FILMED ENTERTAINMENT

Revenue and cost recognition

Agenda

• Revenue recognition• Ultimate revenues• Cost amortization• Participations and residual expense• Other expenses• Impaired films and TV shows• Development cost write downs• Tax incentives/credits

RECAP – LIFE CYCLE OF A FILM OR TV SHOW

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(months)6 1812 30 36

Theatrical

Home Entertainment (DVD, Blu-ray)

Free TV (network & syndicated)

PPV/VOD

243 9 15 21 27 33

Pay TV

Current release windows of a filmLicensing and Merchandising

Digital Media

TV show markets

• Network• Cable• Home entertainment• Syndicated TV• New media D

igita

l M

edia

REVENUE RECOGNITION

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Revenue recognition• Guidance: ASC 926 (SOP 00-2) and ASC 605 (SAB 104, FAS 48)• Five revenue recognition criteria, as defined in ASC 926:

– Persuasive evidence of sale or licensing agreement with customer– Film or TV show completed and available for delivery (not

necessarily physical delivery)– License period has begun and customer can begin exploitation,

exhibition or sale– Fee is fixed or determinable– Collection of fee reasonably assured

• If an entity does not meet any one of the preceding conditions, the entity should defer recognizing revenue until all of the conditions are met

Revenue recognition - theatrical

• Revenues recognized over the exhibition period

• If MG or advance received before exhibition date, defer and recognize in accordance with ASC 926

• Settlement rates and “film rentals”• International markets

Revenue recognition – home entertainment

• Revenue not recognized until “street date”• All criteria of ASC 926 must be met• Shipping considerations (FOB shipping point /

destination)• Reserves (contra-revenue) must be recorded

and inventory must be adjusted

Revenue – home entertainment – reserves

• Returns reserves (must have ability to estimate)– New release– Catalog– Inventory adjustment component

• Price protection• Slotting fees• Charge backs• Co-op advertising

Revenue recognition – PPV / VOD

• All criteria of ASC 926 must be met• Recognized as subscribers access (buy) film

from cable / satellite company• May require reporting from provider for

revenue recognition (estimable license fee)

Revenue recognition – Pay TV

• All criteria of ASC 926 must be met• Recognized as film becomes available• Output deals – contain terms, including

revenue (generally based on box office)• Allocation of license fee – multiple windows

Revenue recognition – Free TV

• All criteria of ASC 926 must be met• Generally recognized when film is available to

the network• Terms included in agreement – output or

“one off”• May require allocation to multiple windows

Revenue recognition – Licensing & merchandising

• All criteria of ASC 926 must be met• Usually subject to advances and/or MGs• MG generally recognized when film is

available in the theatrical market• Overages/royalties based on statements from

licensee• Cash vs. accrual basis

Revenue recognition – TV shows

• Same criteria as for films• License fee on a per-episode basis• Revenue generally recognized as each

episode is delivered• License fees paid over more than one year

must be discounted

Revenue recognition – other considerations

• Cross collateralization– If cannot allocate, recognized on an “earn out”

basis

ULTIMATE REVENUES

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Ultimate revenues - Film• Markets include revenues from:

– Theatrical (U.S. and Non-U.S.)– PPV / VOD– SVOD– Home entertainment– Pay TV– Free TV (network & syndication)

• Includes revenue estimates up to 10 yrs from initial theatrical release

• Should not include revenues from unproven territories or markets• Discounting not allowed except in certain situations

Ultimate revenues – Episodic TV

• Markets include revenues from:– TV license fees– Home entertainment– SVOD

• Includes revenue estimates up to the later of:– 10 yrs from date of delivery of first episode or,– If still in production, 5 yrs from date of delivery of most

recent episode• Include estimates of secondary market sales only if

company can demonstrate history of success

COST AMORTIZATION

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Cost amortization basics

• Individual film forecast (IFF) method, as stipulated in ASC 926 (SOP 00-2)

• Cost amortization is based on estimated gross margin for the life of the film

• Estimated gross margin may change throughout life, which may affect cost amortization in period change occurs

Amortization calculation

• Year 1

• Year 2

Ultimate costs

Costs toamortize

Yr. 1 revenuesUltimate revenues

Ult costs to go

Costs toamortize

Yr. 2 revenues Ult revs to go

Yr. 1Ultimate Revenues (total) $ 60Ultimate Costs (total) 40Ultimate Gross margin 20Actual Revenues: 20

Ultimate costs

Costs toamortize

Yr. 1 revenuesUltimate revenues

2060

40 13

Amortization calc – Example – Yr 1

Recording amortization – Year 1Cost of revenues (Amortization expense) $13

Capitalized film costs (Accumulated amort) $13

Record Year 1 amortization expense

Yr 1 Yr 2 (to go)Ultimate Revenues (total) $ 60 $ 40Ultimate Costs (total) 40 27Ultimate Gross margin 20 13 Actual Revenues: 20 15Actual Costs Amortized: 13 ?

Ult costs to go

Costs toamortize

Yr. 2 revenues Ult revs to go

1540

27 10

Amortization calc – Example – Yr 2

Recording amortization – Year 2Cost of revenues (Amortization expense) $10

Capitalized film costs (Accumulated amort) $10

Record Year 2 amortization expense

Ult costs to go

Costs toamortize

Yr. 2 revenues Ult revs to go

1535

27 12

Amortization calc – Example – Yr 2 (revised ultimate)

Yr. 1 Ult Yr. 2 Ult Yr. 2 (to go) (revised) (revised)

Ultimate Revenues 60 55 35Ultimate Costs 40 40 27Ultimate Gr. margin 20 15 8Actual revenues: 20 15Actual costs amortized 13 ?

Recording amortization – Year 2 (revised ultimate)

Cost of revenues (Amortization expense) $12Capitalized film costs (Accumulated amort) $12

Record Year 2 amortization expense – revised ultimate

CASE STUDY PART 2

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PARTICIPATIONS

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Participations – overview

• Contingent compensation for creative talent (actors, writers, directors, producers)

• Expensed using IFF method (based on ultimates)• Amounts paid, if any, are based on contractually

agreed-upon formulas and cash received (not revenue recognized)

• Formulas vary depending on star power of talent (gross deal vs net deal)

Participations – overview

• Agreements typically include:– Revenues to be included (music, merch, etc)– Percentages to be used (2.5% of net profits)– Producer’s recoupment of direct and indirect

production costs– Producer’s recoupment of exploitation costs– Reporting periods and payment terms– Audit rights

Participations – common terms

• Gross receipts• Distribution fees• Production costs and production interest• P&A, marketing and distribution costs (exploitation

costs)• Adjusted gross receipts• Net receipts• Break even (first, second, rolling)• Bonuses and deferments

REVENUES YR 1% $ Total Ultimate Revenues 567,500$

30% 49,500 Domestic Theatrical 165,000 38% 72,200 International Theatrical 190,000 n/a - Domestic HE (@ 20%) 85,000 17,000 n/a - Int'l HE (@ 20%) 50,000 10,000

30% 4,350 Pay Television 14,500 25% 2,500 Network 10,000 35% 6,300 Domestic Syndication 18,000 40% 10,800 Int'l Syndication 27,000

451,500 LESS: Residuals and other deductions (11,800)

ADJ USTED GROSS RECEIPTS (AGR) 439,700

Production Costs: (209,500) P&A: (160,000)

BREAK EVEN (BE) (369,500) AGR in excess of BE 70,200 Distribution Fees (145,650)

NET RECEIPTS (75,450)$

DIST FEES

Sample participation calculation

MALE STAR (Gross)2% AGR 8,794$ LESS: Advance (250)

8,544 FEMALE STAR (Gross)

1% AGR to BE 3,695 3% AGR after BE 2,106 LESS: Advance (500)

5,301 DIRECTOR (Gross)

2% Adjusted Gross up to $100 million 2,000 3% Adjusted Gross over $100 million 10,191

12,191 WRITER (Net Receipts)

2% of Net Receipts -

SUPPORTING CAST (Gross)1% Adjusted Gross over $100 million 3,397 3,397

SUPPORTING CAST (Net)2% of Net Receipts -

ADVANCESMale Star 250 Female Star 500

750 ULTIMATE PARTICIPATIONS 30,183$

Year 1Participation calculation example

Yr. 1Ultimate Revenues (total) $ 567,500Ultimate Participation Costs 30,200

Actual Revenues: 362,000

Ultimate costs

Costs toamortize

Yr. 1 revenuesUltimate revenues

362567.5

30.2 19.3

Participations – Example – Yr 1

Recording participationsCosts of revenues (Participation exp) $19.3 Accrued participations $19.3

Record Year 1 participation expense and related liability

RESIDUALS

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Residuals – Overview • Additional compensation for “ancillary” markets (DVD,

pay TV, cable, network TV, etc)• Residuals based on percentage of gross revenues

received by a distributor from ancillary markets• Residuals for TV shows based on original salary paid

during the production and are not paid on the initial airing of the show (only on “re-runs”)

• Union or “guild” specific• Payments made to individuals or to the guilds on behalf

of members

Residuals – Overview • Guilds in TV and film:

– Screen Actors Guild (SAG*) – represents motion picture actors– American Federation of Television and Radio Artists (AFTRA*)

– represents television actors and radio personalities– Directors Guild of America (DGA) – represents directors– Writers Guild of America (WGA) – represents writers– American Federation of Musicians (AFM) – represents

musicians– International Alliance of Theater and Stage Employees (IATSE)

– represents production crew and administrative staff

* SAG and AFTRA recently merged

Percentages used for residual calculation:

Pay/ HE HE BasicGuild Free TV 1st $1M > $1M Cable

SAG 3.60 4.50 5.40 3.60DGA 1.20 1.50 1.80 1.20WGA 1.20 1.50 1.80 1.20AFM 1.00 1.00 1.00 1.00IATSE 5.40 6.75 8.10 5.40Pension rate 0.45 0.56 0.68 NAP/R Tax 0.59 0.73 0.88 NA

Potential residual rate 13.44 16.54 19.66 12.40

Residual rates – Motion pictures

Percentages used for residual calculation:

Network Syndi- Pay/ HE BasicGuild Re-run cation Free TV 1st $1M cable

2 50% 2 40%SAG/AFTRA 3 40% 3 30% 3.6 4.5/5.4 6.0DGA 4-6 25% 4-6 25% 1.2 1.5/1.8 2.0WGA 7-10 15% 7-10 15% 1.2 1.5/1.8 2.0

11-12 10% 11-12 10%13+ 5% 13+ 5%

AFM NA NA 1.0 1.0/1.0 NAIATSE NA NA 5.4 6.75/8.1 NA

(% of appl. minimum) (same % as films)

Residual rates – TV shows

Residuals – Overview

• Pro-ration for filming outside the U.S.• Some states are “right-to-work” states (non-

union)• SAG/AFTRA applies no matter where actor works• Range from 12.5% - 20% of revenues generated in

ancillary markets• Fringe benefits (payroll tax, pension, health &

welfare benefits) can add another 25% surcharge to residual payments

Residuals – Guild audits

• Guilds conduct periodic audits of film and TV producers

• Specialized firms do most audits• Industry-wide litigation regarding various

practices employed by film producers when calculating residuals– Percentage of home entertainment revenues

subject to residual payments– Allocation of minimum guarantees

Residuals calculationResiduals Ultimate

Yr 1Pay TV 14,500$ Network & Basic Cable 10,000 Domestic Syndication 18,000 Int'l Syn 27,000 Total Free & Pay TV Ult Rev 48,211 Rate (all guilds) 13.44%Sub Total Ultimate Residuals 6,480

Domestic HE @ 20% 85,000 17,000 Int'l HE @ 20% 50,000 10,000 Total Video 27,000 All Video 1st $1M 1,000 Rate (all guilds) 16.54%Ultimates Residuals HV $1M 165 Video > $1M 26,000 Rate (all guilds) 19.66%Ultimates Residuals HV > $1M 5,112

Total Ultimate Residuals 11,757$

Yr. 1Ultimate Revenues (total) $ 567,500Ultimate Residuals Costs 11,800

Actual Revenues: 362,000

Ultimate costs

Costs toamortize

Yr. 1 revenuesUltimate revenues

362567.5

11.8 7.5

Residuals – Example – Yr 1

Recording residualsCosts of revenues (Residuals expense) $ 7.5 Accrued residuals $ 7.5

Record Year 1 residuals expense and related liability

OTHER EXPENSES

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Other expenses

• DVD inventory– Manufacturing costs– Obsolescence reserves (don’t forget about units

added back as part of returns reserve calculation)• Prints – capitalize and amortize vs. expense• Advertising – ASC 720-35 (SOP 93-7)

– Expense as incurred or– Upon first airing

ULTIMATE COSTS

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Ultimate costs – Film and episodic TV

• Estimated total costs directly associated with generation of ultimate revenues

• Production (or acquisition) costs– Negative costs– Capitalized overhead– Capitalized interest

• Participations and residuals• Other considerations

TAX INCENTIVES AND CREDITS

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Tax incentives and credits

• Offered by various cities, states and countries to entice filming in their locale

• Treated as a reduction to film costs• Timing of recording

IMPAIRED FILMS AND TV SHOWS

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Impaired film / TV show costs

• Pre-release write down• Impairment after release of film• Certain events or changes in circumstances may

indicate company should assess whether product is impaired (fair value less than unamortized film costs):

• Film performance• Costs in excess of budget• Delays in completion or release schedules• Insufficient funding or resources to complete film and

market it effectively

Impaired film / TV show costs

• If there is indication product is impaired, must determine fair value of film and write off amount by which unamortized capitalized costs exceed fair value

• If film already released, calculate and record IFF amortization first, then calculate impairment

• Discounted cash flow analysis

DEVELOPMENT COST WRITE DOWNS

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Development cost write downs

• Presumption that if a film has not been set for production within 3 years of first capitalized cost, it will be disposed of

• Write off required (assumes fair value of $0)• What about films with a longer production

period (e.g. CG animation)?

CASE STUDY PART 3

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