Licensing management

Royalty audits: Improving the value of intellectual property

Intellectual property rights, including patent rights, are an important source of profit for a company, and the strategic management of intellectual property rights is becoming more and more important. When a company (a licensee) enters into a license agreement (for manufacturing technology, software, brands, trademarks etc.) with another company (the licensor), the licensor typically receives a royalty from the licensee. However, the licensee is often the one to calculate and report the necessary payment amounts, and differences and errors in the interpretation of the contract can make it easy for the licensor to overlook underreported royalties.

Royalty audits by our forensic services practice

PwC’s forensic services practice has performed many royalty audits for licensors in a variety of industries by leveraging PwC’s global network. We also have experience in accounting audits to help licensors exercise the auditing clauses included in license agreements. Specifically, we recalculate royalties using accounting data (such as the licensee’s sales data) to verify and report the validity of the royalty amounts from various perspectives. These perspectives include the completeness and accuracy of the data used, and the consistency of the royalty calculation process with the details stipulated in the contract.

In addition to detecting underreported royalties, we also report any breach of contract or potentially problematic interpretation of the contract that we find. This can help you gain a greater understanding of potential future problems related to increases in royalty income and similar issues in other licensing agreements. Continuous communication with your licensees through royalty audits can also help you foster trusting relationships with the licensees.

Examples of findings (underreporting) from royalty audits

Failure to extract data of products subject to royalties

• Some products subject to royalty payments were not reported, because a code setting error occurred during the extraction of data for licensed products subject to royalty payments.
• The number of divisions selling products subject to royalties increased due to the acquisition of an overseas business, but the licensee did not notice this increase, and did not report any royalties for the new divisions’ sales.
• The licensee did not report the shipment of prototypes and samples, although they were contractually obligated to do so.

Calculation and aggregation errors

• During a personnel change, the new person in charge was not sufficiently trained, and used an incorrect method to calculate royalty payments as a result.
• The foreign exchange rate was incorrectly calculated when sales amounts were converted from Japanese yen to US dollars.
• The local staff at an overseas subsidiary were entrusted with calculating that subsidiary’s royalties, but the calculation methods they used did not conform to the license agreement.

Misinterpretation of the contract

• The licensee used an overly broad interpretation of the items subject to deduction (e.g. transportation and packaging expenses), and deducted expenses unrelated to the licensed products as a result, which led to the underreporting of royalties.
• For sales to a consolidated subsidiary’s distributor, royalties that should have been calculated using the market price for third parties were calculated using an intra-group sales price that was below market value.