Are You Getting What You Pay For?

February 09, 2016

A mining company looking to better manage cost overruns and delays on a large construction project decided to contract their mining operations to a third party. The company thought it was improving its efficiency—until they received a bill from the vendor for 100 tonnes of cement. The issue? Only 50 tonnes had been delivered to the site.

Over the past two decades, there has been a rapid growth in contract mining worldwide. Contract mining tends to involve many operations, from rock breakage and materials handling, equipment maintenance, mine design, mine-site development and associated budgeting. By contracting out one or more of mining processes, companies can focus on their core competencies, while using specialists for key mining initiatives.

As organizations progressively rely on globalizing supply chain activities to improve efficiency and reduce costs, managing the risks associated with contract compliance becomes increasingly complex. One of the best ways to manage contract risk is to perform internal audits that allow management to validate that contact stipulations such as product quality, tonnes provided, service rendered and health and safety requirements are being adhered to.

Contract Audits Can Provide Strong Oversight, Contract Clarity and Cost Recovery

As organizations continue to leverage on outsourced vendors to perform mining tasks, there is an ever-increasing need to manage the effectiveness and appropriateness of company dollars being managed by third-parties. Establishing an effective risk-based internal audit plan to identify, assess and manage contracts provides management with strong corporate oversight, clarity and potential cost recoveries to help ensure management is “getting what they paid for.”

When establishing a risk-based approach, it is critical to define goals, objectives and focus to contract audits at hand.

Effective contract audits should focus on the following:

Cost Recovery

The most common reason mining companies conduct contract audits is to ensure that the vendor is adhering to the pricing structure and providing the goods and/or services, as defined in the contract, within a timely manner. These internal audits tend to uncover potential overpayment issues, clerical errors and/or missed credits and discounts. Audits such as these, can result in material recoveries for companies that leverage on significant vendor contracts and institute regular reviews of contract compliance. In most cases, focusing a review on a vendor's internal control.

environment and the transparency of vendor records can provide a strong indicator of potential contract non-compliance issues. In-depth cost recovery audits are performed to determine the root cause, quantify the potential overpayments and establish a basis for negotiating recovery from the vendor. The level of recovery will depend on the complexity of the agreement, materiality of spending and the effectiveness of both the vendor and customer control environments.

Process Improvement

Contract audits also focus on establishing efficiencies in processes between the company and the vendor where working relationships are closely tied. This can include areas such as inventory handling, mine-site development, revenue reporting, and general timely reporting of goods and/or services provided. These reviews may reveal procedural and/or communication improvement areas between the company and the vendor. Identifying and remediating these issues enables mutual opportunities for improved operational effectiveness which could lead to material cost savings. Improved productivity over time has the added advantage of strengthening the company-vendor relationship and promoting further collaboration on mining initiatives.

Fraud Prevention and Detection

Common fraud schemes such as collusion of payments, fictitious vendors and price skimming can be analyzed against vendor processes to ensure company dollars are being properly allocated. The focus of these audits is either transactional specific, due to past events or circumstances arising or are focused on assessing the effectiveness of the company's and/or a vendor's internal control environment to prevent and detect potential instances of fraud.

Use Contract Audits to Maximize the Value of Your Relationships with Vendors

Contract audits for mining operations will vary by operational need, mine-life and contract stipulations. Similarly, internal audit emphasis will vary depending on the approach a mining company wants to take.

Selecting the right type of contract audit

Common types of construction and engineering contract audits include:

  • Contract closeout audits. These audits are typically conducted at the end of a project before the final payment is made.
  • Two-phase audits. In a two-phase audit, the first phase audit tends to occur near the beginning of a project, while the second audit occurs before the final payment is made.
  • Monthly payment audits. These audits keep a close eye on contract cash outflows. They serve to resolve potential contract issues as they arise, enabling both the vendor and the mining company to avoid or minimize delays and cost overruns.
  • Quarterly, semi-annual or annual audits. For long-term projects, mining companies often elect to conduct audits at regular intervals throughout the year to identify issues earlier and to ensure that projects stay on track.
  • Spot audits. These audits are typically performed at a specific point of time, not linked to a key deliverable or milestone within the contract process. They typically focus on cost recovery, operational reviews, existing process enhancements and/or fraud risk assessments.

Developing a strategic risk-based internal audit approach

Regardless of the type of contract audit, mining companies will want to consider developing a strategic risk-based approach to assessing the effectiveness of their third-party relationships. Properly designed and implemented, a strategic risk-based approach can provide the most value for time/effort spent on contract audit programs.

There are six key steps mining companies can take to develop a strategic risk-based approach:

  1. Set priorities. From the outset, companies should understand the objectives of the oversight internal audit program and the underlying needs of the organization and the associated vendor(s).
  2. Develop a framework. Companies can develop and adapt a controls framework based on the needs they have identified, as well as the program objectives and priorities. The framework should address critical areas, particularly those that have been flagged as being higher risk or higher cost.
  3. Assess current controls. Using the framework as a guide, companies perform a gap analysis of existing core policies, procedures and processes. This will help to identify gaps, overlaps and areas of strength and weakness from both an internal and vendor perspective
  4. Implement only the controls needed. When implementing control recommendations, critically evaluate the controls being modified, implemented or removed. Too many controls, or the improper implementation of new controls, can create issues that the framework is designed to avoid.
  5. Implement in phases. Modifying or implementing new controls in phases will enable companies to address issues as they arise. Additionally, not all controls may need to be implemented at the outset. Some may be held in reserve until needed at a later date.
  6. Establish a process for continuous improvement. Controls should evolve as a company's needs change. As such, companies will want to assess controls on an ongoing basis to ensure their effectiveness and ability to address new or emerging risks, such as new regulations. Monitoring a company's controls and relevant risks is critical to maintaining an effective and cost-effective controls framework.

BDO is Here to Help

In today's markets, performing contract audits is one of the many ways BDO has been assisting mining clients to manage vendor risk and drive operational efficiencies in a time where current commodity prices continue to erode margins and there is an ever-increasing focus on cost management. For more information on developing and executing contract internal audit programs or if you would like a copy of the article please contact Kyle Hulme.

Kyle Hulme, CPA, CA is a Senior Manager in BDO Canada's Advisory Services Practice. For the past 7+ years, Kyle has assisted numerous Canadian mining clients in the development of strategic internal audit plans, execution of internal audit mandates and specifically, the performance of mining contract internal audits. He can be reached at or 416 815 3017.

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