Choosing your entertainment royalty and profit participation auditor

By Ilan Haimoff and Grace Guenon; GHJ (HLB USA)

Unlike compliance services like tax preparation or financial statement audits, which are more commodity-based, entertainment royalty and profit participation audits are forensic consulting engagements that are especially crucial in the entertainment industry. These audits require extensive, specialised experience in the intricacies of entertainment contracts, royalties and revenue-sharing arrangements.

Choosing the wrong profit participation auditor can significantly impact financial outcomes and business relationships. Some examples HLB has heard from clients in the entertainment industry about their past experiences include:

• Could not complete the audit due to dissolution of the audit firm or abandonment of the project (especially if they are on a contingency arrangement)
• Did not identify any issues
• Have not communicated timely the anticipated loss of audit rights due to tolling deadlines
• Highlighted a significant issue which turned out, after incurring additional litigation fees, to be immaterial or factually incorrect

Profit participation audits can typically only be performed once! Therefore, to quote Indiana Jones and the Temple of Doom: it is important to choose wisely when picking a profit participation auditor.

In choosing a royalty and profit participation audit firm, it is important to consider the following factors.

Experience

Generally, the more experience the firm can demonstrate — and particularly current experience at the applicable studio or distributor — the more value is derived from the audit. This is the most important factor since such experience would help the firm provide a reliable recommendation as to whether or not an audit is worthwhile. Furthermore, if a profit participation audit is recommended, the audit firm should be able to determine what areas of risk need focus, which would lead to a more cost-efficient and effective review.

In addition, the firm should be able to provide insight regarding the entertainment studio’s process, which is helpful while you navigate through the audit and settlement process. The audit firm should have an established working relationship with the studio, with regular and ongoing points of contact to help facilitate an efficient audit process and to help coordinate between the client and the studio or distributor as needed.

Return on investment

The relative costs and ultimate value are typically considered by clients. Therefore, the profit participation audit firm should have the necessary experience and technical savvy to identify those issues that result in the most settlement value and do so with efficiency and cost-saving strategies. While there are no guarantees, the key would be the underlying experience at the studio and the general technical knowledge, to increase the likelihood of a positive return on investment to clients.

Reputation

The entertainment industry, especially in relation to profit participation audits, is a small community. Consider asking for a recommendation from colleagues or friends in the industry who can provide a solid recommendation based on their experience.

Pre-approval

The studios often pre-approve firms within your agreement (refer to the audit paragraph of the applicable contract for a list of such firms). Pre-approved audit firms have earned their recognition as firms with deep expertise in profit participation and an understanding of the audit process at the studios. If choosing an audit firm that is not pre-approved, be sure that your selection is acceptable to the studio.

Viability

In most cases, a profit participation audit can take a substantial amount of time to complete and settle, possibly years. It is important that the firm is viable and will be able to perform the review, complete the audit report and be available to assist with the settlement discussion (or litigation, if necessary).

Customisable approach

Regardless of whether the audit relates to a motion picture or television series, and depending on the structure of the underlying participation deal — or the applicable studio or distribution company — the audit procedures and related audit fees should be properly tailored (e.g., limited or extensive review) and focused on cost/benefit analysis and risk analysis.

When choosing an audit firm, ensure that the proposed scope has been developed to address your needs and the key areas of risk applicable to the deal. The firm should be able to customise each engagement to address any specific concerns the client may have, which should be clarified within the engagement letter.

Client service

It is important to pick a profit participation audit firm that is responsive and available throughout the audit process and help the client navigate the pre-audit and settlement process. From the initial statement review and recommendation stages through the review of the final settlement agreement and amount, the firm should be available and provide support. Furthermore, the firm should be able to help to facilitate communications with the studio as needed.

As most agreements have specific deadlines for when such a review can take place, it is important to properly track any applicable tolling (or other) deadlines to preserve audit rights. Although tracking such tolling is not the audit firm’s responsibility, it is important for the audit firm to be aware of such deadlines and have an internal process to help alert clients of tolling extensions needed, especially while the audit is process.

Price

While the price factor is important, consider the following:

Does the audit firm represent other participants with which the fee can be shared? If yes, the overall cost of the audit may be shared, which can be cost-efficient for you.

Are the proposals you receive comparable? If an audit firm charges less, will they put in the same number of hours and effort? Through what point of engagement will the fee cover? (e.g. through issuance of the final report, assistance in settlement discussions, etc.)

What is the ultimate return on investment based on the experience of the audit firm? It is possible that, while one audit fee proposal may be lower than another, the ultimate settlement value could also be significantly lower.

If contingency arrangements are available, it is equally important to consider the below:

The audit firm may potentially stop auditing if value is not found

The audit firm may take aggressive positions, which may lead to costly (and possibly unnecessary) litigation and the prolonging of the ultimate settlement.

If litigation is pursued, the audit firm cannot act as the expert as they may be conflicted.

Consider why the audit firm is willing to go with a contingency arrangement, since it may mean leaving money on the table.

Timeliness of audit; how HLB can help

With contractual tolling restrictions, length of the queue and the limited studio resources available to support profit participation audits, there are certain limitations beyond the audit firm’s control to be able to anticipate the date by which an audit can start. If you have reasons to have a rush start, this should be discussed with the studio directly to see if they could accommodate, regardless of your audit firm selection.

At HLB, we provide trusted guidance to make your audits thorough and effective. Using our expertise and extensive global connections, we help you maximise your audit outcomes while protecting your business relationships.

Our dedicated experts are here to support you every step of the way. Contact us today to learn how we can drive success for your business through exceptional audit services.