Managing relationships with vendors can be tricky. Oftentimes, management doesn’t think about their contractual rights until an issue arises. When allegations of fraud, overbilling, waste, or kickbacks by a vendor come to light, management’s initial response may be to call for a vendor audit. The ability to conduct such an audit is usually buried in an often overlooked section of a contract – the audit clause. Not all audit clauses are created equally. A thoughtfully crafted audit clause can allow management to have access to all the tools needed to perform a thorough audit, while a boilerplate audit clause may leave management ill-equipped to investigate allegations of misconduct.
The boilerplate audit clause language is often composed by attorneys or procurement professionals who wish to standardize and expedite the contracting process. However, conducting a vendor audit is anything but standard. While it is nearly impossible to anticipate all possible future circumstances that may arise in a vendor audit, careful consideration of the audit clause can ensure that both parties understand their rights and responsibilities should a vendor audit be needed. When writing an audit clause, you may want to consider the following three tips:
- Financial vs. Compliance Audit: A compliance audit is generally more limited in scope, typically consisting of a review of business records and nonfinancial information and interviews with vendor personnel and subcontractors to ensure that the parties are in compliance with the contract. A financial audit can give you much more broad access to transactional records, financial information, and vendor records. Analyze the risks of the contractual relationship to choose which option is best for your company to ensure that the audit staff has access to all the tools they need for a successful audit.
- Surprise vs. Planned: The ability to perform a surprise audit can be a powerful fraud deterrent – a vendor would have little time to fabricate documentation, coach employees, and destroy or conceal documentation. However, many vendors might object to a surprise audit stipulation in the audit clause. At a minimum, include details outlining the timing of an audit, for example two weeks’ written notice prior to auditors’ arrivals.
- Be Specific: Your definition of a word may be completely different than the vendor’s. Whenever possible, use specific language and define words used within the contract. Reference specific auditing standards, such as Yellow Book and GAAP. Define the period that is allowed to be audited, e.g., the “three most recent fiscal years closed” or “from effective date until termination.” Specify who will choose the auditor, if procedures to be performed need to be approved by the vendor, if copies of documentation are allowed to be made and retained by the auditor, if a nondisclosure agreement will need to be signed by the auditor, the hours the auditor will have access to the vendor business and employees, and remedies for noncompliance with the audit clause.
Knowing and understanding your audit rights can make for a smooth, mutually beneficial relationship with a vendor. If you find it necessary to invoke your audit clause, the Schneider Downs Business Advisors have extensive experience in guiding our clients through the process. Please contact Joel Rosenthal at 412-697-5387 or firstname.lastname@example.org.
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