The accounting of transactions is as old as the businesses. It changed and evolved with the time and changing demands of the business. It started with the single entry system, then turned to double entry system and is now going to switch to a triple entry system.
Initially, business used to follow the single entry system or cash-based accounting system. Its main drawback was that it did not consider the non-cash elements of a transaction.
We all know that self-balancing of debits and credits are the fundamentals of bookkeeping. Each business activity is translated into financial terms and based on the nature of transactions, the financial aspects of the same are recorded in books by debiting and crediting ledger accounts. Each ledger is identified as either income or expense or asset or liability. This is the basics of double-entry system of bookkeeping. Businesses were using this technique of recording business transactions for over 500 years now. It’s a proven system of accounting business transactions. However, it has drawbacks. One of the significant disadvantages is that ledger of a party in books of accounts one business may not tally with the ledger of other party in his books of accounts. It can be due to errors or omissions. It leads to the importance of reconciliations and balance confirmations. Another drawback of the system is that, while auditing auditor has to seek for external documents to form an opinion and to ensure the authenticity of transactions.
What is a triple entry system? It is simple to understand and complex to implement. But it is going to be the future. It is relatively a new concept, still under development stage. It is not an entirely a new system, but an enhancement to the traditional double-entry system in which all accounting entries involving outside parties are confirmed (cryptographically sealed) by a third entry. Under this concept, placed side by side, the bookkeeping entries of both the parties to a given transaction are congruent (harmonious) . A seller books a debit to account for cash received, while a buyer books a credit for cash spent in the same transaction, but in separate sets of accounting records. Then how can we achieve the concept of harmony in books of accounts as parties to a transaction are maintaining independent books of accounts? Or some of the parties do not prepare a book of accounts at all? This is where the role of blockchain comes in. Rather than these entries are recorded in a separately independent set of books, they occur in the form of a transfer between the wallet addresses in the same distributed, public ledger, creating an interlocking system of permanent accounting records. Since the entries are distributed and cryptographically sealed, credibly falsifying them or destroying them to conceal activity is practically impossible.
The concept can be explained through an example. “Customer A” buys a book from “Shop X” by paying cash. In traditional accounting, the salesman debits his cash account and credits his income account. On the other hand, it is an expense/asset for the customer and part with his cash. In this case, there is no authentic audit trial to prove the genuineness of the transaction and the value involved. Invoice raised by the salesman for the book sold is the only evidence available, which is an internal document. All the stakeholders, the business owner, auditor, government, etc. rely on this invoice raised by the salesman. Under triple entry system, the transaction uses a smart contract, cryptographically sealed (through a secure communication) by both the parties, that acts a signed receipt, where the identity of the parties involved is recorded and placed in a public ledger. This smart contract is linked to the individual ledgers of each counterparty.
With this technique, the entries related to this transaction is tallied in the books of both the parties as ledgers of both the parties are linked to the same smart contract in a public ledger, thus eliminating the need of reconciliation. It also leaves enough audit trail and documentation as the entry is confirmed (cryptographically sealed) in the books of both the parties by the other party (external party to the business). Since an external party will confirm each transaction under this technique, the system eliminates frauds and any tampering with the transaction, without consent of the other party, will make the entry invalid.
Some of the business has already started to implement this concept, especially financial institutions. Mobile/Net banking is a classic example of this technique. In earlier days, if we have to transfer funds to our business partner, we had to raise a transfer request in the prescribed form and submit to the bank. Then, the bank clerk makes necessary entries in our accounts and transfer funds to the accounts of the other party. During this simple transaction, many entries are made by different people (filling form, an entry in the account by a bank clerk, entry at the clearing office of the bank, entry at the clearing office of the other party bank and finally in the bank account of the other party). Any error or omission by any of the parties involved in this transaction will lead to ledger imbalance. Under net banking, with one entry and secured confirmation, benefits of balanced ledgers and external evidence is achieved. With the advancement of technologies, more and more transactions will be covered under this technique.
To achieve this, we need to set up “Business Process Assembly Line”, consisting of Data Standards (Json and XBRL as considered to be the data standards), Data storage and distribution infrastructure and Data integrity and standards. Many non-profit organisations are working to achieve these goals, and we will see drastic changes in these areas in the next 3 to 5 years. By introducing the triple entry system, basic concepts of double-entry system or how journal entries are made will not be changed. But it will change the way how it is recorded.
C A Abraham P J