Australia's international aid agency, AusAID provides more than $AU480 million in aid each year to improve PNG's worst health and education outcomes.
But the program's been plagued by fraud and corruption from both sides, affecting the delivery of services.
PNG's National Planning Minister Sam Basil has told Radio Australia's Pacific Beat the zero tolerance initiative aims to address those concerns.
"Some people have termed it corrupt, or even boomerang aid," he said.
"So I think...we are now stepping into the right direction."
Mr Basil is confident the new agreement will ensure corrupt officials from both governments are held responsible and prosecuted.
"I know that it will build confidence of PNG citizens and the receipients of the aid money and expatriates of Austraia that we are doing something about corruption, to address the claims that have been made by the public of both countries," he said.
The agreement will cover allegations of fraud activities by any Australian personnel under any AusAid program, or situations in which PNG government departments misuse aid funding from Australia.
"It will make sure that all the fundings are used properly and appropriately," Mr Basil said.
"I believe that we will build the confidence back of the people."
AUSTRALIA NETWORK NEWS