Manufacturers work hard to track every piece of finished product; service companies are meticulous about knowing their human capital. But many companies with tight inventories in other areas fail to carefully manage their intellectual property—and that can be a costly error.
There are two potential problems with a leaky intellectual property (“IP”) program. First, you may not realize the full value of the IP you have. Second, even if you know you have valuable IP, you may still be leaving money on the table if you fail to audit your agreements on a regular basis.
In this post, we’ll explore the difference between the three main types of audits and discuss their uses and benefits. In the next posts in this series, we’ll delve into the
risks of not performing audits and how to audit revenue-generating contracts in any industry.
Royalties are common in a large variety of industries, from franchising and entertainment to manufacturing, electronics, software, aerospace and defense, and automotive makers. For example, GM designs auto parts that are manufactured by a variety of companies across the country for later assembly in GM factories. Similarly, computer companies like Dell pay Intel royalty fees to use their processors in their laptops.
A royalty audit examines these agreements for errors resulting in underpayment. Sometimes, the error involves a misunderstanding of the agreement by the company paying the royalty for your IP. Other errors include overstated deductions, problematic application of the calculation provisions in the contract, and unauthorized foreign subsidiary sales. In some cases, employee theft, problems stemming from product number changes, and intentional understatement of sales occur.
Profit Participation Audit
These audits are most common in the entertainment industry. They typically involve individuals or estates suing movie or television studios suspected of not properly accounting for contracted payouts. Examples include studios licensing a film or TV series to a cable network for less than its value or bundling successful films/series with less successful ones that have not reached the threshold for profit participation.
This more general audit aims to ensure vendor compliance regardless of where in the enterprise the relationship was generated. It seeks to uncover contractual errors and fraud and may incorporate one or both of the audits described above.
Benefits of IP audits
The most basic reason for having a robust IP audit program is to ensure you’re collecting the maximum amount of revenue from your licenses and contracts. Other reasons include:
- Increased compliance (when audits are performed on a regular basis, licensees are less likely to underreport revenues)
- Safeguarding your company’s reputation and IP
- Re-establishing compliance after an organizational change (a frequent cause of licensee non-compliance)
The word audit is often associated with a negative activity, but the outcome of an IP audit is the exact opposite—you’re ensuring that your standards of usage, distribution, and representation are upheld. For example, making sure your franchisees are adhering to your standards of customer service or ensuring that goods being manufactured by others under your company name are not causing a dilution of your brand.
Finally, when conducted regularly, audits serve to uncover unintentional noncompliance that could have derailed a licensee/franchisee relationship if left unnoticed, as well as establishing a precedent of “trust but verify” between you and those you contract with.
In our next post, we’ll cover the risks of not performing audits.
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.