Although it is common to perform profit participation reviews in the film and television industry, it appears to be less common when it comes to book publishing royalties. Nevertheless, authors may be at risk for underpayment or delayed payment of royalties just as often as film and television profit participants.

At a minimum, for agents who represent authors, it is recommended that they review the publisher statements periodically. Depending on certain risk factors, an author may consider consulting an expert to perform an audit, which is typically within his or her reserved rights of the publishing agreement. As one assesses the need for an audit, one may want to consider the following risk factors related to statement, agreement and market trends.

IN THE BLACK VS. RED

If the author is being paid by the publisher in excess of the initial advance or minimum guarantee, the publisher may be more focused on minimizing overpayment than fulfilling the agreement obligation. Therein lies the potential risk of delaying reporting of revenues or over-reporting expenses, including reserves and internal costs. While an author should review all statements, even more diligence is advised with the review of statements after the recoupment of one’s initial advance or minimum guarantee. If new or unusual entries appear soon before or after earnings are recouped, this may represent a red flag.

Some particular items on a statement to watch out for include:

• Completeness of gross receipts (licensing receipts) or units sold (royalties)
• Allocation issues of both revenue and costs
• Excessive reserves, revenue deductions (such as discounts, bad debts or returns) or third-party fees
• Misapplication of escalation clauses
• Improperly charged internal or indirect costs
• Timeliness of reporting and paying authors

POTENTIAL INCONSISTENCY BETWEEN THE STATEMENT AND THE AGREEMENT

The statement is often issued by someone who is not directly familiar with drafting the publishing agreement’s terms and conditions or the intent of the agreement’s language. This increases the risk of errors and omissions in developing the statement template. Additionally, when developing the template or algorithm for more sophisticated publishers, staff could be interpreting ambiguous or “grey area” terms and conditions of the agreement subjectively. These terms and conditions will likely favor the publisher and could potentially result in under-reporting of revenues or over reporting of expenses.

To mitigate this risk, one should review the statement for improper application of the agreement terms. If any inconsistencies are identified, this could be a symptom of larger issues and, therefore, would also represent a red flag.

UNUSUAL ENTRIES ON THE STATEMENT

The high volume of transactions and the limited resources available to review the underlying details by publishers reduces statement quality control and can lead to increased errors on royalty statements. Unusual entries, such as negative revenues and unfamiliar expense accounts could indicate a risk of other errors on the statement.

COMPLEXITY OF THE AGREEMENT

Generally, the more complex a deal is the higher the risk of errors and omissions. This represents an inherent risk, which should be considered as part of one’s decision to conduct an audit.

NEW MEDIA REPORTING

With the growth of publishing revenues coming mostly from new sources, such as audiobooks, e-books and other digital formats, there is an increased risk of underreporting for such revenues, particularly for older agreements.

Depending on the age of the publishing agreement, recently developed revenue streams may not have been conceived of or specifically negotiated (e.g. fees, royalties), resulting in the incorrect accounting for such revenues on the statement.

OTHER FACTORS TO CONSIDER

Many factors such as a dispute with the publisher, lack of transparency and delays by the publisher in response to inquiries may increase the potential risk of underreporting of royalties.

If any, some or all of the above risks are present, one may want to consult with an auditor, with experience in contract accounting, to further evaluate the possibility of performing an audit on their behalf.

If you have any questions about the above content, please reach out to a member of GHJ’s Profit Participation team.