Mar 3 2021

How to Make Contract Compliance Audits a Success

Why do Contract Compliance Audits Matter? 

A commercial contract is a legally binding agreement between two (or more) parties that is seen in every facet of the business world. Depending on the type of contract, it can be straightforward or extremely complex, however, even the most routine contracts can be more complex than expected. 

Generally, buyers invest a significant amount of time and effort when negotiating complex supplier contracts and there is a typical assumption that when a contract is in place, all negotiated benefits and requested services are automatically received and honored. However organizational change and turnover, inexperienced personnel, misunderstanding, and lack of oversight of the agreed terms mean the value and services promised are often underdelivered.   

According to the International Association of Contract and Commercial Management, nearly 40% of commercial contracts do not deliver their full expected financial benefits. Non-compliance can potentially cost companies between 0.5% and 5% of annual spend. For the modern enterprise trying to cut costs and increase savings wherever and whenever it can, a contract compliance audit is a veritable linchpin to success. 

What is a Contract Compliance Audit?

Global organizations transact business with thousands of active suppliers with one or more complex contracts, the volume and complexity present significant challenges. This makes monitoring of compliance to the applicable terms and conditions difficult.

A contract compliance audit is a task performed to monitor contracts and is normally based on a detailed review of supplier contracts. It involves line-level billing data and supporting information to ensure that the way the contract terms were originally articulated remains accurate and helps to improve supplier performance of any future contracts.

The Contract Compliance Audit Best Practice

Contract compliance audits are not only principally focused on recovering historical billing errors and overpayments, but also uncover contract terms that were not defined with enough clarity; hence this process improves visibility and increases efficiency while reducing risk throughout the organization. This is why contract compliance audits are increasingly considered to be internal control best practice.

In principle, each contract compliance audit program is structured similarly to the following:

1.      Risk Assessment

Ensure the right suppliers and contracts are prioritized.

The risk assessment process is the backbone of a contract compliance audit program. Risk assessment focuses on the spend volume and complexity of each category, working with the business and contract management teams to consider any operational concerns, contract renewal negotiations, as well as the supplier relationship and buying power to ensure the right suppliers and contracts are prioritized.

Does the contract have an audit clause?

It is important to determine if the contract has an audit clause. The audit clause effectively provides the right to audit, giving proper authority to review the supplier’s books and records in respect of the supplier’s compliance with its obligations under a specific contract.

1.      Audit Planning

No two contracts are exactly the same and will depend on: the type of the contract, service category, and terms and conditions. Therefore, the audit test plan is also varied. It is best practice to prepare a detailed audit test plan to follow and carry out each audit test, identify supporting data and compare relative documentation.

2.      Audit Execution

This element involves working with a supplier directly to obtain the supporting data and documents for the billing that has been issued and execute the audit test plan. The process can be accelerated by applying Artificial Intelligence (AI) to analyze and identify revenue leaks and validate any potential non-compliance.

3.      Audit reporting

To minimize any potential disruption to the business, it is important to manage and reduce the audit involvement from client staff. To maximize results,  the auditor should re-engage with the client at the preliminary audit findings stage to discuss and validate the factual accuracy and finalize the final audit reporting.

4.      Post audit meeting

A contract compliance audit program not only helps recover lost profits. It is best practice to have a post-audit meeting with the client to discuss the audit findings.  Focusing on quickly addressing the underlying root cause value leakage, applying proactive corrective actions, and resolving any persistent problems returns significantly more value than a once-off audit, by delivering recurring future cost savings.

By following these steps, you can ensure a more successful (and best practice) contract compliance audit.

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