What is a Contract Audit?
Businesses run on contracts. Whether it’s a straightforward service agreement or a high-stake acquisition, contracts underpin many of the decisions and movements of a company or law firm. It is essential to make sure that every party complies with all of their contractual regulations. As a result, a contract audit examines and assesses performance or information, designed to verify that one or more parties to a contract have complied with requirements or standards outlined in the agreement.
Contract audits are internal assessments of contracts that check key provisions or regulations to ensure all parties understand and follow them. Contractual audits also verify and evaluate current policies, systems and controls to ensure they are up-to-date and accurate. A contracts audit may involve analysing and verifying logs, accounts and transactions.
Contract auditing is the most common post-signature rather than pre-signature contracts. It usually includes multiple contracts, similar to a project review. They may focus on a specific area or look at various departments at once. They should be a regular occurrence in any organisation.
Contract audits are commonly used for maintenance and construction contracts and are frequent in government entities such as the defence contract audit agency.
Types of Contract Audit
The size and type of these contract audits will depend on the purpose and the desired outcomes. There are many different styles of audit, often with interchangeable names depending on the location and industry.
Here we have highlighted a few of the most common contractual audits:
- Scheme audits - typically funded by capital expenditures.
- Contract compliance audits - a legal audit carried out to ensure that signed contractual terms are being honoured by all parties.
- Defective pricing audits - used to determine the accuracy of costs or pricing and identify whether the business is overpaying for products or services.
- Clause audits - carried out to identify incorrect terms and clauses due to changes to the business policies or the economic environment.
Contract audits can also be ‘reactive’ and ‘proactive’. Those that are reactive are related to specific organisational requirements, problems or events.
How to Perform a Contract Audit
When you need to perform a contract audit for your business, you must consider several factors before starting. Important findings could be missed, which might have detrimental effects on the organisation.
What Are Your Objectives?
Firstly, it is vital to work out the objectives you want to hit from the contract audit. They need to be clear and upfront to direct the audit and to make sure you build a strong foundation for a contract audit.
Ideally, contract audit objectives should cover known areas of potential non-compliance and exposure. And to ensure all parties are comfortable with the direction and the outcomes of the audit, stakeholders should also be consulted.
How Extensive is Your Contract Audit? - Scope and Timing
Secondly, look at whether you need to audit every part of each contract or only look at specific areas. Are you examining every contract, or are there batches or types of contracts that can be ignored? Setting the scope will significantly impact how long the project will take and how much resources are required, which also increases or decreases the cost of the process.
You may not have enough resources internally to complete the contract audit quickly and efficiently, meaning you need assistance from contract auditors or a firm. Hiring a contracts auditor adds to the cost, so it needs to be part of the plan. If you complete the audit yourself and have many contracts to get through, it may help you work more effectively if you break them into batches (potentially by type or by area).
Additionally, a contract audit may consider the capacity of the legal team to cope with a potentially lengthy process or any repercussions from the outcomes. If there are also process and system changes, the availability of other business areas also needs to be considered.
Define Contract Audit Roles and Create Your Team
Whether you decide to include an external party or just keep it internal, it is vital to distinctly define tasks and roles so that work isn’t duplicated or missed. The team is vital to the security of the audit - you will be dealing with a lot of confidential items, and team members need to have the correct set of permissions.
Differences Between Contract Audits and Contract Reviews
and contract audits are similar processes, and across different legal circles, the phrases are used synonymously. However, there are a few key differences between the two methods.
Firstly, a contract audit is typically only completed on a signed contract, whereas a contract review occurs on pre-and post-signature contracts. A contract audit is to determine whether both parties are meeting the terms and conditions of an agreement.
Unlike a contract audit, a contract review is part of the negotiation process: making sure parties agree to terms that fit their company policies and positions. They are also often used to identify outdated or incorrect clauses caused by a change in the business or economy and are carried out to flag any legal risks (this is known as a red flag review).
Contract reviews can be completed on individual or multiple contracts, whereas a contract audit involves numerous documents as an internal process.
Why Should You Audit Your Business’ Contracts?
Contract audits are vital to any business. Frequent contract audits control an organisation’s contractual processes. Highlighted below are just some of the benefits your company could gain from regular contractual audits.
Control and Recover Your Costs
By auditing your contracts, you can ensure that payments and costs are verified and that your business isn’t over-paying what was agreed. Not only does this improve your cash flow, but it prevents any future monetary errors, leading to significant savings and improving financial performance in the long run.
It is easy for small mistakes to creep in, leading to inaccurate billing, but these mistakes could add up and significantly impact the finances of any company.
Improve Processes and Increase Contract Quality
By regular examination of policies, systems and controls can highlight areas of non-compliance and outdated processes. Fewer problems appear, particularly around non-compliance, as each contract audit creates new solutions. It reduces the likelihood of any mistakes or inefficiency causing lasting damage (both financially and reputationally) to the business.
The legal team understands the business’ contracts by conducting internal contract audits, so contract management becomes quicker and more effective. Additionally, with this updated information, future contracts are of a higher quality and more clarity, ensuring that the parties’ requirements are always relevant and beneficial for the organisation.
Prevent Fraudulent Activity
Contract audits prevent businesses from overpaying on services and products and identifies any fraudulent activity (if it exists). Detecting these problems early on minimises the impact on the organisation and reduces the likelihood of encountering legislation issues in the future. Regularly auditing contracts thoroughly also helps deter unethical activities and keeps terms and conditions out of grey areas.
Effectively Manage Risk
Contractual audit risk (including financial, reputational or legal risks) can be identified in advance, meaning that an organisation can prepare for any outcome. Even if the terms or clauses causing the risk cannot be changed immediately, having the information indicates that organisations are fully aware of the possibility and can reduce their liabilities, avoiding any long-term, irreversible damage.
Create Better Business Relationships
When examining customer-focused agreements, contract audits ensure all products or services are correct and financial obligations are in line with the deal. By continually monitoring these contracts and the parties’ requirements, the business can avoid under-delivering and develop a better relationship with their customers.
At the end of a collaborative contract audit, transparency between the organisations is much higher, and all involved can fix problems. It creates a more personal relationship across the board and helps to improve future agreements, providing benefits (potentially even financial ones) to each party.
Can Legal Tech Help You With Contract Audits?
The short answer is yes, especially if you find one that works alongside your team and systems. However, it is important to scope out the right technology for you.
Using a solution like Summize, contract audits can be made easy. With a user-friendly contract management system, legal teams can store and analyse their contracts at the click of a button. The instant summaries created for each contract allow users to view every clause and manage legal risk effectively. You can add colleagues or shareholders to view their contracts and your team’s advice immediately.And that’s Summize’s ultimate guide to contract audits!
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