Introduction
According to Merriam-Webster, the definition of an audit is “a methodical examination and review” (Merriam-Webster). Throughout this whole semester, our class discussions have been about the audit practice and the process of auditing companies’ financial statements. There are many other instances where an audit is necessary to produce opinions, outcomes, and conclusions. The music industry consists of different segments where an audit is needed to make sure everyone is getting what they are entitled to whether it is the artist, songwriter, or the producer. I will discuss the roles of a royalty auditor and the process they go through during their audits. I will also point out royalty frauds that can occur within the music industry. But first, I will explain exactly what a royalty is and how it works.
How Royalties Work
A main concern in the music industry is royalties. It is the main source of income for anyone who has something to do with a particular song. A royalty is a payment made for the use of property, such as a patent, copyrighted work, franchise, or a natural resource (Investor Words). It can be a percentage of profit from sales and will be settled by an agreement (usually in writing) between the parties (Obringer). Songwriters and publishers have different royalties than the artist who performs it or records vocals on the song. The artist gets royalties from the sale of their recordings such as CDs. One misconception in the music industry is that the artist gets royalties from public performances such as when their song gets played on the radio or television, but in fact the songwriters and publishers get those royalties from those instances (Obringer).
There are four general categories of royalties. Mechanical licenses and royalties refer to the permissions granted to record the songwriters’ song and publicly distribute it. Performance right and royalties allows the song to be performed live or broadcasted. Synchronization rights and royalties are needed for a song to be reproduced on a television show, movie, or commercial. Lastly, print rights and royalties are paid to songwriters and publishers based on sales from printed sheet music (Obringer). Keeping track of who gets what royalties and how much is the responsibility of performing rights organizations (PRO). The main PRO’s in the United States are The American Society of Composers, Authors, and Publishers (ASCAP) and Broadcast Music, Inc. (BMI) (Obringer). They have different methods of capturing the data about where and how each song was played or performed.
Royalty Auditing
Most license agreements have an explicit or implied audit right, yet many companies, artists, songwriters, and such do nothing to ensure they are receiving the full amount to which they are entitled. A royalty audit is when the licensee’s books and records are examined and inspected to ensure that they paid the licensor the correct amount they owed. Usually the licensor hires a royalty auditor that is usually a certified public accountant, lawyer, or business advisor whom averages a salary of $70,000/year (Simply Hired). Different small accounting firms offer artist royalty services, some usually under its forensic practice. Other accounting firms offer royalty services under its tax practice because some audits are done solely for tax purposes.
The auditor examines sales figures, accounting practices, royalty rates, and other data of record labels, music publishers, film and related distributors (H&H Music Group). Royalty audits are expensive and can cost up to $30,000. One advantage of royalty audits is that the findings of excess royalties outweigh the cost of the audit. In most license agreements, if the auditor identifies additional royalties with a threshold between 2% -5% of what was initially reported, the licensee pays the cost of the audit (Throckmorton).

When an audit is done thoroughly some of the findings include: * Incorrect royalty rates * Excess free goods * Returns improperly allocated to free goods * Understated foreign retail price or uplift * Unreported music video license fees * Incorrect tax computations * Unreported excess free goods for record clubs * Invalid producer-based advance deductions * Overstated video production and recording costs * Overstated promotional expenses * Improper expense allocations * Incorrect royalty calculations for club sales * Underreported and unreported units * Unlicensed songs * Excess reserve calculations
(Nigro Karlin Segal & Feldstein, LLP)
A royalty auditor goes through different procedures during an audit. Some of these procedures are: * They secure and review accounting records for sales data, royalties, prior audit reports, and licensing agreements. * Verify that administration fees deducted on co-published songs were correctly calculated * Review of earnings reported for record companies to ensure payment for all songs that have been released on those labels. * Review that songs have performance earnings from PRO’s and that they were paid at the proper percentages and rates. Improper registration of songs with PRO’s could lead to reduced earnings. * Confirming proper payment of print income such as sheet music.
(Stillo,1995,pg.6)
We have learned that the main objective of an audit of financial statements is to provide an opinion. Likewise, the objective of a royalty audit is to produce a report on the discrepancies that the auditor found. The report consists of the type of royalty, a reason to why the royalty is included in the report, the amount that was actually paid, and the amount that should have been paid (Royalty Compliance Auditing).Usually the differences will be resolved between the auditor and the licensee’s royalty or bookkeeping department. If any issues of a contractual nature cannot be resolved in the former way, the issues are resolved in a meeting between the licensor and the licensee alone or with their respective legal representatives. Furthermore, if those issues still can’t be resolved than legal action is required and settled either through the courts or by arbitration (Royalty Compliance Auditing). Fortunately, most audits are settled on a friendly basis between the two original parties.
Royalty Frauds
As we all know, we live in a world where there are criminals who try to take advantage of and deceive other innocent people. Fraud in the music industry is known especially involving royalties. Recently in the beginning of 2012, 11 people in the UK were caught and sentenced to prison for scamming iTunes and Amazon. A simplified example of how music and royalties work with iTunes is that the artist pays a flat fee to the distributor and uploads their own music to the website. When the music is bought, iTunes pays the royalties to the artist (Boxall).
The ringleader of this scam, Denver White, and his crew uploaded songs iTunes and Amazon and bought their own songs with stolen credit cards. iTunes caught on to the fraud when they realized they were paying basically the same amount of royalties that they pay to Madonna to a “unknown artist” (Boxall). The fraudsters used software to cover up their computers IP addresses but the UK government found them anyway. White and alliances made a net profit of 500,000 pounds an equivalent of $800,000. This scam cost iTunes and Amazon between 750,000 to 1 million pounds, an equivalent of $1.5 million, after compensation had been paid to those whose credit cards were stolen and used (Boxall).

Conclusion
Royalty auditing is one of the many things you can do with an accounting degree and a CPA license. Partnering with artists, producers, songwriters, publishers, and record companies to make sure that everyone is being treated and paid fairly is a big job to have. Music is very near and dear to my heart because I am music producer. I plan to use my business degree and my musical talents to open my own studio and eventually own my own recording label. Learning about royalty audits in depth and auditing in general will help me out in the long run. It gives me an advantage to know what I am entitled to for my art.

Bibliography

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