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© 2019 Association of Certified Fraud Examiners, Inc.

Detecting Fraud Through

Vendor Audits

Identifying and Selecting Audit Candidates

© 2019 Association of Certified Fraud Examiners, Inc. 2 of 27

The Importance of Routinely

Exercising Vendor Audit Rights

▪ There is a significant reduction in vendor audit

costs and overbillings.

▪ Compliance is increased by both employees

and vendors.

▪ Organizational policies and procedures are

strengthened.

▪ Vendors know what to expect from audits, what

documentation to keep, and where their

processes are generating overbillings.


The Importance of Routinely

Exercising Vendor Audit Rights

▪ Audit staff is more adept at conducting the

audits and knowing what to look for.

▪ Contract and audit clause language is improved

based on other vendor audits experiences.

▪ “Increase the perception of detection, decrease

the probability of fraud.”

▪ Company employees are aware that proactive

vendor audits can uncover areas where they are

not performing their jobs or are engaging in

conflicts of interests or kickbacks.


Determining Which Vendors to Audit

▪ The first step in

implementing a vendor

audit program is to

determine who to audit.

▪ The technique used is

largely based on the type

of contract, the goals of the

audit, specific concerns of

management, and other

relevant variables.


Total Spend

Pros

Allows for increased audit

coverage

Low recovery percentages

could still add up to big

dollars being identified

Might be the best option

when audit resources are

limited

Cons

Larger companies might

have better controls in

place

May forego the relative

risks and variables of the

contracts

Could keep the audit team

from assessing low to

medium level


Number of Invoices

Most invoices

• High number of invoices

increases the chances

of errors and makes it

easier to hide

manipulation.

• There may be

significantly more work

for the audit team if

statistical sampling and

extrapolation is not

allowed.

Fewest invoices

• Invoices and supporting

documentation might be

so large that additional

items can be inserted.

• Invoices could be for

significant amounts, but

lack supporting

documentation or have

very short descriptions

of the service.


Number of Contracts

▪ The number of contracts involved, coupled with

variations in terms and conditions, inevitably

complicates the billing process.

▪ Vendor can use higher rates in one contract on

invoices that should have lower rates.

▪ With the number of contracts, invoices, service

areas, invoice entry points, and contract

management points, there could also be an

increased risk of double billing or cross billing

on the wrong contracts.


Sole- or Single-Source Contracts

▪ Risks:

• Increased potential for

conflicts of interests

• Business inappropriately

pushed to certain vendors

• Increased potential for shell

companies

• Insufficient time spent

reviewing the contact terms

or vendor invoices


Sole- or Single-Source Contracts

▪ Number of sole-source contracts by vendor

▪ Sole-source contracts by dollar amount

▪ Sole-source contracts by total number of

change orders

▪ Sole-source contracts with largest percentage

change order amount over original contract

amount


Top-Ten Tests

• By valueContracts

• Who issued the most contracts

• Who issued the most POs

• Who approved the most invoices

• Who approved the most spend

Employees

• With the most contracts

• With the most total spend

• With the most change orders

• With the most sole-source contracts

• With the greatest number of

invoices

Vendors


Benford’s Law

▪ In the 1920s, engineer Frank Benford noticed

that other engineers frequented log tables that

started with the digits 1, 2, and 3 more than

those that started with 7, 8, and 9.

▪ He experimented and determined that naturally

occurring numbers follow a specific pattern.

Ones 30.103 Sixes 6.69468

Twos 17.6091 Sevens 5.79919

Threes 12.4939 Eights 5.11525

Fours 9.691 Nines 4.57575

Fives 7.91812


Benford’s Law


Even or Round Payment Amounts

▪ The generation of invoice amounts is usually

natural.

• Line items, rates, fees, markup percentages, and tax

rates affect the final invoice amount, so the final

number is relatively unknown and random.

▪ Even numbers or round numbers, while

possible, should be few and far between.

• Unit rates or specific even-dollar charge amounts are

an exception and may provide a false positive.


Invoice Sequence

Nonsequential

• Invoice #12387 for

$23,860.13


$31,881.61


$17,712.93

Sequential

• Invoice #1234 for $1,791

• Invoice #1235 for $3,360

• Invoice #1236 for $4,515

• Invoice #1241 for $4,131

• Invoice #1242 for $2,372

• Invoice #1243 for $1,104

• Invoice #1255 for $3,836

• Invoice #1256 for $2,318

• Invoice #1257 for $1,754


Contractor/Subcontractor Selection Method

▪ Identify vendors that frequently work together as

contractors and subcontractors.

▪ Analysis can help uncover unknown

relationships, intentional markups, overbilling,

bid rigging or rotation, and other procurement

issues.

▪ This requires very good contractor/subcontractor

data.


Company

Vendor A

Vendor C

Vendor F

Vendor B Vendor C

Vendor A

Vendor F

Vendor D Vendor E Vendor F

Vendor A

Vendor C



Project #1

• $10 million new construction

• Vendor A is primary contractor

• Vendor C is listed as a sub

• Week of April 11

• $16,239.90 invoice

Project #2

• Routine maintenance

• Vendor C is contractor

• Services performed on April 13

• $2,131.55 invoice



Payment-Method Comparison

▪ Might be difficult to perform or irrelevant

depending on accounts payable data.

▪ Identify vendors who are paid differently than

the bulk of the vendors.

▪ Compare payment methods used for vendors in

similar categories.

▪ Might be helpful in identifying shell companies.


Vendor Touch Points

▪ How many places can a vendor submit an

invoice for processing?

▪ Identify the number of employees who have

approved invoices.

▪ Identify the number of contract managers with

whom a vendor may be working.

▪ Requires fairly good procurement and accounts

payable data.


Payment Trend

▪ When are payments entered and processed?

• Are payments made on weekends, holidays, or

during extended hours?

• This might indicate that someone is processing

defective invoices during off-peak times.

▪ Compare payment terms to actual payments.

• Compare all invoices for a specific vendor and/or the

average payment time frame across several vendors.

• Look for vendors receiving favorable payment terms.

• Example: Net 45 days listed in system, but the

vendor is paid on average in four days.


Vendor Refunds or Reversals

▪ This might indicate that the vendor has an

inadequate system for generating invoices.

▪ There might be additional concern over the

number of errors that have made their way

through the payment process unnoticed.

▪ Refunds or reversals at the end of accounting

cycle could be an attempt to manipulate

budgets.


Length of Time with Company

• May have knowledge of accounting and billing weaknesses

• Relationships, conflicts of interest, bribery, kickbacks

• May be significantly integrated and overly relied upon for

services (trust)

• May receive preferential treatment over other vendors

Old vendor

• New status and growth may be result of internal

relationships

• Could be completely fictitious entity or a shell company

• May have processes that are unable to keep up with new

growth

New vendor


Climbers and Divers

▪ Analyzing the overall spend across a category

of vendors for a period of time:

• Goal: to identify abnormal growth or reductions in

spend at certain vendors

▪ Significant growth or decline might indicate:

• Change in quality or routine business issues

• Disagreements between the vendor and

management

• Failing to pay kickbacks or new corruption

• Retirement and start up of new shell companies

• Bid rigging


Climbers and Divers


Outlier Testing

▪ It requires access to good accounts payable

data.

▪ Run data analytics against payments for the last

1–5 years.

▪ Look for vendors who have invoices that

exceed their 12-month moving average by

200%.

▪ Review outliers to determine significance.

▪ Might help identify double billing issues such as

bundling.


Similar Groups or Competitor Comparisons

▪ Review vendors that offer similar services or

are competitors to see whether they show

different variable trends over time (e.g., the

number of contracts, invoices, average spend,

total spend).

▪ This allows the audit team to focus on a smaller

subset of vendors and better analyze the

variables.

▪ It helps the audit team refine the knowledge,

skills, and abilities needed to audit the vendors

and services.


Similar Groups or Competitor Comparisons


Criticality of Goods and Services Rendered

▪ Is vendor heavily relied on

to provide component or

support products?

▪ Is vendor one of a limited

number of raw material

suppliers?

▪ Does vendor provide key

consulting services that

the organization relies

on?


Criticality of Goods and Services Rendered

▪ Does vendor provide the bulk of the major

construction support or oversight functions?

▪ Is vendor a clearinghouse for the organization’s

cash (i.e., a payment processor)?

▪ Is vendor fully integrated and relied on in the

normal function of the organization?


Complaints, Issues, and Disputes

▪ Vendors that routinely come up in complaints

from frontline supervisors, procurement staff,

administrative staff, or accounting staff

▪ Vendors that routinely fail to deliver on time,

deliver the wrong goods, arrive late, leave early,

or have chronic invoice problems

▪ Past investigations and hotline complaints

▪ Public records search on major/minor vendors

▪ U.S. government’s System for Awards

Management (SAM)

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