Contract Compliance Audit: What You Should Know

Reviewed by Ryan Worthen MBA, CPA, and Vice President of Auditec Solutions

What is a Contract Compliance Audit?

A contract compliance audit is a review process that ensures all parties are following the terms specified in a contract. It verifies that each party is meeting their contractual obligations as agreed.

Expanding on this, the audit involves a thorough examination of financial records, operational procedures, and performance metrics to confirm compliance with the contract’s terms. For financial professionals, this means scrutinizing accounting practices, transaction histories, and internal controls to ensure they align with both contractual requirements and regulatory standards. Conducted by independent third-party firms, these audits provide an objective assessment, identifying any discrepancies or areas of non-compliance. This process enhances transparency, mitigates financial risks, and helps maintain the integrity of business agreements.

Virtually all businesses rely and depend on other businesses to achieve success, revenue, and ultimately profit. Retail companies depend on manufacturers for products and manufacturers depend on retail companies to sell those products. Commercial businesses must have marketing consultants to maintain brand reputation and identity. Countless businesses provide transportation services, communication services, maintenance services, because other businesses need those services. Regardless of the field or industry, companies depend on other companies in the interconnected network of commerce.

Common practice and sound business operation demands those symbiotic corporate relationships are governed by contractual agreement. Before businesses enter into contracts with one another detailing the terms of the respective obligations, both parties negotiate the provisions to maximize their own benefits while making concessions to avoid losing the contract. Procurement teams work hard to bargain for benefits and secure favorable terms into written contracts. However, all that hard work is for naught if those benefits are not actually realized in the event the other party to the contract fails to comply with the agreed upon terms. In fact, many companies are overcharged millions of dollars over the term of a contract simply due to erroneous invoicing and non-compliance by the other party which seriously diminishes the benefits you anticipated. For these reasons, your company should consider the benefits of contract compliance review programs.

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What are the types of Contract Compliance Audits

There are several types of contract compliance audits, each of which focuses on different aspects of contract compliance. Here are some of the most common types of contract compliance audits:

Financial audit: A financial audit focuses on the financial aspects of a contract, such as payments, invoices, and expenses. The audit ensures that all financial transactions related to the contract are accurate and compliant with the terms of the agreement.
Operational audit: An operational audit focuses on the operational aspects of a contract, such as service delivery, quality assurance, and customer service. The audit ensures that the business is meeting its contractual obligations related to these aspects.
Regulatory audit: A regulatory audit focuses on ensuring compliance with laws and regulations that apply to the contract. The audit ensures that the business is complying with all applicable laws, regulations, and standards.
Third-party audit: A third-party audit is conducted by an independent third-party, such as an external auditor or consultant. The audit ensures that the business is complying with the terms of the contract and provides an objective assessment of compliance.
Compliance program audit: A compliance program audit assesses the effectiveness of a business’s overall compliance program, including its policies, procedures, and controls related to contract compliance.

In summary, the types of contract compliance audits include financial audits, operational audits, regulatory audits, third-party audits, and compliance program audits. Each type of audit focuses on different aspects of contract compliance, and businesses may choose to conduct one or more types of audits based on their specific needs and risk factors.

Value of a Contract Compliance Audit in 2024

Prevent Contract Value Erosion

After contracts are signed, their value often diminishes by more than 8.6%, leading to substantial profit losses for large organizations. A contract compliance audit can halt this margin erosion, ensuring you extract maximum value from your agreements.

Maintaining oversight post-signing is challenging, allowing unnoticed value erosion and potential risks. Minor discrepancies can escalate rapidly if audits aren’t conducted regularly. Engaging a third-party team of experts is crucial to maintain control without overextending your internal resources.

Common Causes of Contract Value Erosion

Cost overruns
Lack of governance or visibility
Vague or undefined terms
Poor communication
Unexpected business events

Identify Errors & Ensure Contracts Are Upheld

Contracts can be notoriously difficult to understand—90% of business professionals find them “impossible to understand.” This complexity arises because contracts are often written with litigation in mind, not readability, leading to mistakes and miscommunications with suppliers.

A contract compliance audit ensures all parties fulfill their obligations. Experienced auditors specialize in decoding complex contractual language, swiftly identifying errors and discrepancies.

Contrary to popular belief, third-party audits won’t consume all your time. On average, an audit with SC&H requires only 12 hours of stakeholder support per engagement. This is particularly beneficial for procurement teams facing resource constraints; Chief Procurement Officers (CPOs) cited operational workload as their top barrier to progress in 2023. You can achieve cost savings while reclaiming valuable time.

Recover Millions in Lost Profits

A contract compliance audit can uncover critical errors and discrepancies that lead to significant cost recoveries. Auditors identify root issues quickly, negotiate with suppliers, and facilitate timely resolutions to maximize ROI for your business.

SC&H’s audit team typically recovers 2-4% of the transaction value audited. For large, multi-year contracts, these recoveries can amount to millions, returning substantial funds to your organization. Regular audits also establish long-term process improvements, ensuring every dollar spent aligns with negotiated agreements.

Improve Supplier Relationships

Contrary to common belief, contract compliance audits can enhance supplier relationships by fostering open communication and reducing conflict. When conducted properly, audits can restore confidence in strained relationships, unlocking value for both parties.

Top-performing procurement teams that prioritize supplier relationships experience 35% more collaboration and 58% higher supply chain visibility than their peers. However, cost savings can erode quickly if supplier relationships aren’t properly managed. Audits provide valuable insights to identify mutually beneficial strategies and achieve shared objectives.

Increase Efficiency & Do More with Less

With 74% of CPOs highlighting operational efficiency as a top priority—and operational workload as their main barrier—contract compliance audits are a valuable tool for boosting productivity. Audits reveal where contracts, processes, and controls are misaligned or underperforming. CPOs can use these findings to enhance organizational harmony and standardize procedures.

Streamlining operations directly correlates with better business outcomes. High-performing procurement teams implement standardization strategies 20% more often than low-performing teams and leverage third-party solutions nearly twice as frequently to mitigate resource constraints. Third-party auditors can expedite resolutions with suppliers, allowing your team to stay focused on core business activities.

Examples of How Audit Findings Can Be Leveraged

Audit Finding	Action Taken
Contract renewals are delayed due to manual tracking and lack of centralized oversight.	Implement a contract management system with automated renewal reminders to centralize the process and reduce disruptions.
Multiple departments engage similar suppliers independently, leading to redundant contracts and missed volume discounts.	Consolidate contracts through strategic sourcing, streamline supplier management, and negotiate bulk discounts to reduce costs.
Procurement processes rely heavily on manual, paper-based methods, causing delays and errors.	Invest in a digital procurement platform that automates approval workflows and utilizes AI to reduce processing times and minimize errors.

Mitigate Third-Party Risks

Monitoring supplier risk is complex, requiring both skilled personnel and advanced technology. Contract compliance audits offer a structured process to assess and monitor third-party performance against contractual obligations.

Signs You’re at Risk of Third-Party Non-Compliance

Complex contract terms
Operational challenges within the third party
Lack of mature controls

Data privacy is a top concern for business leaders regarding third-party risk management. Security breaches are on the rise, with 41% of companies reporting a significant third-party breach in the past 12 months—a 20% increase from 2021.

This concern is justified: a single non-compliance incident costs over $14 million on average, and GDPR fines start at 2-4% of annual revenue. Regular contract compliance audits help identify gaps exposing you to third-party risks, allowing you to optimize contract terms accordingly.

What is the purpose of Contract Compliance

Contract compliance auditing is a process of reviewing and assessing the performance of parties involved in a contract to ensure that they are meeting the terms and conditions outlined in the agreement. The primary purpose of contract compliance auditing is to identify any non-compliance issues and take corrective action to address them, thereby reducing the risk of disputes, legal action, and financial losses.

Contract compliance auditing can provide numerous benefits for businesses, including:

Risk Mitigation: By identifying non-compliance issues, contract compliance auditing can help mitigate risks associated with contract breaches, potential legal action, and reputational damage.
Cost Savings: Identifying non-compliance issues can also help businesses save costs by preventing overpayments, reducing waste, and improving efficiency.
Improved Performance: Contract compliance auditing can help parties involved in a contract improve their performance by highlighting areas that need improvement and encouraging them to meet their obligations and responsibilities.
Enhanced Relationships: By ensuring compliance with the terms of a contract, contract compliance auditing can help build trust and enhance relationships between parties involved in a contract.

In summary, contract compliance auditing is an essential process for ensuring that parties involved in a contract meet their obligations and responsibilities. It can provide numerous benefits for businesses, including risk mitigation, cost savings, improved performance, and enhanced relationships.

Key Benefits of Contract Compliance

Risk mitigation: By identifying non-compliance issues, contract compliance auditing can help mitigate the risks associated with contract breaches, potential legal action, and reputational damage.
Cost savings: Contract compliance auditing can help businesses save costs by preventing overpayments, reducing waste, and improving efficiency.
Improved performance: By highlighting areas that need improvement, contract compliance auditing can help parties involved in a contract improve their performance and meet their obligations more effectively.
Enhanced relationships: Contract compliance auditing can help build trust and enhance relationships between parties involved in a contract by ensuring compliance with the terms of the agreement.
Regulatory compliance: Contract compliance auditing can help ensure that businesses comply with applicable laws and regulations related to their contracts.
Process improvement: Contract compliance auditing can help identify areas where processes can be improved, resulting in greater efficiency and effectiveness.
Financial transparency: Contract compliance auditing can help provide greater financial transparency, ensuring that parties involved in a contract are meeting their financial obligations.

Errors that Contract Compliance Auditing Typically Uncover

Contract compliance audits are designed to identify any non-compliance issues with the terms and conditions outlined in a contract. Here are some of the errors that contract compliance audits typically uncover:

Payment errors: Contract compliance audits can identify payment errors, such as overpayments or underpayments, which can result in financial losses for businesses.
Contractual obligations not met: Contract compliance audits can identify instances where parties involved in a contract have failed to meet their contractual obligations, such as delivery schedules or quality standards.
Inadequate documentation: Contract compliance audits can uncover instances where documentation related to a contract is inadequate or incomplete, which can result in disputes or legal action.
Unauthorized modifications: Contract compliance audits can identify instances where the terms of a contract have been modified without proper authorization or approval, which can lead to contract breaches and legal action.
Non-compliance with regulations: Contract compliance audits can identify instances where businesses are not complying with applicable laws and regulations related to their contracts, which can result in fines or legal action.
Inaccurate reporting: Contract compliance audits can uncover instances where reporting related to a contract is inaccurate, which can result in financial losses or damage to a business’s reputation.

In summary, contract compliance audits can uncover various errors related to payments, contractual obligations, documentation, modifications, regulatory compliance, and reporting. By identifying these errors, businesses can take corrective action to prevent financial losses, disputes, or legal action.

What types of businesses utilize Contract Compliance Auditing

Contract compliance auditing can be utilized by various types of businesses and organizations that engage in contractual relationships. Here are some examples of businesses that commonly utilize contract compliance auditing:

Government agencies: Government agencies often engage in contracts with private businesses and other organizations, and they utilize contract compliance auditing to ensure that the terms of the agreement are being met.
Large corporations: Large corporations typically engage in complex contractual relationships with multiple parties, and they utilize contract compliance auditing to monitor compliance and mitigate risks associated with contract breaches.
Healthcare providers: Healthcare providers, such as hospitals and clinics, utilize contract compliance auditing to ensure that their contractual relationships with insurers and other entities are being managed effectively and efficiently.
Non-profit organizations: Non-profit organizations utilize contract compliance auditing to ensure that donors and grantmakers are meeting their obligations and that the organization is complying with the terms of its agreements.
Educational institutions: Educational institutions utilize contract compliance auditing to ensure that they are meeting their contractual obligations with vendors, suppliers, and other entities that provide goods and services.

In summary, contract compliance auditing can be utilized by various businesses and organizations that engage in contractual relationships, including government agencies, large corporations, healthcare providers, non-profit organizations, and educational institutions.

How often should a Contract Compliance Audit be performed

The frequency of contract compliance audits depends on several factors, such as the complexity of the contract, the risk level associated with non-compliance, and the nature of the business relationship. Here are some factors to consider when determining how often a contract compliance audit should be performed:

Contract complexity: Contracts that are complex, involve multiple parties, or have a long duration may require more frequent contract compliance audits.
Risk level: Contracts that involve a high risk of financial loss, legal action, or reputational damage may require more frequent contract compliance audits.
Business relationship: Contracts that involve a critical business relationship, such as a key supplier or customer, may require more frequent contract compliance audits.
Industry regulations: Contracts that are subject to industry-specific regulations may require more frequent contract compliance audits to ensure compliance with those regulations.

In general, contract compliance audits should be performed regularly to ensure ongoing compliance with the terms and conditions outlined in the agreement. However, the specific frequency of contract compliance audits will vary based on the factors mentioned above. Some businesses may conduct contract compliance audits annually, while others may perform them quarterly or on an as-needed basis.

In summary, the frequency of contract compliance audits depends on several factors, including the complexity of the contract, the risk level associated with non-compliance, the nature of the business relationship, and industry-specific regulations.

Contract Compliance Audit Cost in 2024

The cost of a contract compliance audit can vary depending on several factors, including the scope of the audit, the complexity of the contract, the industry and regulatory requirements, and the level of expertise and experience of the audit team. Some audits may cost a few thousand dollars, while others may cost tens of thousands of dollars or more. It is best to consult with a reputable audit firm or consultant to get a specific cost estimate for your particular situation.

How to perform a Contract Compliance Audit Assessment

Performing a contract compliance assessment involves a thorough review of the terms and conditions outlined in the contract to ensure that the parties involved are meeting their obligations. Here are the steps to perform a contract compliance assessment:

Review the contract: The first step is to thoroughly review the contract and identify all of the terms and conditions that are relevant to the assessment. This includes any specific requirements related to deliverables, timelines, pricing, and other key aspects of the contract.
Gather relevant documents and data: Next, gather any relevant documents and data related to the contract, such as invoices, purchase orders, and other records. This will help to verify compliance with the terms of the agreement.
Assess compliance with contractual obligations: Using the contract and the gathered documents as a guide, assess compliance with the contractual obligations. This includes verifying that all parties are meeting their obligations related to deliverables, timelines, pricing, and other key aspects of the contract.
Identify areas of non-compliance: If areas of non-compliance are identified, document the issues and determine the root cause of the non-compliance. This may involve conducting interviews with stakeholders and reviewing additional documentation.
Develop recommendations: Based on the findings of the assessment, develop recommendations to address any areas of non-compliance. This may include changes to processes or procedures, renegotiation of the contract, or other corrective actions.
Communicate findings and recommendations: Communicate the findings and recommendations to relevant stakeholders, such as contract managers and other key personnel.
Monitor compliance: Once corrective actions have been implemented, monitor compliance with the contract on an ongoing basis to ensure that the issues have been resolved.

In summary, performing a contract compliance assessment involves reviewing the contract, gathering relevant documents and data, assessing compliance with contractual obligations, identifying areas of non-compliance, developing recommendations, communicating findings and recommendations, and monitoring compliance.

If you want to continue learning more about recovery audit check out our other resources found below.

Frequently Asked Questions about Contract Compliance Audits

An example of a compliance audit is a financial institution undergoing an audit to verify adherence to anti-money laundering regulations. The auditor reviews policies, procedures, and transactions to ensure the institution complies with legal requirements. Similarly, a contract compliance audit examines whether all parties in a contractual agreement are following the stipulated terms and conditions.

Contract compliance refers to the process of ensuring that all parties involved in a contract fulfill their obligations as outlined in the agreement. It involves monitoring and verifying that contractual terms are being met, such as pricing, deliverables, timelines, and quality standards, to prevent discrepancies and protect the interests of all parties.

Contract audits are systematic examinations of contracts and related processes to assess compliance, performance, and financial accuracy. They involve reviewing contractual terms, financial records, and operational activities to identify any deviations from the agreement, errors, or areas of non-compliance. The goal is to ensure transparency, accountability, and adherence to contractual obligations.

Tracking contract compliance involves several steps:

Implement a Contract Management System: Use software to centralize contracts, set reminders for key dates, and monitor obligations.
Regular Monitoring: Establish routine check-ins to review performance metrics and ensure terms are being met.
Assign Responsibility: Designate team members to oversee compliance for specific contracts or areas.
Maintain Documentation: Keep detailed records of communications, modifications, and compliance activities.

Monitoring contractor compliance involves:

Establishing Clear Expectations: Define performance metrics and deliverables in the contract.
Regular Reporting: Require contractors to provide progress reports and evidence of compliance.
Site Visits and Inspections: Conduct on-site evaluations if applicable to assess compliance firsthand.
Communication: Maintain open lines of communication to address issues promptly.
Using Compliance Checklists: Utilize checklists to systematically review compliance areas.

Maintaining contract compliance involves proactive management:

Educate Stakeholders: Ensure all parties understand their obligations under the contract.
Monitor Performance: Regularly assess performance against contractual obligations.
Update and Amend Contracts: Modify contracts when changes occur to keep them current.
Conduct Periodic Audits: Perform internal or external audits to identify and rectify compliance issues.

The contract compliance audit process typically involves:

Planning: Define the scope, objectives, and criteria for the audit.
Data Collection: Gather relevant contracts, financial records, and performance data.
Review and Analysis: Examine documents and data to identify compliance with contractual terms.
Reporting: Prepare a report outlining findings, discrepancies, and recommendations.
Follow-Up: Work with stakeholders to address issues and implement corrective actions.

The key steps in maintaining compliance are:

Identification: Understand all applicable laws, regulations, and contractual obligations.
Implementation: Develop and enforce policies, procedures, and controls to meet compliance requirements.
Monitoring: Continuously monitor activities to ensure ongoing compliance.
Response: Address any compliance issues promptly through corrective actions and updates to policies.

To ensure compliance with a contract:

Clear Documentation: Have a well-defined contract with explicit terms and conditions.
Effective Communication: Maintain open dialogue with all parties to clarify expectations and address concerns.
Regular Monitoring and Evaluation: Track performance metrics and review compliance regularly.
Training and Awareness: Educate your team about their responsibilities under the contract.
Enforce Consequences: Implement penalties or remedial actions for non-compliance as outlined in the contract.

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