From revenue recognition for a variety of income sources, to distribution deals and taxes, there are multiple accounting challenges in the film industry. However, with sound financial management, it’s possible to avoid the five most common issues in the sector.
1. Revenue Recognition
The film industry relies on several different revenue streams. These include income from theatrical releases, streaming services, advertising, merchandise, DVD or Blu-Ray sales, and content licensing.
As such, the process of determining when and how to recognize revenue from each channel can be complex. For example, many streaming platforms rely on subscription-based models for generating income. In this instance, revenue is recognized over the subscription period rather than as a single transaction.
Income from content licensing presents the same challenge. Depending on the nature of the license, revenue can be recognized once-off, or as recurring, depending on metrics like viewership.
In accounting terms, subscription periods and recurring income mean that revenue cannot be recognized immediately; instead, it is recorded as deferred income.
What is deferred revenue?
Deferred revenue is essentially prepayment for something you’ll deliver at a future date. Consider, for example, when a film producer receives pre-production funding. Until the film is completed (which rarely happens in the same accounting period that the funding was received) accountants do not consider the funds as earned revenue in the project’s cash flow. Before filming has wrapped, distribution agreements are finalized, or a subscription period is complete, this ‘prepayment’ is seen as an incomplete transaction in an asset account.
For this reason, deferred revenue is seen as a liability on an income statement until the point that it officially becomes earned income.
To ensure accurate financial reporting of deferred revenue, it’s necessary to maintain detailed records of all transactions involved. Moreover, you need to be aware of the accounting standards that outline regulatory compliance with revenue recognition.
Regulatory compliance in revenue recognition
Accounting standards like ASC 606 or IFRS 15 provide guidelines for recognizing revenue in all industries, including media and entertainment. These standards were first introduced in 2002 by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB).
The scope of both standards encompasses the contracting, handling, distribution, and transaction prices associated with film production. However, there are several subtle differences between ASC 606 and IFRS 15. As a result, it’s best to speak to your CPA about compliance, as an accountant will understand the nuances of these standards.
A second aspect of film accounting to consider is dealing with cost capitalization and amortization.
2. Production Cost Capitalization and Amortization
Budget overruns are a common occurrence, and can compound accounting challenges in the film industry. There are three main reasons a film might overrun its budget.
- Economic factors, including interruptions such as the recent SAG-AFTRA strike.
- Technical reasons, like incorrect data gathering (especially when considering the complexities of revenue recognition).
- ‘Psychological causes’, such as a lack of project commitment.
Budget overrun can be calculated by subtracting the budgeted amount from your actual expenses. But while it’s easy to determine your budget overrun, how do you prevent it?
One way is through actualizing costs. Here, your actual costs incurred during the production are compared with your initial budget. This allows you to make informed decisions on how to optimize resources.
Project overrun can also affect the capitalization of production costs.
These include direct costs associated with film production. For example, writing fees, cast and crew salaries, set construction, and post-production editing.
Under the FASB’s ASC 925 standard, these costs should be capitalized as an asset on your balance sheet, rather than expensed. When the film is released and begins to generate income, the costs are then amortized.
What is amortization?
Amortization refers to how you allocate the depreciable amount of a film’s production costs, depending on the expected revenue from distribution channels or the film’s performance. Thereafter, production costs are recognized in your income statement as earned revenue.
The individual-film-forecast method is one way to do this. Here, amortization is calculated by dividing the current accounting period’s actual revenue by the remaining unrecognized ultimate revenue (or estimated total revenue generated in all markets).
Provided that your estimates don’t change, this allows for a constant profit rate over the revenue-generating period.
However, there’s another aspect to consider once your film generates income: residuals and participation.
3. Residuals and Participations
Residuals and participation are one of the most notorious accounting challenges in the film industry. This is due to their complex natures, as several aspects influence the calculation and payments of both.
What are residuals?
Residuals are mandated payments for film or television content that is rerun or reused in a different medium or platform. They are calculated by using formulas established by the Screen Actors Guild (SAG-AFTRA), the Directors Guild of America (DGA), and the Writers Guild of America (WGA).
Residuals are paid out to a number of parties, including:
- Actors with speaking lines and voice-over actors
- Stunt Performers
- Unit Production Managers
- Directors (as well as first and second assistant directors)
- Credited writers
Generally, one of two main types of residuals are paid:
- Variable (percentage-based) residuals: These are paid based on the film’s gross income. The guilds decide on a percentage to be paid, based on factors like the type of production, how long it took to complete, and whether it’s for a domestic or foreign market. This percentage is then divided among the qualifying parties mentioned above.
- Fixed residuals: These are set payments not based on income, which are negotiated ahead of production. As such, these payments aren’t equally divided among all qualifying parties, although they are still affected by each guild’s percentage.
When it comes to new media (like streaming platforms), residual payments are structured differently. Usually, they are calculated on a sliding scale, in which the percentage paid out decreases every year.
Further complicating this is payments for below-the-line (BTL) crew members, like costume designers, lighting and camera crews, and prop makers. BTL crew members aren’t paid residuals. Instead, they are paid a pension fund.
Residuals need to be paid on time. If you miss the payment deadline, the guilds charge interest! SAG and DGA charge up to 12% annually, while the WGA charges up to 18%.
And then there are participations.
What are participations?
Participations (also known as backend payments or contingent compensation) don’t depend on the film’s income. Instead, they are a percentage of the film’s profits that are paid out.
Unlike residuals, there are no specific parties to be paid. For an individual to become a participator, they need a certain amount of bargaining power. This often means that only higher-paid parties like A-list celebs and established directors, writers or producers are eligible. Moreover, as these payments rely on profits, the more your film makes, the higher the participation.
Thanks to the reasons listed above, calculating and tracking residuals and participations can be extremely complex.
On top of this, you’ll also need to consider the tax implications of filming.
4. Tax Credits and Incentives
The most common film industry tax incentives include:
- Grants: A tax-free payment to production companies.
- Rebates: Taxable payments made to production companies as a percentage of expenses.
- Tax Credits: Excess production credits which are repaid after income tax.
While they can help you manage production costs, tax credits and incentives present further accounting challenges in the film industry. After all, they depend on location, as well as when they are recognized.
For example, countries like Australia, China, France, Hungary, Spain and the UK offer a variety of tax rebates for productions filmed in these locations. Others, like Canada, Italy, and Lithuania allow filmmakers to apply for production tax credits. In addition, locations in Germany and Norway also provide grants for filmmakers who wish to film in these countries.
Many US states also offer film tax breaks. However, each state has a different set of rules and regulations concerning tax incentives.
Tax incentives can also affect your revenue recognition. As mentioned earlier, these funds may be considered ‘prepayments’, meaning that they will be classified as deferred income.
Of course, geography can affect more than tax incentives. When it comes to international operations and distribution, foreign exchange can pose an additional accounting hurdle.
5. Foreign Exchange and International Operations
Because films often have expenses and revenues in multiple currencies, managing and accounting for the effects of currency fluctuations is essential. For example, if the dollar weakens or strengthens during the production of a film, it can affect projected expenses and income. This is particularly true for productions with vendors or staff from different countries.
More importantly, international operations can affect your tax filings, as different countries have different accounting standards and tax regulations. This requires a sound knowledge of foreign tax treaties, which outline high-level tax treatment and define basic terms and compliance.
Tax treaties for film production
For example, the US has a federal tax treaty that covers working in a foreign country for fewer than 183 days in a 365-day period. This treaty exempts US productions with US crews and assets filming in a foreign country from paying employment-related withholding and social security tax.
However, not all countries have tax treaties. For instance, if you film in Argentina, you need to follow the country’s tax code when handling your taxes. Some countries also have clauses in their tax codes outlining exceptions to treaties, so it’s essential to work with a CPA or legal advisor to ensure compliance.
The five accounting challenges in the film industry listed above can lead to discrepancies in financial reporting. However, with the assistance of a CPA, these challenges are not insurmountable.
If you require assistance with any aspect of film accounting, consider scheduling a Discovery Call with one of our CPAs.
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