Academic journal article International Journal of Digital Accounting Research

Auditing with Smart Contracts

Academic journal article International Journal of Digital Accounting Research

Auditing with Smart Contracts

Article excerpt

1.INTRODUCTION

Digital transformations and the preponderance of large volumes of data have forced businesses to adapt to an electronic world and modify their business practices (IAASB, 2016; PCAOB, 2016). Disruptive technologies such as deep learning, along with Big Data (Vasarhelyi et al., 2015) are increasingly changing the type of information that is collected, how that information is analyzed, and disseminated. For example, deep learning models that incorporate textual data from social media posts can assist in the prediction of reputational risk (Forbes, 2016). More recently, smart contracts enabled by blockchain technology have demonstrated the potential to transform supply chain and financial industry business practices.

With its cryptographic and consensus mechanisms that secure the integrity of transactions, blockchain demonstrates great potential as a tamper-proof audit trail. Fused with smart contracts (Szabo, 1994; Szabo, 1997), which are computer programs that perform a task on behalf of a human user, blockchain can significantly alter existing business practices. Essentially, blockchain enabled smart contracts can generate agile supply chains and financial organizations by automatically monitoring and executing the terms of bills of lading and financial derivatives (Mainelli and Smith, 2015; Vaziri, 2016; Yermack, 2017). Given these recent digital transformations, it is important for the auditing profession to consider the impact of blockchain-based smart contracts. Hence, a natural research question that emerges is the extent to which the auditing profession will be disrupted by these technologies. In particular, this research study attempts to examine if blockchain enabled smart contracts have the potential to help auditors deliver improved audits.

Business organizations have been proactive regarding exponential changes in technology. However, the same premise does not apply to the external auditing profession. Pressured by rapidly changing business practices, the external auditing community, standard-setters, regulators, and academics have created initiatives aimed at examining the impact of sophisticated audit analytics in financial statement audits; these initiatives include the Data Analytics Working Group (IAASB, 2017) and the Rutgers and AICPA data analytics initiative (AICPA, 2017). Though the external audit paradigm has witnessed significant transformations in the last three decades (Mathews, 2006; PCAOB, 2017), with the recent requirement to report Critical Audit Matters (CAMs) as its last major transformation, it is clear that the external audit profession substantially lags in technological innovation. Increases in volume, velocity, and variety of data and rapidly evolving technologies raise the question of the relevance and applicability of the traditional audit model (Appelbaum et al., 2017; Badertscher et al., 2017).

This research study makes several important contributions. First, it contributes to the emerging literature on audit data analytics (ADA) by proposing a new generation of audit analytic tools, smart audit procedures, which are enabled by blockchain technology. Second, this study presents a discussion regarding the effect of smart audit procedures on audit quality and the public interest thus helping initiate the debate on the role of emerging technologies in the audit process. Finally, this study contributes to the literature by providing direction for future research with respect to the evolution of the external auditing paradigm.

The next sections of this paper are organized as follows. Section 2 suggests the evolution of the auditing paradigm with blockchain and smart contracts. Section 3 describes the origins of smart contracts and their relevance to auditing. Section 4 illustrates the execution of a smart contract and introduces smart audit procedures. Section 5 proposes smart audit procedures as the next generation of ADA. Section 6 highlights some challenges related to the application of blockchain and smart contracts to auditing and suggests avenues for future research. …

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