Why carry out a Royalty Audit?

Writers' and composers' financial reward for their creative work is the receipt of royalties. But, how often do writers and composers check whether the amounts they have received are correct? In our experience, not as systematically and regularly as perhaps they should.

After the creation of the original work and its commercial exploitation, royalties fall due for payment on subsequent reproduction of that work. Writers and composer are used to receiving a royalty statement detailing the title/work involved, the units and values on which royalties are calculated and the resultant royalty value.

It should be remembered that a royalty is a periodic payment that arises from the commercial exploitation of the original work and may involve the grant of a licence or an assignment of the rights attaching to that work to do so. Both of these would properly be represented in the form of an agreement which defines the relationship, responsibilities and duties of the parties, as well as recognising their rights.

Calculation

Within such an agreement would be the royalty clause which sets out the timing of payments and the manner in which the payment is to be calculated. There are three basic elements to such a calculation, namely:

For each element there could be aspects that might change, depending on the particular circumstances. An example would be different royalty rates for different territories, or varying provisions for returns' allowances.

A further clause which should be in the agreement is the right of audit clause. It is vital that this is included so as to provide the writer or composer with protection in the event that proper accounting has not taken place. Furthermore, only once a thorough review or examination of accounting system has taken place, can the initial question of whether proper financial reward has been given, be answered. An incorrect amount may be paid for a number of reasons - in some instances it may be because monies have been deliberately withheld - in others, it may be because the agreement has been misinterpreted, or the incorrect financial parameters included (e.g. royalty rate) or the omission of sales of units within certain territories.

Information

The statement issued with a royalty payment should provide the basic information required to check whether monies are being paid on all relevant works. At a minimum, the statement should show the three basic elements to the royalty calculation - the units sold, the base price and the rate. But, the statement is unlikely to provide sufficient detailed information to enable individuals to ensure that either the units have been determined in accordance with the contract, or that the base price is correctly calculated and reflects the actual price being achieved. In some instances, the royalty rate may vary depending on the country of sale or the type of sale and this again cannot be easily determined from many royalty statements issued. In others, relevant considerations may include royalty-free issues such as promotional or other similar issues.

In view of the limited ability to check the accuracy of information on royalty statements, the importance of the right of audit or audit clause can be more readily appreciated. The clause should allow unrestricted access by professionally qualified accountants to the licensee's books, records and documentation relating to the contract and, as a consequence, allow a thorough review to take place of the quantities, rates and values applied within the various territories involved.

An important consideration in relation to royalty audits is the question of timing. Clearly, any time restriction included within the audit clause should be adhered to, although in our experience it has not proved difficult to reach agreement between contracting parties to enable all relevant periods required to be reviewed to be covered. Nonetheless, the exact time when a royalty audit should be conducted needs to be considered carefully, having regard to the number, success and period in which the relevant works have been exploited.

There are a number of distinct advantages obtained by a composer or writer from a royalty audit and these can be summarised as follows:

Overseas

Royalty audits should not be restricted to the UK; indeed, their importance increases when an overseas party is involved with whom there is little, if any, regular contact and knowledge of the market is less than the domestic market. This area is understandably more complex as it may involve relationships with a licensee who has sub-licensed writers elsewhere: however, knowledge of the licenses granted and exploitation undertaken can significantly improve the knowledge of the individual writer or composer and could lead to improvements in future financial arrangements. Such knowledge might also be sufficient to permit termination of the contracts on the grounds of improper or unauthorised licensing of product. In any event, new agreements could be reached on a more favourable basis.

Professional

Royalty audits are usually carried out by professional accountants who have experience in the field. The audit is not, contrary to popular expectations, provided free!! It is charged for either on the basis of hourly rates depending on the expertise of staff required to undertake the work or an agreed fee before commencement.

In our experience, it would be unusual for findings arising from a royalty audit to be less than the cost for undertaking the work. However, there are ways in which the cost can be further controlled and examples of this include a group of writers or composers with a common licensee to give a single instruction to an auditor to audit all of their works. It is also possible to include in the audit clause of your contract a requirement that, should any shortfall uncovered, be more than, say, 5% of royalties owed for the period, then party being audited shall pay the audit costs.

A further way to limit cost would be to narrow the scope of the audit. It may, for example, be considered appropriate initially to conduct a brief review of the licensee's royalty accounting function and, in the event of problems being identified, conduct a fuller examination. Alternatively, it may be appropriate to consider only one particular area of accounting (e.g. territory, sales units, royalty rates). But the impact of any such limitation would need to be considered very carefully.

Conclusion

As will be appreciated, simple reliance on a royalty statement may not be sufficient to give a writer or composer the comfort that proper accounting of royalties has taken place. More often than not, under-accountings do arise, either through genuine error, a misunderstanding or misinterpretation of contractual terms, or the deliberate understatement of sales units, rates and royalty values.

The right to audit should, therefore, be high in the list of priorities of individual writers or composers so that in the best business sense they ensure they have full and proper accounting at the right time and have full use of monies due to them.

Johnsons Chartered Accountants

Johnsons Chartered Accountants have extensive experience in carrying out royalty audits for some of the biggest and best names in the business and would like to offer their professional services to you.