Reserving the Right to Audit the Suspicious Vendor

By Ralph Q. Summerford, CFE, CPA, CVA

Right-to-audit clauses in vendor contracts help control fraud and abuse by affording discovery devices in examinations. 

Management was finally getting worried. On six different occasions, employees in the purchasing department and other vendors of the ABC Company had alerted executives of a cozy relationship between a department purchasing manager and an outside vendor. The company called our firm, we conducted a fraud examination, and their worst nightmares were confirmed: a $6 million kickback scheme. And it could have been prevented with a simple vendor audit clause in the contract or purchase order.

We requested both the vendor and the vendor's sub-contractor to allow the internal audit department of ABC Company to perform an audit, but both the vendor and the sub-contractor flatly refused. So what could have been a successful recovery by ABC - and possible criminal conviction of the fraudulent vendor - turned into a long and expensive civil lawsuit. ABC Company finally tired of pursuing its claims, abandoned the suit, and licked its wounds.

Determined to not be burnt again, ABC adopted an ethics policy, clearly defining fraud, and now requires all employees - staff and management - to sign annual disclosure statements stating they have reviewed the policy and aren't aware of any violations.

But most importantly, ABC Company now includes a "right-to-audit clause" on every vendor's purchase order. Also, every contract with a contractor or vendor contains a specific provision for the right to audit.

Vendor audit clauses can help control fraud and abuse by affording a discovery device in a fraud examination.
When the right to audit is exercised, the fraud examiner or auditor is generally looking for fraud by vendors and violations of company ethics policies such as:

  • faulty or inferior quality of goods;
  • short shipments;
  • high prices when the goods can be bought directly and/or cheaper from the same or another vendor;
  • goods not delivered;
  • kickbacks;
  • gifts and gratuities to company employees;
  • commissions to brokers and others;
  • services allegedly performed that weren't needed in the first place, such as equipment repairs; and
  • conflicts of interest.

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