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The Right To Audit Clause

audit clause

It is rare in business these days that a company handles all aspects of its business in-house. It used to be that only payroll processing was outsourced to the likes of ADP and Paychex, and most every other function would be handled internally. In today’s world, companies want to be more nimble and specialized in what they do best. As a result, many functions, specifically additional go-to-market services, are being outsourced to third-party specialists.

Some examples include:

  • Life science companies license their intellectual property in order for another company to develop products for market;
  • Generic pharmaceuticals as well as e-commerce companies utilize third-party logistics experts that manage all aspects of their inventory lifecycle including shipping and invoicing;
  • Many sports and entertainment marketing deals utilize the licensing rights for a particular talent endorsement;
  • Various licensing arrangements and co-op marketing deals are prevalent in today’s consumer products industry;
  • In the Healthcare industry, hospitals utilize physical recruitment agreements to increase its number of patients.

No matter what the industry, the use of these third-party specialists creates different forms of risk for the respective company, with the biggest risk being fraud. One of the best ways to combat fraud risk is to ensure that your formal outsourced agreement contains a Right to Audit clause.

When carrying out audits, there tends to be greater trust in the relationship. It clearly sends a message that the company will be ensuring that:

  1. The third party is complying with the company’s ethics or business standards; and
  2. The third party is complying with the contractual relationship between both parties.

A typical section of a Right to Audit clause contains language such as:

[Third Party] will keep accurate and complete accounting records. Upon no less than ten days written notice and no more than once per fiscal year, the [Company] may audit or use a reputable accounting firm to audit, the [Third Party]’s records relating to its performance under this Agreement.

Best practices would include adding an additional paragraph to the Right to Audit clause regarding findings and costs:

Costs of any audits conducted under the authority of this right to audit and not addressed elsewhere will be borne by [Company] unless certain exemption criteria are met. If the audit discovers substantive findings related to inappropriate accounting, non-performance, misrepresentation or fraud, [Company] may recoup the costs of the audit work from the [Third Party]. Any adjustments and/or payments that must be made as a result of any such audit or inspection of the [Third Party]’s records shall be made within a reasonable amount of time (not to exceed 60 days) from the presentation of the [Company]’s findings to [Third Party].

In the ever-evolving business of specialization and the desire for continued growth, many companies are utilizing third party specialists to assist with various revenue streams. Using third parties can prove to be extremely beneficial in terms of cost and time savings, but they do come with added risks. Having a Right to Audit clause and acting on it annually will help mitigate those added risks.

How Can We Help?

For questions or to speak with a member of Withum’s Accounting and Audit Services Group, please contact us by filling out the form below.

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