The business world, and accounting profession in particular, is abuzz with predictions of how blockchain technology will dramatically reduce the role accountants play in auditing client transactions. Traditionally, an accountant’s audit-related work is focused on their specific client and determining whether the client’s accounting records accurately represent the goods and services it purchased or provided.
When that client enters into a private blockchain relationship with one of its vendors or customers, the transaction is completed and effectively audited in real time by the participants.
While the auditing function for clients that utilize blockchain relationships with trading partners will likely be scaled back, blockchain will have a far smaller impact on forensic accountants and their usefulness in detecting and unraveling fraudulent schemes. The most apparent reasons include the following:
- Blockchain, despite its inherent efficiency, is only a method of decentralized accounting or record management.
- Most companies that enter into private blockchain relationships with vendors or customers appear to implement them on a go-forward basis.
- At least two parties to the fraudulent scheme will need to be participants in the blockchain. Many frauds involve multiple parties who may not all be participants.
- Most fraud schemes rely on deception where the fraud is “baked-into” the supporting documents with no apparent mismatch between accounting records.
We’ll explore three common fraudulent schemes that blockchain technology may not be able to detect, whether effectively or at all, below.
1. Expense Reimbursement Schemes
For many companies, reimbursing employees for expenses incurred on personal credit cards is not amenable to the blockchain model. The advantages of blockchain become evident when the parties are validating or confirming their agreement with the counter-party’s transaction — in this case, between an employee and employer.
In this scheme, the “bad block” is a fraudulent expense report that probably includes enough documentation to trick the unsuspecting clerk into providing reimbursement. It seems unlikely that a typical company would establish a private blockchain with its employees and their credit card company to provide visibility into the actual expenditures incurred (e.g., hotels, restaurants and auto rentals).
This suggests expense reimbursement schemes will probably not be impacted as companies adopt blockchain models because employees and the beneficiaries of their spending likely will not be subject to full disclosure.
2. Kickback Schemes
Companies and their trading partners that utilize private blockchains may or may not be able to identify certain kickback schemes.
In a typical kickback scheme, the bad block is an inflated payment where the excess will find its way back to the schemers. The easiest way to implement a kickback scheme is to have a perpetrator in both organizations who can manipulate the accounting treatment for inflated payments and ill-gotten refunds.
The accounting for the receipt of the excess payment will probably not reveal a scheme unless the victimized company monitors the initial pricing or prevalence of refunds.
The likelihood of revealing a scheme will also depend upon the sophistication of the fraudulent accounting. In a low-sophistication scheme, the refunds may simply come in the form of chronic overpayments by a victimized company. A higher-sophistication scheme could involve inventory adjustments, product returns, freight cost differentials or prompt payment discounts.
In either situation, the payor and payee accounts will likely balance, which will prevent an immediate red flag from the blockchain.
3. Altered Check Payee Scheme
Most altered check payee schemes are relatively unsophisticated because the fraud will only continue until the party awaiting payment takes the initiative and contacts the customer to inquire about outstanding invoices. The misdirected payment is the bad block.
Assuming the trading partners are utilizing a private blockchain to manage their transactions, the partner whose payments are being diverted will not validate receipt of payment and thereby create a violation.
In a perfect world, the violation would spur an investigation and quickly identify the misdirected payment as the bad block. In reality, the fraudster may be in a position that allows them to “fix” the bad block by misdirecting additional payments to appease overdue vendors. Unless the most recent victim/vendor also maintains a private blockchain with the fraudster’s company, there will be no more bad blocks — only a disgruntled vendor.
Depending upon the diligence of the victimized party, the blockchain may reduce its exposure in comparison to a traditional exchange of information and corresponding excuses for payment delays.
Forensic Accounting Will Still Be the Best Way to Detect Fraud
The private blockchain model has significant appeal for parties that are performing transactions or sharing information. As stated earlier, the audit of the exchange occurs in real time by the participants.
Unfortunately, neither traditional audits nor the real-time auditing enabled by the blockchain model can automatically detect a well-concealed scheme. The detection and unraveling of such schemes will continue to require the skills of a forensic accountant.
If you would like to learn more about how forensic accounting can help your business prevent or detect fraud, contact Wipfli.