5 Phases of a royalty audit
In her TAA webinar, “The Anatomy of a Royalty Audit”, royalty auditor Juli Saitz, senior managing director for Ankura Consulting Group, shared the five phases of a textbook royalty audit: preparation, paperwork, communication with the publisher, document analysis, and the publisher’s response.
1) Preparation phase. This phase consists of three parts: talking to the client, reviewing contracts, and reviewing statements.
When talking to the client, Saitz says her first goal is to understand why the author wants to perform an audit, including what the issues are, what the author has heard about in the past, whether there have been identified errors, and what makes the client feel uncomfortable that would warrant the audit process.
After the initial discussion, she reviews the contract, looking for unusual situations specific to the manuscript or author to ensure that the royalties from these areas are properly calculated. For example, special rates associated with a specific distribution channel (i.e. VitalSource) or a specified market (i.e. the K-12 sector).
Lastly, she will briefly review the royalty statements to identify the number of ISBNs associated with the work and any specific trends over time. For a more accurate trend analysis, “the more statements provided by the author, the better,” she says. The discussion and review that takes place during the preparation phase is then used to determine if an audit is warranted before proceeding to work with a client.
2) Paperwork phase. This phase consists of four parts: the engagement letter, release of records, non-disclosure agreement, and document request list.
The engagement letter serves to engage the auditor with you as a client in the audit process, says Saitz. It defines what the auditor will do, how they will be paid, and other important details of the audit process. The engagement letter can be written to an attorney with you as their client and doing so has a few benefits, she says, including:
- An attorney is useful if litigation with a publisher is possible or if the publisher is not cooperative with the audit process.
- By incorporating an attorney, attorney/client privilege is implemented protecting all communication between the auditor and author in the process.
- If the publisher is not cooperating, the attorney can draft letters to the publisher on your behalf for compliance with requests necessary for the audit.
The release of records signed by the author, authorizes the auditor to request records on your behalf. This document is sent to the publisher, thereby putting them on notice of audit, she says.
After receiving the release of records document, the publisher will generally request that both the auditor and author sign a non-disclosure agreement. This agreement is in addition to any non-disclosure clause that may already be present in your publishing contract, but applies to the auditor, attorney, and author involved in the audit process. If the author is not included, the auditor cannot share results with you as the client, so Saitz advises that you verify that you are included in this document. This document generally takes 1-3 months to get from publisher, she says.
The final component of the paperwork phase is the document request list. The additional documentation needed varies based on the author, but these requests will identify any special items needed by the auditor. Typically, it takes another 1-3 months to get documents from the publisher, so requesting them early in the process helps to shorten the overall timeframe for the audit, she says.
3) Communication with publisher. The first step to take in communication with the publisher is to ask for an audit, says Saitz. Additional communication between the auditor and publisher will be done in accordance with the audit clause of your contract. The absence of an audit clause in your publishing contract, however, does not mean that an audit cannot be granted. In many cases, the publisher will agree to an audit even in the absence of the clause, however, if refused, a lawsuit for an accounting is possible for remedy in extreme situations.
Once the audit process is underway, the auditor will begin exploring elements associated with packages, bundles, electronic components, exclusions, and escalation clauses present in the contract while waiting on the requested documentation from the publisher, says Saitz. The intent of this exploration process is to determine for what you as the author are entitled to receive payment and whether the right rate has been applied to the edition, package, format, etc. as documented in your royalty statements.
4) Document analysis. This phase involves the primary role of the auditor in their efforts to identify discrepancies, says Saitz. It begins with number crunching efforts from the author-provided royalty statements and compares the reported values with the information received from the publisher in response to the document requests discussed above.
The number crunching efforts take PDF versions of the royalty statements and extract data into Excel for filtering on various details of the data, she says. The auditor uses this data to explore rates, subsidiary rights, types of sales over time, overall unit sales, top selling works over time, price per unit over time, overall revenue trends, and deductions in accordance with the contract.
The auditor will then compare the information from the royalty statements with the information received from the publisher. The main documents typically received by publisher are: detailed sales records, bill of materials, subsidiary rights agreements, and inventory records.
While reviewing detailed sales records, the auditor wants to see sales records for both packages and component sales (what is credited to your contribution to the package). Saitz noted that package sales are a common place for discrepancies either in quantity or value of contribution. Underlying invoice records should support the sales records provided.
The bill of materials guides the package structure and value attributed to components of the packaged books. It is used to identify whether the author is getting a fair representation of value for their work included in the package.
Further, subsidiary rights agreements can impact royalty calculations and may be requested by the auditor. Sometimes a different rate may be applicable for sales of work between third-party publishers vs. subsidiaries of the publisher.
Finally, one of the best sources of information for an audit is inventory records. Saitz says, “Inventory records can help corroborate sales records because you want to see what was made, what was shipped out (because it was sold), what was returned, and what was destroyed.”
5) Publisher’s response. According to Saitz, almost all audits result in findings with an average of 15-20% in underreporting of royalties. Findings are either 1) clear mistakes and/or miscalculations or 2) disagreements over contract interpretation. Those findings are reported to the publisher either formally or informally and may include actual or estimated underreporting values based on the amount of data analyzed.
After reporting findings to the publisher, the response time may be 2-6 months. Based on what they agree with from the findings, there will be negotiation and payment. Due to response times throughout the process, start to finish an audit takes 9-18 months.