Triple-Entry Accounting And Blockchain: A Common Misconception

If you’ve been keeping up with bitcoin, Ethereum and other cryptocurrencies over the past year, you’ve likely heard a lot about blockchain and its potential to revolutionize many industries. Another concept that has re-emerged as a result is called triple-entry accounting. At a high-level, triple-entry accounting is an alternative method of accounting in which a third component is added after the global standard debit and credit. It’s an interesting concept, given that it would be a significant departure from double-entry accounting, which the world of business has relied on for hundreds of years. It does not, however, have anything to do with blockchain.

In order to explain, it’s best to provide a quick background on double-entry accounting, followed by blockchain and triple-entry accounting.

Double-Entry Accounting

In the late 1400s, merchants in Venice developed a new method for tracking their finances: double-entry accounting. Previously, they reviewed their cash balances at the end of each day and recorded the related transactions that impacted cash flows. The trouble with this approach is that cash flows don’t provide complete information about operations. Double-entry accounting takes into account the other side of the transaction, which drives profits or losses and changes in owner’s equity -- all of which are critical to consider when managing a business' finances.

With double-entry accounting, you’re forced to assess the total impact of a transaction. Debits must equal credits, which requires you to determine the account coding for each side of a transaction. Every time a company purchases goods, issues stock or pays their employees, there are two sides to the transaction. In complex situations, the other side of the entry ensures the business has a firm understanding of the underlying nature of the transaction, as otherwise, they’d be unable record it.

Blockchain

A blockchain is a digital ledger that is distributed among multiple locations to ensure security and ease of access globally. Currently, the primary use of this technology is for bitcoin and other cryptocurrencies but blockchain will entirely disrupt accounting processes as we know them -- it’s only a matter of time.

The ability to utilize a blockchain that records all information related to a particular transaction in real time and between multiple parties is incredibly powerful. The applications for automating business processes, particularly around payments and controls, are seemingly endless. For this reason, a common misconception has come up that the writing of each piece of information to the blockchain is actually a third entry. It’s not.

Triple-Entry Accounting

Triple-entry accounting is a scholarly concept conceived by the late Yuji Ijiri, a professor at Carnegie Mellon University. It presents a framework for a new way to do accounting, replacing the standard accounting formula (Assets = Liabilities + Equity) with a more complex framework.

Essentially, what Yuji has done is taken the familiar concept that the change in Wealth is equal to Income (effectively the same as the standard accounting formula) and added on some new concepts to provide more information about where the organization is headed. The idea is that accounting could be fundamentally tied to forecasting and, therefore, enable better strategic decision making.

Whether or not it’s worth pursuing this alternative accounting method is up for debate, but it certainly isn’t currently being used in any significant way. In my opinion, even if regulators and companies could get over the monumental hurdle of moving away from double-entry accounting, it’s impractical to use a more complex system. It’s hard enough to get the accounting right when there are only two sides of an entry.

Conclusion

While triple-entry accounting isn’t the term for it, there are considerable benefits in writing transactions to a blockchain. Much like journal entries are currently recorded in an organization’s subledgers (e.g., Accounts Receivable) and general ledger, recording transactions on a blockchain would provide visibility into related transactions.

For instance, a blockchain could be created once a contract is signed, then a purchase order could be issued against that contract, bills against that purchase order, payments against those bills, etc., tracking any issues that arise along the way. There would be a unique ID related to the contract/purchase order/bills in that chain to tie all of those separate pieces together.

Having a ledger that easily shows the entire string of related transactions would not only provide excellent audit records, it would allow both parties to a transaction to have real-time status updates. Every time the blockchain is updated with a new record, both parties to the transaction are able to immediately see the update. Plus, with blockchain technologies such as Ethereum, you’re able to restrict access to the parties to the transaction. I look forward to seeing what’s next as this technology evolves and reaches widespread adoption. It’s just getting started.