Accounting for Music Distributors (#343)
/Accounting for Providers of Background Music
What is the accounting for a company that provides background music to other businesses, such as retail stores? The first step is to collect the facts about the transaction. In this case, the company is providing background music, which means that a canned playlist is probably being provided, so there’s probably a fixed charge for the service for a specific period of time. There might also be a minimum contract period, like one year. In this case, you might bill the customer once a month, at the end of the period for which you provided services, and would then record the receivable as revenue right away, since it’s been earned at that point.
If there’s a minimum contract period, you would not record the revenue for the full period in advance. If you billed the full amount in advance, then you’d initially record the customer payment as a liability, since it hasn’t been earned yet. At the end of each month, you’d then recognize a portion of the liability as revenue. So, if the initial billing was for a year, then you’d recognize one-twelfth of the advance payment at the end of each month, until the full amount has been recognized as revenue by the end of the twelve-month period.
And of course, you’d also recognize an allowance for bad debts at the same time, to cover your best guess for the portion of total receivables that won’t be paid by customers.
Accounting for Users of Background Music
Now, let’s look at the situation from the perspective of the company that’s using the background music. They get billed once a month, and charge it straight to expense, since they’re consuming the service right away. Or, if they pay for multiple periods in advance, then they record the payment as a prepaid expense – which is an asset – and then charge off a portion of this prepayment in each month, over the usage period. Pretty basic stuff, really.
Accounting for Music Streaming Businesses
Now, let’s look at the situation from the perspective of a streaming business, like Spotify.
In this case, the company is paying a fraction of a cent every time a song is played, and the amount paid will probably vary, depending on the licensing agreement with each of the record labels.
So, the streaming service compiles the number of times that a song is played, multiplies this figure by the contractual usage rate, and pays the amount to the record label. There are two accounting problems here. The first is defining what constitutes a song that has actually been played. For example, if someone switches away from a song after 30 seconds, does this constitute a usage of the song for licensing payment purposes? So, the usage tracking database has to recognize when a minimum threshold of time has passed for a song, to decide whether a licensing fee should be paid.
The second issue is that there may be rate changes to the licensing fee, so someone has to make sure that the correct fee is being paid. This means having a solid process in place for updating the licensing fee system with the latest contract rate. And this may not be so simple. For example, a record label might charge a higher fee if a song has just been released, and then allows a lower rate after a year has passed. So the system has to accommodate that. I could certainly see the need for an internal audit staff to review the licensing fees being paid, to make sure that there aren’t any issues.
Accounting for Record Label Advances
That pretty much covers the question, but I’ll keep going and address a related issue, which is the accounting by a record label for any advances paid to an artist. There is an accounting standard for this. When the record label pays an advance, it records this amount as an asset, but only as long as the past performance and current popularity of the artist provides a reasonable basis for estimating whether the advance can be recovered from future royalties. When this is not possible, then the remaining amount of the advance is charged to expense. Or, if the popularity of an artist suddenly drops off a cliff, then that means future royalties will decline, which makes it more difficult to recover the advance from future royalties – which will result in a write-off of some part of the advance.