And How Contract Management Software Can Simplify the Process
Contract audits are good example of the oft-quoted maxim: Trust but verify. Contracts are created to provide a degree of certainty so business can proceed. Trusting in the contract’s terms, both parties start fulfilling their side. But over time, fulfillment can fall short, costs can grow, and management of the contract can go astray.
Contract audits address these possibilities for both parties by examining how the contract is being fulfilled in practice. Key to a successful audit is access to information about the contract: what it says and how it is being carried out.
Here are some different types of contract audits, the contract information you may need to carry them out, and how to use contract management software to simplify the process.
1. Cost Audit
When procurement negotiates with a vendor for goods and services, it uses the contract terms to control costs. To be sure the organization is being charged correctly, the buyer may request an audit of the costs being reported by the vendor. Federal Acquisition Regulations (FAR) require such audits to ensure that the contractor’s costs are fair and reasonable. State and local governments have similar requirements.
Contract information needed: As a start, selecting contracts by counterparty and date range will put you and the auditing party on the same page, since any audit will include only specified contracts. Within the contract’s terms, three are likely to be important:
- Contract type – Costs are defined differently depending on contract type, with the most typical being Time and Materials, Cost Reimbursable, and Firm Fixed Price.
- Employee classification – Billing correctly for an employee’s work often depends on that person’s qualifications as defined in the contract or supporting document. An audit of costs will include labor costs broken down along the definitions agreed to in the contract.
- Subcontractor agreements – The contract terms for any work by subcontractors will need to be evident to the auditors as they examine subcontractor costs that are passed on to the purchasing organization.
Other relevant contract language includes definitions of indirect costs, expressly unallowable or disallowed costs, and approvals of specific costs such as travel. In addition, financial records and source documentation such as receipts and timesheets will be needed.
Ideally, the relevant contract terms have been surfaced from the start so that accounting bills according the contract. For the audit, it will make sense to associate cost documentation with the contract it pertains to. This material can be assembled for auditors to review, filed with appropriate cross-referencing, or managed electronically so that reporting can virtually assemble what is needed for the audit.
Using Contract Management Software to Assist a Cost Audit:
Contract management software can assist with a cost audit by making it easier to monitor financial obligations, identify discrepancies, and ensure that the terms and conditions of contracts are followed properly. Here are the three most important ways contract management software can help with a contract audit:
- Centralized Contract Repository for Easy Access and Search
A centralized contract repository allows auditors to easily access, search, and retrieve all contracts in one place. This eliminates the need for manual collection and ensures that auditors can quickly find relevant documents, terms, and clauses. It also helps ensure that all contracts are up-to-date and readily available for review. - Audit Trail and Version Control for Transparency
Contract management software provides an audit trail and version control features that record all actions taken on a contract (e.g., edits, approvals, amendments). This allows auditors to track any changes made to a contract over time and verify compliance with the original terms. This level of transparency ensures accountability and reduces the risk of unauthorized changes. - Automated Compliance Checks and Reporting
The software can run automated compliance checks to ensure that contracts adhere to internal policies, industry regulations, and legal requirements. Additionally, it can generate custom reports that highlight potential compliance issues, missed obligations, or financial discrepancies. This streamlines the audit process and helps auditors quickly identify areas that need attention, reducing manual workload and the risk of human error.
2. Recovery Audit
In the “trust but verify” department, the recovery audit is essential to the management of a long-term contract. The goal of a recovery audit is for either side to recover costs that were incorrectly billed. The audit compares the billing in a given period with the contract’s terms for billing and payment. The short-term result may be a charge back to the customer or an adjustment in the vendor’s favor – but with repeated recovery audits, both buyer and seller get better at administering the contract they worked so hard to negotiate.
Contract information needed: The terms to have ready during a recovery audit, are:
- Delivery terms – These may include discounts for late or unacceptable delivery.
- Payment terms – At a minimum, these include the window for on-time payment and any increase for late payment. However, other terms may be relevant to determining correct billing: volume discounts, tiered pricing, service type rates, and rebates.
- Acceptance criteria – Refusal to accept a product or service delays payment. Criteria for customer acceptance of a product or service is defined in the contract – sometimes in a brief clause and other times with a multi-step procedure. Disagreement over what is constitutes a reasonable refusal is common. Refusal to accept deliverables costs both buyer and seller as time goes on, which makes it a good candidate for routine examination in a recovery audit.
Accounts payable is normally the first check on over-billing by a vendor, missed claims or uncollected revenue, so a system for extracting delivery and payment terms that can be easily referenced by accounting is a good idea. This can be done manually if contracts and finance are using separate systems, or through an integration of contract management software and the finance system used at the organization.
Using Contract Management Software to Assist a Recovery Audit:
Here are the three most important ways contract management software can provide critical support:
- Automated Invoice and Payment Reconciliation
Contract management software can automate the reconciliation of invoices and payments against the terms and conditions outlined in contracts. This helps auditors quickly identify overpayments, underpayments, duplicate payments, or missed payments by comparing actual financial transactions with contract terms. By flagging discrepancies, the software streamlines the recovery audit process and ensures that financial errors are easily detectable. - Visibility into Financial Obligations and Cost Tracking
Contract management software provides real-time visibility into all financial obligations, including payment schedules, contract value, penalties, and discounts. Auditors can track how costs align with contract terms and uncover areas where the organization may have missed out on rebates, discounts, or penalties for non-compliance. This comprehensive view helps identify any opportunities for recovering funds that were not previously claimed. - Detailed Reporting and Analytics
Contract management software allows auditors to generate custom reports and analytics on spending, contract performance, and payment histories. This feature can help pinpoint patterns of overpayment, discrepancies in contract execution, or areas where financial recovery is possible. The detailed analytics offer insights that auditors can use to assess potential recovery opportunities and present findings more efficiently.
3. Terms Audit
Standard terms and conditions are crafted to work across many contracts over time. Eventually they require review – when new laws are passed, new decisions are handed down, and new business circumstance arise. A terms audit, conducted internally, may focus on updating contract templates with language to reduce risk going forward, or it may examine language in executed agreements that needs to be amended. A terms audit may be warranted in response to a change in the legal landscape such as the GDPR, changes in state labor laws, or acceptance of cryptocurrencies within a jurisdiction.
Contract information needed: Like any contract audit, a terms audit should carefully define its scope: the area of risk or the terms in need of updating. A team may select contracts for audit based on location of the counterparty, operations, or governing law and jurisdiction. In addition, audits may be appropriate for contract clauses dealing with the following:
- Intellectual property – Not only is there a lot of litigation around IP (with potential impact on current contract language) but an evolving business model can affect what kind of IP needs definition and protection: Forward IP that may be developed? Background IP already in use? Third-party IP?
- Data protection and privacy – The GDPR (General Data Protection Regulation) of the European Union makes the rights of data subjects clear and stipulates that data controllers (this includes most organizations that handle customer data) need contractual agreements protecting personal data with data handlers such as cloud services providers.
- Labor law – Clauses that relate to worker protections and terms of employment may deserve reexamination when laws change. In addition to state and federal legislation, state and federal courts continually shape labor law. So do decisions by the National Labor Relations Board.
Preparing for a terms audit means identifying the contracts that are relevant to the focus of the audit. An advantage of an electronic repository with search-and-filtering capabilities is that contracts can be selected based on contract type, clause type, or even the presence or absence of a key phrase.
Using Contract Management Software to Assist a Terms Audit:
In a terms audit, the focus is on ensuring that contract terms and conditions are being followed as agreed. Contract management software can play a crucial role in this process by helping to verify compliance and identify discrepancies. Here are the three most important ways it can help with a terms audit:
- Centralized Repository to Access Contract Terms and Clauses
Contract management software provides a centralized repository for storing all contracts, allowing auditors to easily access and review specific terms and clauses. This ensures that auditors can quickly locate and examine key provisions such as payment terms, deliverables, warranties, and penalties to verify that they are being followed as agreed. The searchable database makes it easy to pinpoint specific contract sections for review. - Automated Compliance Monitoring
Contract management software can automatically monitor compliance with contract terms and trigger alerts for any missed obligations, upcoming deadlines, or non-compliant actions. For example, it can track deadlines for deliverables, service level agreements (SLAs), or renewal terms and send reminders to ensure they are met. This feature helps auditors quickly identify areas where terms are not being followed, reducing the manual effort involved in tracking contract obligations. - Change Management and Version Control
With version control and audit trail features, the software tracks any changes made to contract terms over time. This allows auditors to see if any terms have been modified, updated, or amended without proper authorization. The audit trail provides a clear history of who made changes, when they were made, and what was altered, helping auditors ensure that contract terms remain intact and are enforced as originally agreed.
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4. Compliance Audit
A negative balance or a persistently late deliverable tends to draw attention to itself. Other contractual requirements go unfulfilled for years if nobody checks. Examples include health and safety requirements, fair labor standards, environmental testing, anti-bribery assurances or standards of business ethics.
Compliance audits examine whether contract terms around ethical, labor, environmental, or other defined standards are being complied with. Inspections, certifications, or specific outcomes can confirm that the standards are being upheld.
Contract information needed: Certain contract types may be the subject of a compliance audit; for instance, manufacturing contracts may require certification of the labor conditions at the site where the product is made. Other contract-based information of value to this audit:
- Milestone records – recurring contract-based tasks that require a person to confirm that work was completed in accordance with a standard.
- Third-party inspection – documents that record inspection results as evidence of compliance with a contract’s standards; for example, health and safety standards, emission standards, etc.
- Certifications – documents that confirm that a third party has met a level of operations consistent with the standards in the contracts, for example, a level of sanitation, reduction in injury, anonymity in communicating grievances or violations, etc.
- Proof of licensing and insurance – documents that demonstrate the training, skill, and responsibility of any persons responsible for helping fulfill the contract. This might include doctors and other providers, architects, engineers and construction firms, accountants or appraisers, or any specially trained worker.
Since proofs of compliance are not financial documents, they may find many homes in a busy organization. Ideally, they should be filed or cross-referenced with their relevant contracts. Electronic systems can usually store them with the related electronic contract.
Using Contract Management Software to Assist a Compliance Audit:
For a compliance audit, where the goal is to ensure that contracts adhere to internal policies, legal requirements, and industry regulations, contract management software offers several key benefits. Here are the three most important ways it can help with a compliance audit:
- Automated Compliance Monitoring and Alerts
Contract management software can automatically track compliance with legal, regulatory, and contractual obligations. The software often has built-in compliance features that check contracts for adherence to internal policies, external regulations, and industry standards. Additionally, it can trigger alerts for missed deadlines, non-compliant clauses, or upcoming regulatory requirements, making it easier to identify compliance risks in real-time. - Centralized Repository for Legal and Regulatory Documents
Advanced contract management software provides a centralized repository where all contracts, amendments, and regulatory documents are stored. This ensures easy access to essential documentation needed during a compliance audit. Auditors can quickly search for specific clauses or documents that demonstrate compliance with specific laws, such as data protection regulations, financial reporting standards, or industry-specific rules. Having all documents in one place minimizes the risk of missing or misplaced information. - Audit Trail and Documentation for Transparency
A detailed audit trail feature records every action taken on a contract, including edits, approvals, and amendments. This ensures complete transparency, enabling auditors to trace the history of a contract, including who made changes and when they were made. By having a comprehensive record of contract activity, the software makes it easier to verify compliance with policies and regulations, ensuring accountability and providing a clear audit trail for external regulators.
5. Control Audit
Control audits take different forms. Sometimes a purchasing organization wants a cost control audit of its vendor to be certain that the vendor has systems in place to control and adequately document the costs of a project. This provides some assurance that the costs the vendor bills for are correctly arrived at and can be backed up.
Some organizations undertake a control audit internally to see if their contract management practices are being upheld. This often means checking whether contracts, negotiated clauses, and amendments are being approved only by authorized persons.
A control audit may suggest improvements to a system with few controls. Alternately, it may discover that the controls in place are adequate but are not being consistently followed.
Contract information needed: Contract approvals and signoffs can be tracked with a worksheet or even email approvals printed and stored with the completed contract. Without an accepted system of approval procedures, however, the presence or absence of a paper approval is hard to evaluate in an audit. If clauses, contracts, and changes are managed within an electronic system, an audit of approvals and other processes will have the data to see who accessed the documents and with what levels of approval authority.
In either case, the following information will be important in most internal control audits:
- Contract approvals – including signed final contracts as well as approvals required for different clauses and levels financial commitments.
- Change orders – changes to the statement of work or the acceptance criteria for a contracted project. An audit will often show if these changes are being made ad hoc or through a defined process with one responsible approver.
- Renewals – evidence that contracts are being reviewed for value before renewal and not simply allowed to auto-renew. Some organizations associate estimated savings from renegotiation with the contract record.
Using Contract Management Software to Assist a Control Audit:
In a control audit, the focus is on assessing whether internal controls related to contract management processes are effective and functioning as intended. Contract management software can significantly improve control audits by offering features that enhance transparency, accountability, and monitoring. Here are the three most important ways it can help with a control audit:
- Role-Based Access Control and Permissions Management
Contract management software allows for role-based access control, ensuring that only authorized personnel can access, edit, or approve contracts. This feature helps enforce internal controls by restricting access to sensitive contracts and ensuring that contract-related actions are performed only by individuals with the necessary authority. During a control audit, auditors can review user permissions to verify that appropriate access controls are in place, preventing unauthorized actions or data breaches. - Comprehensive Audit Trail for Accountability
The software maintains a detailed audit trail that tracks every action taken within the contract management system, such as edits, approvals, rejections, and changes to contract terms. This allows auditors to verify that proper control procedures are being followed. They can assess whether all actions are documented, who performed them, and whether they align with the organization’s internal control policies. This level of accountability is essential for identifying any gaps or weaknesses in control processes. - Workflow Automation and Approval Processes
Contract management software often includes automated workflows and approval processes, ensuring that contracts follow a predefined sequence of steps, including review, approval, and execution. These workflows are critical for enforcing internal control measures by ensuring that no contract bypasses necessary approvals or checks. During a control audit, auditors can review the workflow logs to ensure that contracts were processed according to the organization's control framework, reducing the risk of non-compliance or process deviations.
Contracts and audits go together. Contracts lay out a plan. Audits look back to see how the plan is working and suggest course corrections. For an audit to be effective, the organization needs information about its contracts. The more quickly it can assemble and report on that contract information, the better it will manage its contracts and its business going forward. By streamlining and automating various processes, contract management software reduces the time, effort, and risk involved in a contract audit, leading to more accurate and efficient audits.
Contracts 365 –Leading Contract Management Software for Microsoft 365 Customers
If your business counts on contracts to function, then contract management software may be right for you. Contracts 365 is the leading contract management software for businesses that run Microsoft 365. With usability, functionality, and security at the forefront of development, Contracts 365 addresses all aspects of the contract lifecycle through a modern, intuitive interface specific to your users. If you would like to learn more, please don’t hesitate to reach out to us or, even better, request and we can show you how it works in real-time.
