An analysis is done of the accounting methods employed in the world of glitz, glamour, fame and money in other words the movie industry to assess the increasing disparity between the techniques adopted by them to arrive at the financial statement figures as opposed to those stated in the "Generally Accepted Accounting Practices."
The standards and regulations of the accounting world have been twisted to give them an entirely different meaning in the light of movie accounting. This is majorly done by distributors and studios in order to show the failure of a particular project and their by deprive the profit participants of their lawful share as per the contractual agreement.
Applications to real life scenarios have been quoted to demonstrate how movie accounting is incorporated within the financial statements. It can be concluded that this form of accounting is not only illegal but also unethical. However studios and distributors will continue to adopt these practices as the power resides in a handful of parties who have the major say in negotiating contracts.
It is rather surprising to hear that a movie that has done so well commercially could face a loss. However in recent times this is becoming the norm of the movie industry. Movie accounting is the process of adopting creative accounting practices for reporting profits in a manner such that expenditures are inflated and revenues are reduced their by decreasing the reported NET PROFIT and ultimately reducing the royalty and profit sharing payments.
Movie Accounting refers to accounting practices of studio/distributors that ranges from adoption of dishonest practices to making up fictitious companies that are used to transfer profits in the name of "service charges." As rightly said by John D. MacDonald's in his novel Free Fall in Crimson (1981) above movie accounting:
"Darling! This is the Industry! The really creative people are the accountants. A big studio got over half the profit, after setting breakeven at about three times the cost, taking twenty-five percent of income as an overhead charge, and taking thirty percent of income as a distribution charge, plus rental fees, and prime interest on what they advanced."
How Movie Accounting works?
Movie accounting can take various forms for example the most popular one is the formation of a special purpose subsidiary whereby the parent company transfers revenue from the subsidiary by charging service fees for various activities undertaken. Or fictitious entities are created whereby instead of showing the total revenues earned from DVDs and home rentals a transfer of revenues in form of "royalty payments" is made from one entity to another resulting in lower net profits for the profit participants.
Studios that have various production and distribution channels can manipulate the license fee among their associated entities so that profit participants receive a lesser share than the fair market value.
These schemes can range from being simplistic to complex but many of them revolve around the concept of overhead. An estimation of the studios general overheads is required in operating a studio. This amount is then charged off as an expense of the film or Television show. The studios calculate 15% of total production costs as production overheads followed by 30% of gross rentals as distribution overheads and finally 10% of advertising costs are assumed to be marketing overheads. All these are deducted from gross receipts to arrive at the final net profit figure.
All these calculations are made on an arbitrary basis and do not adequately trace overhead costs to actual activities undertaken. The extreme overestimation of overheads mean that it does not come as a surprise when only 5% of movies officially show net profit while major block buster's report losses.
The wide usage of such a method is further stressed by the fact that many actors demand to have a percentage of gross revenue as opposed to having a percentage of net revenue because there is virtually no net profit remaining once the studio and the movie makers take out their shares.
All in all, studios get millions while conveying to the profit takers that the film is a money "loser" as far as accounting is concerned.
Contrasting GAAP and Movie Accounting
The financial information presented to the users of account must adhere to certain standards and guidelines and should be a free of biasness or any inconsistency. The guidelines are stated in General Accepted Accounting Principles and every entity must adhere to them when issuing financial statements.
These include the principle of regularity or consistency, principle of non-compensation, principle of prudence, principle of continuity, principle of periodicity, representation in good faith and comparability over time and with other entities. However, movie accounting is seen to be far from the principles of GAAP and sways the numbers towards the studio and distributor.
The movie industry denies the incorporation of GAAP in studio accounting. Movie accounting is based on the negotiations that take place between different parties and are not hampered or limited by GAAP. The movie accounting is contractual based, whereby contracts have their own definitions of profit participations, gross and contingent proceeds which are very different from those defined as per GAAP.
These movie accounting practices have helped a few handful entities to gain dominance in the market. It is these practices that ultimately determine whether the producers, directors, actors, investors will get a share in the profit generated by the motion pictures.
Accounting concepts and practices applied to Movie accounting
All financial statements must be made in accordance to the guidelines issued by various accounting bodies. Each guideline includes various conditions that need to be satisfied before the accounting practice is adopted. Below is a description of how the rules of accounting have little or no value within the movie world and how movie accounting is different from our day-to-day accounting.
In the accounting world, an accounts receivable that is unlikely to be recovered is generally written off in the profit and loss statement, however this is only done when there is high probability of the debtor not paying and inflow of cash is unlikely (principle of prudence). However in movie accounting the distributors themselves decide that certain amounts are uncollectible based on some objective criteria in the distribution agreement and writes them off against the revenue earned by the film thus lowering down the profit share for producers and other profit participants.
An audit is generally done of the entities financial statements in order to ensure accuracy and completeness of the records. It is can either be an internal audit or an independent audit of the firm's activities with full access given to the auditor to analyze the business activities. The auditor examines the system of internal control and the details of the books of account, including subsidiary records and supporting documents, while reviewing legality, mathematical accuracy, accountability and the application of accepted accounting principles.
However in movie accounting the audit rights are typically negotiated by the dominant bargaining partied in the distribution agreement curtailing the right of auditors to undertake a complete assessment of the studios activities. Distributors naturally want to limit audit rights by restricting when the audit may be started and conducted, limiting the purpose of the audit, restricting who may conduct the audit, requiring that copies of all reports completed by the producer's accountant be delivered to the distributor at the same point as the producer, placing restrictions on the amount of time an audit can take, permitting entity's records to be audited once, limiting the time during which objections may be made, providing that all statements by the distributor are requisite unless objected to in script within a certain period of time, forever excluding the producer or other profit participants from instituting any lawsuit unless well-timed objection is made and only allowing review of the books of the subject picture even when the picture is marketed with other pictures as a package. Distributors will also insert language which permits them to keep records in their own unique way.
In everyday accounting terminology breakeven is the point at which the costs of the firm are equivalent to the firm's revenue resulting in no profit or loss situation. If revenue exceeds the cost the firm shows a profit and vice versa. When applied to the movie industry this would have meant the point when the revue from the movie equals the cost of production and distribution. However it is estimated that less than 5% of the films in Hollywood breakeven. This is not because the industry faces high levels of cost or has inefficient operations but rather is due to the application of creative accounting whereby the overheads are escalated, accounts receivables are set off against profits and revenue from rentals are vastly understated. The accounting concept of breakeven holds little or no value in the world of movie accounting.
Contractually Defined Profits
In the accounting dictionary the term "profit," "gross profit" and "net profit" have statutory defined meanings and every entity must adhere to these…