I performed thirteen trademark licensing audits in the past six months for five different corporations. Theses audits were contracted and overseen by Internal Audit (IA) for only one of these five clients. Upcoming audits we scheduled or are scheduling with three other clients are similarly contracted by functions other than IA. All these clients have an IA function. There are several reasons why IA should oversee trademark licensing audits. So why is co-sourcing for trademark licensing audits left to others? IA leaders must communicate the organizational necessity of their contracting and overseeing the trademark licensing program.
The Licensing Department is typically a small group in the enterprise. For this reason, the function may be partly overlooked when preparing full process and controls documentation. Royalty income from trademark licensing is typically not subject to the internal control procedures used for other sources of revenue. If invoices are issued for royalties, these are typically for guaranteed minimum royalties or estimated royalties using manual invoicing either within or outside of your ERP system. Internal control activities should include the oversight and analysis performed by the internal licensing accounting team to arrive at these invoiced/recorded revenues as well as tracking/recording other obligations of the licensee. Do they analyze and recalculate all the royalty statements, submissions for advertising and other reporting provided by the licensees? Do they reconcile all payments and follow-up on late/missing payments? Is there sound internal communication of exceptions (e.g., sales to Warehouse Clubs outside the license agreement) from the licensing team to the accounting team so that they expect/accrue/invoice these additional royalty receivables?
There are two aspects to the controls over the licensing function. The internal processes of the licensing/accounting team to oversee and record the current activity and the audit of licensee books and records to validate the complete and accurate reporting and compliance with the licensing agreement. To the extent that non-compliance is identified by licensee audits and additional amounts are due, there is a shortfall in the overall internal control process because such recoveries are recorded in an accounting period subsequent to the period in which they are earned. This risk of understatement is inherent to licensing due to reliance on complete information from an outside partner. To reduce this risk to an acceptable level, the trademark licensing annual risk assessment (see my prior blog) which determines the frequency of audit of each licensee should be a key control. Those licensees deemed of a higher risk should be audited more frequently to ensure the complete and accurate revenues are captured during or close to the appropriate financial reporting period. Performance of the licensee audits by IA either directly or through co-sourcing partner with IA setting the parameters and scope becomes an extension of the Internal Audit plan and a service that IA provides to the business. Oversight of licensee audits by a business function requires IA to document and test the oversight performed by this function. Direct oversight of licensee audits by IA is a more timely and effective approach.
The independence of the IA function and especially the reporting to the Audit Committee should not be understated. My experience as a Chief Audit Executive (CAE) for a company with more than 30 licensees highlights this distinction. The licensee audit co-source partner was overseen by the Finance function for many years prior to IA adding this oversight to our responsibilities in the early 2000s partly as an extension of oversight in response to SOX requirements. Many of the licensee audits ended in negotiated settlements prior to our oversight. We brought the rigor and structure of an IA approach in coordination with the same co-sourcing partner which eliminated many of the “gray areas” in the findings. More importantly, the licensees recognized IA as an independent function with the weight of reporting to the Audit Committee and knew that there was little room for negotiation of amounts due. The result was incremental recoveries of several hundred thousand dollars each year and a more responsive attitude on the part of licensees to address the issues that led to the findings. Following IA leadership of licensee audits, the only negotiated settlements were related to contract terms that were truly ambiguous and for which we tracked such issues to a future contract addendum to clarify the ambiguity.
Our experience was that IA oversight and follow-up led to a higher level of licensee contract compliance over time. The number and amounts of recoveries decreased, which was our goal. The decrease in recoveries directly reflected an improvement in the completeness and accuracy of licensee reporting and payment. This meant that the accounting for licensee activity likewise improved as did the timeliness of cash flow from licensing. Adding the oversight of trademark licensing audits to your audit plan is one more way to leverage compliance to improve business process and profitability for your Company.
About the Author
Glenn Murphy, the co-founder of BestGRC and founder of GRC Management Consulting LLC, primarily focuses on empowering entities to leverage their compliance activities through the BestGRC “cloud” software, his consulting work, publications, and the “Leverage Compliance” blog. In addition, Glenn provides licensee compliance audits in conjunction with Licensing Compliance Group and Cybersecurity/NIST/Penetration Tests/SOC for Cyber/SOC 2/3 Assessments in conjunction with Ra Security Systems. Find Glenn’s full profile at http://www.linkedin.com/in/glenntmurphy/, follow him @GlennMurphyGRC and subscribe to the Leverage Compliance blog at http://www.bestgrc.com/blog/