Overview of Vendor Audit

Activity
Agenda

• What is Vendor Audit?

• Vendor Audit Vs. Internal Audit

• Why Organizations Need Vendor Audit Function

• Benefits of Vendor Audit

• Some Facts About Vendor Audits

• Right to Audit Clause

• Audit Process

• Types Of Contracts

• Scope or Areas of Audit Coverage

• Typical Audit Issues Identified

What is Vendor Audit?

Definition:
An Audit Activity to provide Management with an objective assessment of
contractors’ or vendors’ compliance to the terms and conditions of the
contracts/agreements.

Objective and Role:

The objective of Vendor Audit is to develop an audit function comprising of
qualified resources to effectively perform compliance audits to ensure that the
contracts are being executed in accordance with the intent and address the net
benefit to include cost recoveries, process improvement savings, fraud
prevention and identification of hidden risks.

The role of Vendor Audit is established as the appraiser of the legitimacy of

costs billed by the contractors and vendors. This also includes the compliance
with procedures, policies, standards, rules, regulations and laws.
Vendor Audit Vs. Internal Audit
Why Organizations Need
Vendor Audit Function
• Business environment is overlaid with increasing pressure on
management for cost reduction, governance and accountability

• Shortages of quality resources, materials, equipment and

vendors. Accordingly, cost estimation and schedule planning are
inherently high risk.
• Capital Expenditure
 Project execution performance is often weak
 Poor budgeting (overruns and over budgeting)
 Risks not managed
 Project expenditure forecasts inaccurate during execution
 Project complexity increasing (consortiums, contracting structures, complex business cases etc)
 Weak owners and out sourced project management teams - shortage
 Mobility of Project Staff

• Operation & Maintenance Cost

Benefits of Vendor Audit

• Cost saving

• Process improvement

• Risk mitigation

• Relationship building

• Value addition / creation

• Help management to achieve objectives

Some Facts About Vendor Audits

• On average 3% of contract values audited are identified as non-compliant to

contract terms. Further, out of that 3% noncompliance, actual vendor cash
recoveries range from 20% to 100%, with an average of 50%.*

• To understand the magnitude of these recoveries, in the Alberta oil sands alone
this provides for a potential non-compliance of $690m, with a cash recovery
average of $345m, based on CAPP forecast of $23b capital spend in 2013.*

• Expected Return on investment ratio of between 4:1 and 6:1*

* Source – Vendor Benchmark Survey conducted by EY.

Right to Audit Clause

• Adequate Right to Audit Clause, i.e. Right to audit all cost elements with the
exception of contractor’s profit.

• Companies shall have the right to audit and copy any record, invoice,
document of the Vendor pertaining to the performance of the work.

• Records for all contracts, specifically including but not limited to lump sum
contracts (i.e. fixed price or stipulated sum contracts), unit price, cost plus or
time & material contracts with or without a guaranteed maximum (or not-to-
exceed amounts) shall upon reasonable notice be open to inspection and
subject to audit, scanning, and/or reproduction during normal business working
hours.

• Clearly defined Commercial Terms

Audit Process
• Identification criterion
• “Spend Amount” / Contract value
• Nature or type of contract (cost reimbursable, unit rate, lump sum etc.)
• Scope of work (project, operation, maintenance, sustaining capital etc.)
• Management Input

• Planning considerations
• Brainstorm with stake holders (business unit, supply management, project)
• Preparation of charter document (planning document to identify areas to be tested)
• Opening meeting (explain audit process, objective and scope)
• Formal audit notification

• Execution approach
• Document / data collection (back of charges)
• Audit tests execution / Field visit
• Draft audit report preparation (report writing)

• Reporting and follow up

• Formal Audit issuance (distribution to stake holders)
• Management response review
• Recovery of overcharges (cheque, credit invoices, future benefit etc.)
• Audit closure
Types Of Contracts
Cost Reimbursable (CR)
A written agreement in which the Company agrees to pay the Contractors for All
Actual Costs for the work plus some type of Mark-up to cover profit and
Overhead.
Time and Materials (TM)
Contract provides for acquiring supplies or services on the basis of Direct labor
hours at specified All Inclusive Hourly Rates that include wages, overhead,
general and administrative expenses, and profit.
Materials at cost, including, material handling costs as part of material costs.
Lump Sum (fixed price, stipulated sum)
A written contract between the Company and Contractor wherein the owner
agrees the pay the contractor a Specified Sum of Money for completing a scope
of work.
Guaranteed Maximum Price (GMP)
The GMP contract provides for the Contractor to be reimbursed for Cost of
Work plus a Fee which together shall not exceed the pre-established contract
ceiling (the GMP).
Areas of Coverage for CR & TM
Contracts:
• Labour
• Base Salary Billed Vs. Paid to Labour / Employees
• Vacation (Annual Paid + Stat Holidays) Billed Vs. Paid
• Payroll Burdens (Including Employee + Employer contributions) Billed Vs. Paid
• CPP, EI, WCB, Pension, RRSP, Bonus etc.
• Material
• Actual cost of the material is considered for billing
• Proper credits have been given for the returned material
• Purchases of excessive amounts of material
• Rebates / Volume discounts paid / credited
• Small Tools & Consumables
• Equipment
• Standby rates billed
• Application of Hourly, daily, weekly and monthly rates
• Mobilization and demobilization cost
• Other Indirect Cost
Areas of Coverage for CR & TM
Contracts:
• Labour – Audit Testing (Calculation of Over Recovery of CPP, EI & WCB)
Areas of Coverage for CR & TM
Contracts:
• Labour – Audit Testing (Vacation / Stat Holiday and H&W Costs Overcharged)

Time &
Stat All Inclusive OT Half
Classification Base Wage Holiday Vacation H&W CPP EI WCB Reg. Rate Premium Rate

A B C D E F G H=(A+B+C+D+E+F+G) I=H/2 J=I+H

Assistant Manager - Document Control $45.00 $1.80 $2.70 $1.00 $1.50 $1.00 $0.95 $53.95 $26.98 $80.93

QA Manager $60.00 $2.00 $2.90 $1.00 $2.00 $1.50 $1.05 $70.45 $35.23 $105.68

• The OT Premium in “I” is calculated by 50% of all components from A to G

• When full time employee works more than regular hours then is he or she entitled to or compensated
for more vacation?
• If employee works OT hours than is he or she entitled for the better health plan?
Areas of Coverage for CR & TM
Contracts:
• Material – Audit Testing (Actual Costs Verification)
Contract States that Sale price = actual cost + freight (actual cost 8%) + mark-up (actual cost * 10%)

• Actual Cost of the inventory item used for billing may be overstated
• Higher freight or mark-up % used for billing
• Contractor earned profit more than stated in the contract
Areas of Coverage for CR & TM
Contracts:

AUDIT TESTS’ OBJECTIVE : To ensure that all costs

defined as reimbursable, have actually been incurred and
billed at ACTUAL cost.
Typical Audit Issues Identified
• Labor
• Labor base rates billed higher than actual in payroll
• Hours worked overstated
• Regular Hours billed as Overtime
• Over-recovery of statutory burdens (CPP, EI & WCB)
• Over-recovery of payroll burden costs (Vacation, Pension, Health & Wellness)
• Billing for overhead type personnel
• Material
• Excess mark-up earned for inventory goods
• Mark-Up Billed on Material Purchased from Affiliated Company
• Non-reimbursable small tools and consumables billed as direct cost
• Discounts / Rebates received for material were not appropriately credited
• Material not used for fabrication billed as direct costs
• Excessive material purchased and billed on job resulted in scrap or waste
• Equipment
• Incorrect equipment rates billed
• Daily rates billed for equipment used on weekly basis
• Operator / fuel costs billed for all inclusive equipment
Questions & Answers

Salman Yasin, B. Comm., CIA, CRMA, CCSA