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Crash Course Part I: Underpayments and What to be Aware of

Without years of professional expertise, conducting a royalty audit or participation audit can appear daunting. This article will provide a crash course on the most important things you should know to recover your clients’ unpaid monies and reduce exposure.

In order to manage compliance, clients generally have a team of professionals consisting of attorneys (to negotiate fees, installments, deferments, and back-end calculations), a business manager, an agent, a manager, and an auditor—who should be seen as an integral component of the client’s team in managing compliance issues.

Because there are likely unpaid monies that are owed to royalty and profit participation earners, “royalty audits” and “participation audits” are crucial. In the film and television industry, for example, there is a large range of underpayments that clients can be exposed to:

  • Under-reported gross receipts for the reported revenue channels

  • Under-reported barter

  • Completely unreported revenue channels

  • Inaccurate distribution fees

  • Miscalculations and overstatements of distribution costs (including advertising, prints, and shipping)

  • Vertical integration issues (self-dealing with affiliated entities)

  • Improper calculations of breakeven

  • Straight-lining of package license fees

  • Failure to obtain necessary authorization

  • Failure to render (or continuing to render) statements

Any or a combination of these underpayments can be caused by mistakes; system inflexibility; contract interpretation; upper management “company policies”; and even dishonesty .

Fortunately, there are several solutions to recover your monies owed:

  1. “Royalty Audit” & “Profit Participation Audit”

  2. “Desk-Audits”

  3. Ongoing Income Recovery (the Gold Standard)

  4. Other Audits (e.g., business manager)

In order to maximize your security in recovering your lost funds, it is important to be aware of special accounting and audit contract provisions. Attorneys drafting an agreement should require that statements include specific and relevant details that you need; incorporate interest penalties for late reporting when possible; understand and address the deductibility or non-deductibility of foreign withholding taxes; recognize a good objection period of 3+ years as well as an additional 6 to 12 months for litigation to commence; and note the following audit rights:

  • There should be no restriction on hiring any qualified auditor

  • If possible, you should get a reimbursement of audit costs if the results disclose a 5% error

  • There should be no limits or restrictions on the books/records that can be reviewed and copied for the Auditor to retain

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