Fatal Subtraction For Hollywood Bookkeeping
There truly is no business like show business. Hollywood enjoys accounting rules unique in American industry. How unique? Millions spent on executive salaries, failed projects, advertising costs, and even lunches can be counted as long-term assets, not expenditures. The remarkably pliant rules have allowed some companies to rejigger quarterly profits and balance-sheet entries with more ease--and less public outcry--than ordering up a happy ending for The Scarlet Letter.
That's about to change. An eight-man task force of public accountants, studio finance executives, and a Wall Street analyst has been quietly working since last year on new accounting rules that aim to reform the Hollywood numbers game for the first time in decades. The proposed reforms will be unveiled on Mar. 5 and could be approved by the Financial Accounting Standards Board, which dictates accounting rules for all U.S. companies, by yearend.
There's a lot more at stake than a footnote in a 10-K. If the most radical of the reforms being pushed by members of the panel are adopted, valuations for entertainment companies will undergo a seismic shift. Task-force member and Schroder Wertheim & Co. Managing Director David J. Londoner estimates entertainment companies could be forced to take more than $2 billion in immediate write-downs and that reported earnings could fall by as much as 15%, though stock-price multiples will likely rise.
Reform has been brewing for several years, as financial woes at such companies as Cannon, Carolco, and Orion caused investors to lose hundreds of millions of dollars, in part because the accounting rules allowed these companies to obscure their true financial condition. Last year, the FASB asked the task force to draw up new rules.
SCHMOOZER BLUES. Chaired by Spelling Entertainment Group Inc. Chief Financial Officer Thomas P. Carson, the task force already has agreed to stamp out many of the abuses that have given investors nasty surprises in the past. Studios will have only ten years to fully amortize a movie, for example; currently, they face no limits. Other changes may cramp many a schmoozer's style, as such expenses as a producer's lunch tab no longer will be lumped in with vague overhead costs but instead must be tied to one project.
But the toughest reform on the table is the one the industry-dominated task force is as yet unwilling to make. Studios' most unorthodox practice is the capitalization of exploitation costs. This lets studios list as assets billions of dollars for advertising that other industries must count as expenses. The payoff: bloated assets and fatter near-term profits.
The FASB and another group overseeing the task force are extremely uncomfortable with this practice, and sources say the powerful accounting mandarins ultimately will prevail on this point. After all, other industries (except for some catalog retailers) are barred from capitalizing--treating as an asset--advertising costs. "Most of us think that how we do the accounting makes sense," counters task-force member Peter Cyffka, senior vice-president of finance at Twentieth Century Fox Film Corp.
OVERBLOWN. The industry's rationale: Since movies are valuable for several years, studios should be allowed to estimate a movie's lifetime profit margin and show that profit immediately as the film takes in its first dollars at the box office. If not, even a blockbuster would show big losses in the year it was released, since box-office receipts don't cover production and advertising costs.
Here's how it works under the current rules: Movie executives can guess what a film's ultimate revenues will be as it takes in revenue from theaters, home video, foreign sales, and repeated TV airings. Then executives are free to choose a figure for the film's expenses, often adding in big charges for studio overhead and millions lost on unrelated, never-released projects. The film's bloated expenses are counted as assets and deducted from the studio's balance sheet bit by bit, for whatever number of years the studio chooses. The benefit of rejiggering estimates can be striking (table). "What companies have done is estimate revenues high and expenses low," says Londoner. "The majority have been responsible. [But some take] a bad quarter and make results look better than O.K."
Londoner estimates that for the assets of a "typical" film company, from 40% to 55% of the reported value of already-released films is actually old advertising and overhead costs. That means such assets aren't really assets at all, but expenses that haven't yet been paid for. It adds up to a lot of questionable assets. Sony Corp. has $2 billion in unamortized film costs; Twentieth Century Fox has $450 million on its books. The only studios that wouldn't be affected: Walt Disney Co. and Time Warner Inc., which follow more conservative accounting practices to keep their balance sheets more pristine.
Although the reforms will force studios to offer a more comprehensible picture to bankers and investors, the high-profile issue of net-profit participation by writers and actors would not be affected. Those payments are based on formulas agreed to in contracts.
Any change is an unwelcome prospect for such players as Peter M. Hoffman, former Carolco Pictures Inc. CEO. "There's this attitude that [we're] getting away with murder," says Hoffman, who is mulling a public offering for his new company, CineVisions, which produced the recent Johnny Mnemonic. Changing the rules "will be devastating." Maybe for those who've made it big playing the Hollywood numbers game. But for plain-vanilla investors, the reforms will mean Hollywood finally speaks a language they can understand.