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AUDIT

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A formal, and in the case of an IRS inspection, an official examination to verify the validity of accounting records such as those which record income, exemptions, and deductions. (For more detailed information concerning IRS audits, obtain tax publication #556 from any IRS office.)

In the record industry, royalty audits are very important. Royalty audits are undertaken to determine if proper distribution of royalties has been made by a contractor or licensee. The money trail in the music business is extensive and often complicated. Therefore, the audits undertaken to substantiate total income may also be complex. For example, an artist may audit a record company, record producer, production company, commercial producer, mechanical licensee, synchronization licensee, multimedia licensee, name merchandiser, or foreign licensee. There may also be third-parties involved such as a record company's record and tape club licensees. And, if the artist has also written his own material he may also audit the music publisher and performance rights society. All this just to insure that the full payment of royalties has been received!

The right to audit is defined in the "right to audit" clause of a particular contract. This clause must be included in all contracts (where accounting is involved) to enable separate accountings of the same transactions. For example, with this clause in all contracts, a record company's accounting of records sold could be cross-checked with the mechanical rights society's accounting of records sold. Just the presence of this clause will go a long way to insure that the proper credits are being made to the licensor's account. It is possible, however, even with this clause that the licensee may refuse to allow an inspection of their books. Here, legal proceedings against the licensee may be necessary to enable the audit. In an effort to insure the right to audit some licensors will attempt to add a default clause that states that the contract can be terminated by the licensor in the event an audit is refused. Usually audits are not made to substantiate integrity, but rather, are undertaken because of the complexity of the business transactions involved. See Cross-links: CONTRACT-RECORDING CONTRACT clause #39, CONTRACT-SONGWRITER/PUBLISHER CONTRACT clause #29

As can be imagined, it can be very costly to carry out an audit. Therefore, sometimes it is not even cost effective to follow through with it.

A CPA's fees usually include an hourly rate plus expenses. The work involved may be extensive. For example, the audit involved to substantiate an artist's royalty statement may include: analyzing the contract(s) involved, reviewing the artist's royalty statements, doing a preliminary estimation of the potential recoupment to determine if an audit will be cost effective, sending written notice to the proper party(s), securing legal access to the proper account(s), analyzing the accounting system, determining if the accounting records do in fact reflect all the special provisions contained in the contract(s), inspecting the accounting records to determine if royalties are owed the artist, submitting a report claim, and collecting the royalties due (which may involve litigation).

See Cross-links: INTERNAL REVENUE SERVICE (IRS), COPYRIGHT MANAGEMENT COMPANY, TAX AUDIT, TAX LAW, TAX AVOIDANCE-A CLOSER LOOK, ACCOUNTANT under "Certified Public Accountant," ACCOUNTING under "Royalty Statement," ROYALTY under "Artist Royalty."
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Right to Audit:
A contract clause that entitles the licensor the right to audit the accounting records of a licensee in order to confirm whether or not the licensee is fulfilling the terms of his contract. See Cross-links: AUDIT, CONTRACT-RECORDING CONTRACT clause #39, CONTRACT-SONGWRITER/PUBLISHER CONTRACT clause #29.

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