These components would have to probably talk through APIs or similar such technologies.

Stakeholders
  • IT/ITES/Fintech/Regtech/Startups
  • Chartered Accountants / CPA
  • Government Bodies such as Finance Ministry, Regulators, Tax Authorities
  • Auditors
  • Investors – VCs/PE/Angel Investors etc. 
  • Banks/FIs/NBFCs
  • Legal bodies and professionals bodies like ICAI (Institute of Chartered Accountants of India)
  • Policy makers and institutions driving policy change
Stakeholders need to be aligned to a common goal of building trust within the system and not to exploit the system for their own selfish benefits.
EconomicInitial capacity creation by technology upgrades would lead to higher spend from various stakeholders. However, benefits in the long term would outweigh this initial spend. Might be a lower priority for the government given the current situation in 2020. Current investment needs are to improve economic growth affected due to pandemic.
InvestmentInvestment is needed for R&D, driving policy change, educating stakeholders, building and maintaining relevant products/solutions, connecting multiple legacy systems together and othersGiven that the use cases are governance related, it is very tough for individuals or VCs to fund such R & D and technology transformation as ROI might be achieved in long term. Commercialization of the technology might be tough.

By Soorya Nath MM , Co-founder CEO @spathion (www.spathion.com)

Author is the lead of Global Smart Economy working group hosted by GBA.
Spathion is a blockchain platform for facilitating inter company trade transactions utilizing triple entry accounting network. We also provides an easy infrastructure for professionals to learn and implement a triple entry accounting system in their everyday work.

Feel free to connect through e-mail: soorya@spathion.com

References

  1. Ian Grigg, ‘Triple Entry Accounting’ – https://iang.org/papers/triple_entry.html
  2. https://systemsinnovation.io/triple-entry-accounting-articles/
  3. https://www.finextra.com/blogposting/18183/accounting-auditing-and-blockchain-the-common-thread-that-binds-the-3-is-triple-entry-accounting
  4. https://www.researchgate.net/figure/A-Payment-Transaction-between-Alice-and-Bob-in-a-Triple-Entry-Accounting-System-with_fig1_336645713
  5. http://xbrlsite.azurewebsites.net/2017/IntelligentDigitalFinancialReporting/UnderstandingTripleEntryAccounting.pdf
  6. https://www2.deloitte.com/content/dam/Deloitte/de/Documents/Innovation/Blockchain_A%20game-changer%20in%20accounting.pdf
  7. https://blog.goodaudience.com/blockchaintech-can-triple-entry-accounting-save-the-world-896092da4694

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