Practically all license agreements have an explicit or implied audit right, yet many companies do nothing to ensure that they receive the full amount to which they are entitled. Under most license agreements, if the audit identifies additional royalties (usually with a threshold between 2%-5% of what was initially reported), the licensee pays for the audit’s cost.
A royalty audit can identify significant additional royalties not timely reported to the licensor, and additional royalties most times exceed the cost of the audit. Reasons to perform an audit include:
1. To obtain all royalties to which you are entitled;
2. To induce future compliance by the audited licensee (a licensee is less likely to underreport if the licensor engages in a regular audit program);
3. To induce future compliance by the non audited licensees (as they are deterred from underreporting once the licensor is known to have audited others);
4. To determine material noncompliance with an existing licensing agreement in order to modify or terminate it.
Unaudited licensees have economic incentives to misreport royalties. An experienced auditor is familiar with the wide range of royalty misreporting possibilities, such as:
1. Purposeful, otherwise unexplained underreporting of what is owed.
2. “Misunderstandings” regarding what is covered by the technology being licensed.
3. Product numbers/SKUs alterations.
4. Not reported sublicense revenues.
5. Clerical errors related with reliance on manual processes and/or spreadsheets.
6. Not reported bundles of royalty-bearing products with non-royalty products.
7. Transactions reported prices do not reflect market conditions.
8. Incorrect use of exchange rates in international transactions.
9. Licensee-favorable interpretations of various “allowances”.
Finding these errors requires specialized audit experience and related data processing skills. Fulcrum Inquiry performs forensic accounting and investigations. We have substantial experience and success performing royalty audits in many industries (entertainment, manufacturing, software among others). Using computer audit skills, our royalty and other compliance audits are more complete, yet cost less. Our results usually far exceed the cost of our work. Unlike many of the well-intentioned but timid auditors with whom we compete, our auditors are bulldogs in getting information needed to learn the truth.
Visit www.fulcrum.com for more information.
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Best Practices in Royalty Audits.
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Licensing and Royalty Audits Deserve Greater Attention
