Using the Right to Audit Clause to Detect Procurement Fraud

by: Craig L. Greene, CPA/CFF, CFE, MAFF, CCEP, MCJ


In 1997, the Institute of Management and Administration surveyed the readers of their newsletters and other professionals on the use of the Right to Audit Clauses for vendors. The survey found the participants believed that these clauses were a good idea, citing their use when:

• Purchasers want to ensure sound financial management.
• Companies must respond to a dynamic and changing environment such as outsourcing, downsizing and ISO 9000.
• Industry practices include subcontracting.

Further, by carrying out regular audits of vendors there tends to be greater trust in the relationship. It also sends a message that the Company will be monitoring the vendor to ensure that the:

• Vendor is complying with the Company's Ethics or Business Standards and that the
• Vendor is complying with the contractual relationship between buyer and seller.

When the right to audit is exercised, the internal auditor may be looking for fraud by vendors and violations of company ethics policies such as:

• Fictitious "shell companies" setup by employees or others that may or may not provide goods or services;
• Faulty or inferior quality of goods, such as substitution of material schemes;
• Short shipments or goods not delivered;
• Services allegedly performed that weren't needed in the first place, such as equipment repairs, or services never performed at all;
• High prices when the goods can be bought directly or less expensively from the same or another vendor;
• Corruption schemes including improper:

— Payments and kickbacks;
— Conflicts of interest.
— Gifts and gratuities to company employees;
— Commissions to brokers and others;

Right to Audit Clauses

The buyer usually obtains the right to examine records of a vendor to determine if a fraud or a violation of company policy has occurred through the following methods:

Right-to-audit agreement: The agreement can be printed on the back of a purchase order, or other procurement form. The clause could be worded as follows on a purchase order: "Seller shall establish a reasonable accounting system, which enables ready identification of seller's cost of goods and use of funds. Buyer may audit seller's records anytime before three years after final payment to verify buyer's payment obligation and use of buyer's funds. This right to audit shall include subcontractors in which goods or services are subcontracted by seller. Seller shall insure buyer has these rights with subcontractor(s)."

Right to Audit Clause in a Contract: If a buyer inserts a right-to-audit clause in a contract, he has a much greater chance to expand definitions and include other compliance provisions for the vendor.

Other options for obtaining the right to audit may include:

— Inserting a specific provision into a contract that's normally entered into between buyer and vendor, e.g., construction contract or supply contract in addition to the basic right-to-audit clause included in the purchase order;

— An audit provision included within a special document (such as a vendor survey mailed to all new or proposed additions
to the vendor master file) that's completed and signed by vendors.

— And finally, the least desirable option is a civil lawsuit in which documents and records are subpoenaed.


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