Contract Auditing — Everything You Should Know

Contract auditing allows parties to know their obligations and follow them thoroughly. However, what is it?

In this article, we will discuss what contract audit means. We will tell you the purpose and the different types of auditing contracts. Also, we will tell you how to prepare for contract contracts. 

Once you are done reading this article, you will be able to understand the importance of audits in your contract. Thus, it will enable you to ensure that all parties are compliant with the requirements stated in the contract. 

I have created a free-to-download, editable procurement contract template. It’s a set that includes a PowerPoint file and a Word file. You can use and tailor them to your needs when contracting with a supplier. I even created a video explaining how to use the templates. 

Contract Audit: What is it?

A contract audit refers to the process of assessing and evaluating performance or information, which verifies that the parties involved in a contract have fulfilled the standards or specifications outlined in the contract.

It involves analyzing the terms and conditions of a contract to ensure that both parties are meeting their agreed-upon obligations and that the terms are being executed according to what they have written in the contract. 

These audits are performed based on the agreement between the parties, as specified in the contract, and not as a legal requirement, unlike audits required by law. 

Contract audits typically involve reviewing various documents, similar to a project review, and may concentrate on specific departments or particular areas during the audit process.

Performing contract audits is crucial for any growing business. However, it is an overwhelming task that many businesses see as a burden. Contract audits require a significant amount of attention and a considerable time commitment.

Furthermore, contract audits are an effective tool that can help you control costs, promote quality, and strengthen your relationship with the other parties. 

What is the Purpose of a Contract Audit? 

Contract audits have multiple purposes that include  the following:

1. Managing costs

Contract audits guarantee that your business is not overpaying or underpaying as agreed in the contract, and ensure that costs are accurately recorded. This process can aid in forecasting and help legal and finance teams better control expenses.

Identifying even small errors can help you avoid inaccurate billing and help optimize your financial performance. 

Additionally, the audit can identify opportunities to negotiate better rates during contract renewals by assessing and managing costs on a case-by-case basis.

2. Identify risks before it gets worse

Conducting contract audits proactively is an efficient way to recognize potential problem areas and risks before they worsen.

For instance, checking if there are billing errors at an early stage can prevent the accumulation of unexpected expenses, which could severely impact revenue. 

Similarly, identifying any unfulfilled contractual obligations at an early stage can prevent non-compliance from escalating into a potential legal dispute later on.

3. Improve the quality of the contracts

Contract audits offer a vast amount of valuable data that can help businesses make more informed decisions about contracts, their terms, and the procedures involved.

The audit can guide improvements in internal processes and enhance the overall quality of the contracts. Furthermore, it can identify specific opportunities to increase revenue or reduce costs that align with the company’s strategy.

The audit can also highlight clauses that require updating, either to comply with regulatory changes or to reflect the direction of the company’s growth.

Different Types of Audit 

There are many types of audits and the size and type of these contract audits depend on the purpose and desired outcomes. Here are the most common contractual audits:

1. Contract compliance audits

A contract compliance audit reviews how well the parties involved in a contract are adhering to the terms and objectives of the agreement, and whether they have effectively fulfilled their obligations. 

The audit can also assess an organization’s compliance with specific regulations, such as data protection and information security laws.

2. Defective pricing audits

Defective pricing audits are conducted to assess the accuracy of the costs or pricing and to determine whether the business is overpaying for its purchased goods or services.

3. Term audits

Term audits, also known as clause audits, consist of evaluating the set of terms and clauses incorporated in contracts and detecting any incorrect or outdated terms. 

This enables legal and business teams to determine which contract terms require updating to align with the regulatory and economic environment, as well as the business strategy.

4. Contract management audit

A contract management audit involves evaluating a company’s contract portfolio and its capacity to manage contracts at each stage of its lifecycle. 

Contract audits can be categorized as either “reactive” or “proactive”. Reactive contract audits are conducted in response to particular organizational demands, issues, or incidents.

How to Prepare For Contract Audits

Here are some tips that can help you prepare for contract audits:

1. Identify your objectives

Before auditing a contract, you must identify first why you need to conduct a contract audit. It is essential to establish clear and upfront objectives that will guide the audit process and lay a strong foundation. 

The objectives should address potential areas of non-compliance and exposure, and stakeholders should be consulted to ensure their agreement and understanding of the audit’s direction and outcomes.

2. Consider the scope of your contract

The second step is to determine the scope of the contract audit, which involves deciding whether to audit every aspect of each contract or only specific areas. 

It is important to consider whether to review all contracts or focus on certain groups or types of contracts to save time and resources, which will affect the overall cost of the process. 

Defining the scope will help you to establish a clear direction for the audit and ensure that the necessary resources are allocated appropriately.

3. Involve relevant parties

Lastly, once you identify the objectives and scope of your contract audit, it is time for you to involve relevant parties to make the audit efficient. 

Defining tasks and roles is essential whether you choose to involve an external party or keep the audit internal. This helps to prevent duplicate or missed work. 

The team is crucial to the security of the audits because confidential items will be handled, and team members must have permission to access them.

In Conclusion

In conclusion, this comprehensive guide on contract auditing elucidates the critical aspects of this process. Exploring the meaning, purpose, and types of contract audits, the article emphasizes their significance in ensuring compliance and managing costs. The importance of preparation for contract audits is underscored, with insights provided on setting objectives, determining scope, and involving relevant parties. Contract audits emerge not only as a tool for managing expenses but also as a proactive approach to identify risks, enhance contract quality, and foster efficient contract management throughout their lifecycle.