Nothing is more fulfilling than opening your record label, getting your artist in the studio, laying down some tracks and mastering your final project. You’ve gotten investors involved who really believe in your project as much as you do and they’re putting a significant amount of money behind your company for both production and marketing. The only uncomfortable part about the whole process is that they have accountants, business managers and financial gurus working for them behind the scenes and they need you to put together a budget of what it’ll take to produce and market the project, your project profitability analysis which should include an explanation of your revenue projections and a set of financial statements for the next three years. Huh?
Budgeting for a recorded release can be a tedious and unforgiving process. There are a number of factors that you have to take into consideration including; revenue projections, ancillary revenue activity, online sales projections, royalty and copyright obligations, marketing costs, recording spend, manufacturing, shipping and handling, distribution costs, interest on loans given, sales escalations, domestic and foreign licensing sales and expenses, investor reimbursements, operational overhead and most dizzying of all, recording and marketing recoveries.
When you spend money for recording on a project you are entitled to recoup those costs prior to paying the artist and producer (as long as you didn’t agree to pay the producer on a “Record One before Recoupment” contract where the producer gets paid right away while the recording costs are being recouped by the artist-avoid this like the plaque) their share of the earnings at their contracted royalty rates. For example, if you spend $25,000 for recording you would book the following entry to your accounting books:
Debit balance sheet Recoupable recording spend-asset $25,000
Credit balance sheet Cash-asset/Accounts payable-liability ($25,000)
(this entry is necessary to record your right to receive this money back from the artist)
then you would book this:
Debit P&L Recoupable recording spend writeoff-expense $25,000
Credit balance sheet Provide for bad debt on recording spend-contra asset ($25,000)
(accounting rules demand that the money spent be written off right away assuming you will never collect this money. Which is normally true.)
and assume the artist’s royalty rate is 0.60¢ per unit and the producer’s rate (assuming only one for the album) is 0.10¢ per unit and you sell 5,000 units, you are obligated to record a royalty expense of $3,000 (5,000 x .60) for the artist and $500 (5,000 x .10) for the producer. Since you are showing some success with your record sales you can’t forget that you have an obligation to pay the artist and producer a portion of the sales so you have to record the following entry:
Debit P&L Royalty expense-artist $3,000
Debit P&L Royalty expense-producer $500
Credit B.S. Royalty Payable ($3,500)
(This is the entry to record the artist and producer’s share of the record sales)
Now, the mistake that most labels will make, aside from not even entering into these dark waters, is that they’ll stop here. They are comfortable with having displayed that they have written off the recoupable spend and have accounted for the earnings of the artist and producer and will look to depend upon the royalty statement to determine the account status of those third party participants. Instead, what should happen not only in your accounting books, but also in your budgeting process is the use of those earnings to record or show your recoupment of your recording spend. As you know, the artist royalty statement will display the recording costs and advances that are being charged against the artist account as well as all of the earnings that the artist is entitled to from the various revenue streams (physical, digital, licensing, etc.). The royalty statement will then report whether the account is recouped and payable or un-recouped and non-payable. Well, you have to account for this position in your accounting records as well by booking the following:
Debit balance sheet Provide for bad debt on recording spend-contra asset $3,000
Credit P&L Recoupable recording spend writeoff-expense ($3,000)
(This entry reverses the original writeoff of the recording spend which now becomes a collectible receivable by taking the artist earnings to recoup them)
Debit B.S. Royalty Payable $3,000
Credit B.S. Recoupable recording spend-asset ($3,000)
(Entry needed to show that the artist royalties are being used to recoup the recording spend)
You can elect to utilize separate accounts for the two entries above in order to track your gross activity. For instance, if you didn’t have a separate schedule to track what you’ve spent on recording you wouldn’t know by examining your books what you have spent because you have booked credits to record the recoupment of the artist earnings.
So, what does this mean for your budgeting process? This means that as you increase your royalty expense amount to show how much is owed to the artist [$3,000] you will be decreasing your recording expense by the same amount [from $25,000 to $22,000 left to recoup] and that the total of the two accounts [$22,000 + $3,000 = $25,000] will always add up to the original amount spent. You don’t want to include a line item for the recording spend that you believe is necessary and then create a line item for the amounts that will be due to the artist once sales activity starts and not take into consideration that you will be keeping ALL of the sales for a while until the artist recoups that recording expense amount. Until this amount goes to zero every dollar stays in the company’s coffers.
What this also means is that as a label executive sitting in your lavish office you’ll be able to show your investors that you will be taking in a good profit far before you are required to pay the artist a royalty.