Contributed September 1, 2001 by Thomas.Perez@bmge.com
INTERNAL AUDITING LICENSEE ROYALTY AUDIT PROGRAM ASSIGNMENT NUMBER:
OBJECTIVES To ascertain whether the licensee has properly reported royalties due to the licensor/s in accordance with the applicable licensing agreements. To prepare a report of our findings and comments and review it with the Legal/Business Affairs/ Financial/International functions as appropriate. To issue the claim report and follow up on its settlement with the appropriate functions.
AUDIT PROCEDURES Preparation: 1. A. Issue engagement memo to appropriate personnel. B. Pre-arrange access to appropriate accounting records, including sales, royalties, inventory, production, etc. with the licensee. 2. Prepare audit planning sheets (i.e., scope, dates and budgeted time and expenses). 3. Obtain and review the following: A. Prior audit workpapers and report/settlement details. B. Current applicable licensing agreement(s): i. Highlight/summarize key contract provisions in an abstract. Obtain an understanding of all pertinent contractual clauses.
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-2ii. Obtain clarification/guidance with respect to legal issues from appropriate legal/financial personnel. C. Review correspondence files from Business Affairs and Royalty Accounting. D. Summarize royalties reported and review minimum guarantee. Verify the following: i. Arithmetical accuracy of royalty statements. ii. Selections have been properly classified in terms of label category, product line, matrix origin and retail price. iii. Exchange rates, tax rates (if applicable) are correct. iv. Royalty payments were made in a timely fashion per license agreement. E. Obtain cash receipts file(s) from the appropriate department (i.e., domestic royalties, international royalties, special products, etc.). i. Inquire as to the availability of the file in an Excel format. (Note: Any file format will do for use in ACL; however, Excel provides a means of sorting the data before upload into ACL and gives the auditor an option as to which software to use relative to his/her computer prowess). ii. Ensure that the file(s) contain the necessary data fields. The data file(s) should contain fields for information required to be reported by the licensee. iii. Ensure that the file(s) includes all information for the period under review. F. Reconcile royalty statement information for the period under review with the information on the data file(s) for the period under review. Investigate any differences and obtain explanations from royalty accounting/other departments as appropriate.
AUDIT PROCEDURES G. Obtain Dun & Bradstreet reports and other available financial
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-3Information. 4. Discuss licensee with Contracts Administration/Business Affairs and Royalty Accounting to obtain an understanding of problems/areas of required audit emphasis. 5. A. Determine licensee's sales trend in terms of volume and product line mix. B. Determine the nature of licensee's operations regarding club Operations, extent of compilations and location of Manufacturing/distribution facilities. 6. Determine name of local copyright society and applicability of public performance and broadcasting (PP&B) fees. Fieldwork System Narrative/Walkthrough: 1. A. Prepare system narratives on licensee's policies and procedures in accounting for the following: i. Sales ii. Returns iii. Promotional Units iv. Free and Bonus Units v. Deletion and Discount Sales vi. Production/Purchases, including Imports vii. Physical Inventories viii. Maintenance of Royalty Records ix. Maintenance of Perpetual Inventory Records B. Perform walkthroughs to confirm your understanding of the Operating/accounting procedures.
-4AUDIT PROCEDURES Royalty Payments/Recoupment 2. Obtain support for payments made by the licensee and agree with the royalties reported on royalty statements. Schedule out the payments (royalty and advance) on a recoupment schedule and obtain additional support/explanations from licensee management with respect to differences. A. Obtain tax rates for the territory(s) under review and ascertain that the tax amounts withheld were correctly calculated. B. Ascertain that tax receipts were remitted by the licensee along with the net payment. C. Obtain applicable exchange rates for the payments made from the foreign territory(s) and verify that the payments were converted into USD correctly. Unit Accountability/Rollforward Review: 3. Review the licensee's system and method of recording sales and develop a testing procedure to verify that all units have been properly reported for royalty purposes. The approach to be taken depends on the nature of the licensee's systems, but the following audit tests are recommended (at a minimum): W/P REF. PERFORMED BY
A. For the quarters under examination, obtain and test or perform an overall rollforward of inventory units (i.e., beginning inventory plus production plus returns less sales and plus or minus inventory adjustments equals ending inventory). B. Reconcile unit sales in the rollforward to unit sales in the royalty statements. C. Agree unit sales in the rollforward to sales recorded in the general ledger by utilizing detailed sales records (e.g., sales register) and invoices to equate units to dollars.
-5AUDIT PROCEDURES (If the licensee's records do not permit an inventory rollforward in total, steps A, B and C above should be performed by selection on an extended test basis.) W/P REF. PERFORMED BY
D. For a sample of selections and related units reported in the royalty statements (sample should cover at least ____% of all units reported on each royalty statement), trace selection number and units to detailed sales records and, on a further test basis, to customer invoices and shipping documents.
E. Review physical inventories and method of booking adjustments. Substantiate purchases/production, returns, deductions from sales and product scrapping. F. i. Review Export Sales ii. Review Imports 4. Scrutinize production, sales and inventory balances for the quarters under examination for any abnormal fluctuations which may indicate unreported sales. 5. Review licensee's cut-off procedures to insure sales are reported in the proper period. 6. Determine that returns are deducted in accordance with the contractual provisions: A. Ascertain that negative sales are not reported (unless permitted by the contract). B. Review reserve retention practices. C. Determine the quantity of returns in each quarter. D. Determine that bonus units (e.g., 2 for 1) are reported as two units.
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-6Royalty Rates: 7. A. Compare the royalty rates applicable to each product line with the contractually stated rates in the licensee agreement. Investigate any differences and discuss with management. B. Ascertain that required approval for changes in product line (i.e., selling a medium line selection at budget line prices) have been obtained per the licensee agreement. C. Investigate unapproved changes in product line and discuss with management. Negative Sales: 8. A. Ascertain whether negative sales were reported by the licensee. B. Determine the total amount of negative sales and the amount of units involved. C. Investigate the reasons for the negative sales and discuss with management. Royalty Base Pricing: 9. Review and verify the percentage container and tax deductions for conformity with the licensing agreements. 10. Test to review the reasonableness of licensee's suggested retail price lists (SRPL)/constructed prices used to compute royalty base prices: A. Obtain licensee's price lists and recalculate the royalty base price per the license agreement for the product lines and periods under review. If suggested retail price does not exist, review constructed price in conjunction with official copyright agreement provisions and licensing agreement. B. In unusual situations when SRPL/copyright formula do not exist, visit retail stores to obtain selling prices of product and compare with constructed prices/royalty base prices.
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-7C. Test prices to sales invoices.
D. Determine applicability of invoking alternate clauses in the licensing agreements to insure that royalty base prices are reasonable. 11. If possible, obtain and review a copy of the most recent copyright society audit report.
12. A. Obtain price lists from licensee and recalculate the royalty base price per the license agreement for the product lines and periods under review. A. Compare results with the royalty base price per the royalty statements sent in by the licensee.
C. Investigate differences in the calculated and reported royalty base price and discuss with management. Compilations: 13. Determine that compilations are properly reported. Test to determine that all compilation listings have been sent for approval and assignment of a catalog number and royalty percentage. Public Performance and Broadcasting Fees Review: 14. Verify whether the licensee has received any public performance and broadcasting fees. If yes, determine whether licensee has paid (company name)’s share.
Interest: 15. A. Assess the total unpaid amount due by the licensee. B. Determine the lateness of both payments made and unremitted amounts. C. Apply the interest rate specified in the licensee agreement with respect to late and non-payment and calculate interest payable by the licensee.
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-8Other: 16. Review licensee's catalog and test check against royalty statements to ascertain unreported selections, including compilations. Trace unreported selections to inventory and sales records to determine whether sales were made during the period. 17. Determine that deletion/cutout sales (and low price sales) are reported to (company name) for royalty purposes unless the licensee has complied with contractual provisions relative to such sales on a royalty free basis (e.g., prior written consent was obtained from (company name).) 18. Determine that royalties are paid on promotional units except for units shipped to media/reviewers as permitted by the agreement. Report: 19. Draft audit report and review findings with licensee. Review audit findings with (company name) Finance, Business Affairs and Legal personnel. Follow up on settlement of claim.