Contract Leakage: What It Is and How to Stop It

What is contract leakage?

Contract leakage is the money a company loses when the terms it agreed with a supplier never reach the invoices it pays: a negotiated price the invoice ignores, an amendment applied late or not at all, a fee the agreement never allowed, or a deposit that is never credited. If you own or run the business, it is value you already won at the negotiating table and then handed back one invoice at a time. Often it is not fraud at all, just ordinary errors in amounts small enough on each invoice that nobody has a reason to ask.

Where does contract value leak in procurement?

It leaks wherever a term in the agreement has to be carried by hand onto an invoice.

• Price: the invoice uses an old price, a list price, or a rise the agreement does not permit.
• Amendments and notices: a signed change or a price notice is applied from the wrong date, or to orders placed before it.
• Fees: handling, fuel or administration charges appear that the agreement does not mention.
• Quantities: more is billed than you ordered or received.
• Credits: a deposit or an earlier payment is not taken off the final invoice.
• Duplicates: the same delivery is billed twice, under the same invoice number or a new one.

What is off-contract spend?

Off-contract spend is buying outside an agreement, either from a supplier you have no written terms with or for items your agreement does not cover, at whatever price the supplier names. It leaks differently from the list above, because there is no agreed price to compare, so nothing on the invoice looks wrong. The fix is to put written prices in place with the suppliers you buy from most often, and to ask why a new supplier with a large first bill has no agreement at all.

Why does nobody catch it?

Because invoice matching in the procure-to-pay process usually confirms that the goods arrived, not that the price matches an agreement that sits with whoever negotiated it. Your external auditor is not looking for it either, since the PCAOB’s standard on audit evidence, AS 1105, describes audit sampling as testing less than 100 percent of the items in a class of transactions, and the audit’s aim is an opinion on the statements as a whole.

Worked example: a year of Ferrygate invoices against its agreements

Ferrygate Plumbing & Heating is an invented company, one of the Demo companies Ressura uses to show its checks, and every figure below is made up for the example. Its owner, Marcus Oyelaran, asked a simple question at year end: did the terms he negotiated with his suppliers actually reach the invoices Ferrygate paid?

Four agreements had leaked.

• Hilltop Uniform Service agreed $186.00 a week for uniform rental, but invoices from April onward read $198.00 with no amendment or notice behind the rise. That is $12.00 a week over 39 weeks, $468.00.
• Rainier Water Heaters added a $35.00 handling fee to 22 invoices, and the agreement allows no such fee: $770.00.
• Commencement Fuel Co-op sent a notice raising its price by $0.18 a gallon for orders placed from 1 June, yet billed 2,400 gallons ordered in May at the new price: $432.00.
• Narrows Truck & Van Sales took a $9,700.00 deposit on a new service van, and the final invoice never credited it: $9,700.00.

Together that is $11,370.00, and only the deposit was large enough to notice on its own. The invoices from Ferrygate’s other suppliers under written agreements matched what was agreed, which is a result worth reporting too, because it tells Marcus where procurement is under control.

The catch is timing. Hilltop’s overcharge began in April, so the earliest invoices may sit outside the dispute window, the number of days the agreement gives Ferrygate to challenge an invoice, and the supplier may refuse to credit them. Had each invoice been checked as it arrived, the first $12.00 would have been one email to correct.

How do you stop contract leakage?

You stop it by checking every supplier invoice against its agreement before you pay it, not once a year. Keep each agreement, its amendments and any price notices where the people who pay invoices can see them, compare every line on the six points above, and raise any gap in writing inside the dispute window. Record clean results as well as gaps, so you can say which suppliers billed exactly what was agreed. For the line-by-line method, see checking supplier invoices against agreed prices, and for the warning signs, how to tell if a supplier is overcharging you.

How can Ressura help?

Ressura’s Procure-to-Pay Module checks every supplier invoice against what you agreed to pay. It compares each unit price with the agreement on the invoice date, applies amendments from their start dates and price notices only to orders placed after them, matches every fee to one the agreement allows, holds quantities against your orders or receipts, checks credits against the deposit the agreement calls for, and flags duplicates. Any gap is shown in dollars with the arithmetic beside it. You can start with one agreement and one invoice and nothing to connect, and if every line matches, the result says so and lists what was checked.

Sources

1. audit evidence, AS 1105