Audit Those Vendors

By Craig L. Greene, CFE, CPA

A vendor can be an entity’s best colleague or worst nemesis. Keep the relationship pleasant and successful by conducting vendor audits. 

Bigco Inc., a Midwest manufacturer, hired Energy Services Limited, an energy consulting firm, to provide specialized procurement services to acquire inexpensive and reliable energy for its manufacturing plants and offices. Energy Services sent invoices to each of Bigco’s divisions and its corporate headquarters based on hourly charges for its professional staff and related out-of-pocket costs. Bigco’s CF0 found Energy Service’s invoices had quintupled in a three-year period and called in our firm.

When we examined the invoices in total, we found that some of Energy Service’s professionals had billed each division and the corporate headquarters for seven hours a day for a total of more than 24 hours. We also found that most of the Energy Service’s professionals consistently exceeded an eight-hour workday and some worked on holidays. Yet the routine services they provided could have been performed during a normal eight-hour workday. Routine vendor audits would have prevented the overcharging.

Entities often implicitly trust vendors. But just as good fences make good neighbors, vendor audits produce good relationships.

The participants of an Institute of Management and Administration survey said they use “right-to-audit” clauses in vendor contracts when they want to ensure sound financial management; when they must respond to dynamic environments such as outsourcing, downsizing and ISO 9000; and when they need to use subcontractors.

Routine vendor audits send the message that the entity is always monitoring the vendor to ensure that it is complying with ethics or business standards and contractual agreements.

When the entity exercises the right to audit, the fraud examiner may be looking for such vendor fraud and violations of company ethics policies as:

  • fictitious “shell entities” set up by employees or others that may or may not provide goods or services;
  • substitution-of-material schemes that supply faulty or inferior goods;
  • short shipments or goods not delivered;
  • services allegedly performed that were not 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; and
  • corruption schemes including improper payments and kickbacks, conflicts of interest, gifts and gratuities to company employees, and commissions to brokers and others.

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