As mentioned in the prior chapter on Licensee
Recordkeeping,
licensing is unique in that the customer
(the Licensee) must prepare the “invoice” (the royalty
report) to notify the Licensor how much they owe. Good business judgment
and common sense dictate that Licensors should periodically visit
Licensees to verify the accuracy of the royalty reports and complete
other contract compliance testing that must be, or is more easily,
completed at the Licensee's location. Licensors also have a duty to
their other Licensees to complete these visits and tests. For Licensees
competing with other Licensees, the On-Site visit is necessary to
ensure competitors are also accurately reporting their sales and paying
royalties in a consistent manner – that
they are both “on a level playing field.”
Preparing for an On-Site Compliance Review is the “flip side” of
keeping records. Keep good and adequate records and the review is a
snap. When records are poor, the review is usually a nightmare. Proper
preparation for the On-Site Compliance Review is completed daily. There
will be small “last minute” preparations, but they should
be minor. Start preparing for the On-Site visit as soon as you sign
your License Agreement – as you are setting-up your “royalty
system.”
Understanding the Licensor Objective
Licensors view On-Site Contract Compliance Reviews as a necessary
cost of doing business. Sophisticated Licensors prefer that there not
be any recoveries – that their Auditor's report indicates the
Licensee has a royalty reporting system in-place to ensure they accurately
report the licensed Net Sales. Licensors (and those they send
to visit Licensees – whether in-house employees or independent
contractors) DO NOT view or want the visit to be perceived as adversarial.
Consequently, few Licensors will contract with outside “contingency” Auditors – those
who receive a percentage of “audit recoveries.” In fact,
you should view the visit as the source of possible ideas to simplify
and further improve you royalty-reporting systems. Most Auditors understand
that no one likes others to check them. Therefore, an experienced Auditor
will go out of their way to make the visit pleasant – help them
in this effort as much as possible.
Audit Yourself
Your “audit” objective should be to make sure you do
not make and overlook large mistakes. Usually, a review will note an
error or two. As hard as we try, as much as we check and recheck, we
usually make a mistake now and then. You simply want to make sure any
overlooked errors are small. This requires that you audit yourself!
The Licensor is sending someone to hopefully verify you have controls/checks
and balances in-place – they are happier if you have already
completed in-house audits, on a monthly basis.
You do not have to be an Auditor to use some of their techniques.
An Auditor starts with the reasonable assumption that everyone makes
mistakes. Reviewing what we have prepared is important, but too often
we overlook our errors. It is far more important that we “check” (verify
independently) what we have done. In the last chapter (Licensee
Recordkeeping) we outlined simple steps you should complete, as
a part of the licensed sales accumulation and royalty reporting process,
to note any significant reporting problems. They are:
- Before you use the report from which
you obtain your licensed sales for reporting,
make sure the report is accurate – compare
it to another Company report that you know
is correct.
- After you complete the task of “pulling” numbers
from this report, verify the amounts are
correct by comparing the total to an adding
machine tape of the licensed item/style
sales.
- After you prepare the reporting forms
for submission, compare the total sales
on the reports to the amounts in the prior
steps.
- And I suggest to Licensees that they
periodically (once or twice a year) review
invoices, note licensed sales and make
sure they are properly accumulated on the
required sales to the invoice level reports.
This will catch the other reporting “sins” that
might otherwise be overlooked.
The Auditor's question (whether asked directly or indirectly), is “How
do I know the amounts are correct.” The best answer is: “Because
we have audited them. We have checks, within our report preparation
process to verify the amounts are accurate.”
Preparation for the On-Site Visit
The following is what we normally ask Licensee to prepare for us – this
makes our visit and testing as efficient as possible for both us and
the Licensee. There may be other reports and documents required to
complete the testing, based on an understanding obtained in the initial
discussions, but the following are the major requirements.
- Have all past (or since the last On-Site
Compliance Review) royalty reports available
and in date order. The Auditor may have
copies of all reports, or more likely they
will use copies of your royalty reports
since they may only have a summary of the
reports, but not the actual reports themselves.
Do not make copies of these reports – the
Auditor will use and return them to you.
If you keep your royalty reports in files
with other correspondence place the royalty
reports in separate files. Make sure you
have a royalty report for each period – if
you are missing a report, contact the Licensor
for a copy to complete your files.
- Also have the royalty report backup
(the reports from which you obtain your
licensed sales) available for each period.
Have these reports in date order, as well,
so the Auditor can locate them quickly.
- Catalogs and price lists for the review
period.
- A list of all your Company locations
and what you do at each – this includes
Outlet Store and Retail locations, if applicable.
- Read the License Agreement.
This should have been done before the contract
was signed (or certainly before preparing
and submitting the first royalty report),
but it often is not. Make sure, however,
you read it as preparation for the On-Site
visit.
The Visit
The first few minutes will set the tone for the entire visit. Remember,
as mentioned earlier, the visit is not adversarial! The purpose of
the opening “interview” is to obtain an understanding of
your operation so the work can be completed as efficiently as possible.
Initially the Auditor should talk with the employee preparing royalty
reports, and others in your Company you think appropriate, to understand:
- How you code licensed styles/designs
within your Item Master File system.
- Your basic inventory system and computer
reports. This will include determining
whether the licensed articles are manufactured
by you or purchased complete.
- The processing procedures as you receive
orders and then ship and invoice licensed
product – your sales/accounts receivable
system including the number of invoice
copies and their distribution or filing,
etc.
- How you identify and accumulate these
sales for royalty reporting – your
procedures and personnel for preparing
royalty reports, including determining
if any changes in procedures and/or personnel
have been made during the review period.
The opening interview will generally be completed with a tour of
your facility.
It is helpful to have sample copies of a few licensed sales orders
and invoices available. It helps to have a sample to look at instead
of trying to understand by talking theoretically.
Testing
The objective of testing is to verify the Licensee properly reported
all sales of the licensed product – both the units sold and the
price at which they were reported. If you have good records, and have
completed the limited preparation requested, you will probably be surprised
at how little time you must devote to helping the Auditor.
The most common, significant, errors are:
- Overlooked licensed items/styles.
- The report from which licensed sales
are taken is not accurate or the sales
amounts, on this report, are less than
the License Agreement's defined Net
Sales – the Licensee improperly
excludes some sales, allowances or sales
discounts from the reported sales.
- Clerical errors in the preparation
of the royalty reports.
- More recently, with increased overseas
manufacturing, Licensees sell product outside
their licensed territories – for
example, FOB the Orient. Any time you sell/report
licensed sales at less than your “normal
wholesale selling price,” beware,
additional royalties are PROBABLY due on
these sales. Again, read your License
Agreement very closely.
Closing Interview
At the conclusion of the testing and visit, the Auditor will probably
review the finding with you – what will be reported to the Licensor.
This is the last time I will mention the caution of not making the
visit adversarial. The Auditor is simply relating what will be communicated
to the Licensor. It is appropriate to ask if certain issues are negotiable
(with the Licensor), but the Auditor seldom has any decision-making
authority. If you feel the Auditor has not understood something correctly,
you can try to make it clear. But, again, the Licensor has the final
authority and you can, in these instances, write them and explain the
situation or your position.
That Easy?
We ended the previous chapter on Licensee Recordkeeping with
the same question, and it is equally appropriate here. If you have
maintained adequate records, and included in your licensed sales accumulation
and royalty reporting process “internal (simple) audits,” the
On-Site Compliance Review will be a “snap.” And, even if
you haven't, you should benefit from the visit by receiving the input
of someone that may make the task far easier and more accurate. |
