It was in late 2009 that NI Water's then chief executive Laurence MacKenzie asked its internal audit unit to investigate payments of £465,000 to a particular company.
The firm held a contract for meter installation and management services.
Auditors found the contract, due to expire in March 2009, had been extended to March 2010 – 12 months outside the agreed period.
This was a potential breach of European Union procurement regulations.
They also noticed that an unusually large number of invoices were under £20,000 – even though daily expenditure levels under the contract often substantially exceeded this.
One highlighted example found that on April 11, 2008, seven separate invoices with a total value of £108,000 were submitted by the company, and subsequently seven separate payments were made by NI Water.
Auditors established that the company had been told to limit invoices to under £20,000 by the NI Water manager responsible for awarding the contract.
The motivation for limiting invoices' size can be to circumvent rules which require larger payments to be authorised.
In other words, they are split up, thus falling below the threshold which makes them subject to a high-level check.
According to Tuesday's report, "invoice-slicing" is an indicator of fraud.
The Audit Office report details how the contract manager claimed he was acting on instructions from his line manager.
The report states: "The internal audit established that the instruction to Company E to limit invoices to under £20,000 had been given, in January 2008, by the NI Water manager who was at that time responsible for the contract (the contract manager).
"This was confirmed by the contract manager, but he initially claimed to have acted under instruction from his line manager.
"The contract manager subsequently alleged that this instruction had come from the then director with responsibility for this business area."
By April 2010 the internal audit team's final report concluded there was no evidence of fraud.
But it did identify serious control weaknesses in contract management procedures which needed urgent attention.
A disciplinary investigation found the contracts manager and line manager had a case to answer over breaches of procedures relating to invoice slicing.
Disciplinary action was launched "regarding incidental poor contract management issues found".
Hearings with the two officials were held in late July 2010.
However, less than a fortnight later, both were told that no further action would be taken.
The Audit Office discovered problems with the disciplinary process, including errors in correspondence sent to both individuals.
"Crucially, formal disciplinary letters issued to two members of staff contained an error of fact, which may not have been identified until the disciplinary hearing," the report said.
"In our view, the error led directly to the disciplinary panel's conclusion that the employees concerned had no case to answer."