In our previous posts, we outlined the differences between the three main types of audits (royalty audit, profit participation audit, and contract audit), examined their uses and benefits, and looked at the consequences of not performing sufficient audits. Now it’s time to discuss the elements of an expert Intellectual Property audit.
First, you’ll want to select an Intellectual Property auditor who not only specializes in this type of work, but is an expert negotiator (often, disputes can be resolved without litigation). The auditor should also have the necessary technical acumen to conduct the audit, access to resources such as engineering or technical experts, strong litigation skills, and an ability to be persistent.
The audit begins with an initial letter to your licensees asking for specific documentation such as:
- Deductible costs
- Units and sales amounts
- Product numbers
- Currency translation used
- Figures related to internal product uses, promotional uses, returns, and amounts manufactured but not sold
- Royalty rate calculations
The audit itself must include a comprehensive examination of multiple aspects of the agreement and current procedures.
- Verify that the licensing agreement includes detailed definitions such as how sales figures will be reported and what currency the royalties will be paid in. It should also include an audit clause and spell out the procedure for arbitration, should it become necessary.
- Examine any special terms in the agreement such as secondary branding requirements, quality control requirements, terms related to accommodating tax situations, and periodic sample product evaluations.
- Review classifications such as category, product line, and retail price.
- Review sales data, royalty data, inventory figures, production figures, and prior audit reports.
- Review minimum guarantees to verify accuracy.
- Review exchange rates being used.
- Review taxes being deducted and the escrow procedure being used.
Although the audit should cover all aspects of the agreement, make sure no areas with high potential payoff are left out or under-examined. Those areas include under-reported sales due to related product lines using licensed technology, poor adherence to contractual requirements, cost allocations that unfairly burden licensed products, and product bundles designed to work around licensing.
If you’re in computer hardware or software, pharmaceuticals, medical devices, telecommunications, consumer products, aerospace/defense, entertainment/music, or franchises, conducting regular, thorough audits is the best way to protect your company’s Intellectual Property and corporate reputation.
This blog post was written by Veronika Fritz. Veronika is a Managing Partner with Vonya Global, a premier provider of internal audit consulting services. Veronika is a CPA with over 18 years of audit and management experience. Her experience covers all areas of business including compliance, financial, operational and IT. She has led the planning, development and successful execution of financial audits, Sarbanes-Oxley Engagements, pre- and post-implementation ERP system reviews, and business process evaluations. Veronika has expert knowledge in evaluating the design, integrity, effectiveness and reliability of internal controls for financial reporting processes and Enterprise Resource Planning software. She has been a trusted advisor to companies spanning various industries.