Today let's look at some really creative accounting - Hollywood accounting.

Summary

On some movies actors are paid a percentage of net profits. Logically this makes sense since it provides an incentive for them to ensure the film is successful. The problem is that the studios would rather keep any profits for themselves and have the movie appear to be a total loss. The process of the studios removing any trace of profit from a successful film is called Hollywood accounting.

Example

Below is the earnings statement for Harry Potter and the Order of the Phoenix. Notice how a quite profitable movie manages to have a loss after all the expenses are deducted.

The Framework

To help accomplish this feat, each movie is incorporated as a separate subsidiary of the studio. This means each movie is a separate legal entity so if a movie turns a loss, that corporation can declare bankruptcy without affecting the studio.

Now that the movie is legally separate from the studio, the studio can now charge the movie large fees for 'services'. In this way the parent company can pull all the money out of the subsidiary so the subsidiary reports a loss.

Back to our Example

In the example above, these fees and charges for 'services' come up a few times. These are likely charges from the parent company with the express purpose of drawing down the income of the subsidiary. When the parent company creates its financial statements the consolidation process will hide both ends of this transaction, but it still punishes the subsidiary.

The other interesting anomaly I noticed was in the Investment and Other section. Now in my mind an advance is basically a loan, so it is weird that the repayment of the loan shows up in the income statement instead of the balance sheet. Ideally the loan should not be shown here, but you could also record the receipt of money from the loan as revenue and the repayment as an expense for the sake of consistency.

Lastly, admire the interest line for a moment. Not only is the parent company charging interest on money provided to the subsidiary, it is charging an absurd amount of it - around 18%. It looks like they put the cash advance on a credit card.

Conclusion

In comparison to Generally Accepted Accounting Principles (GAAP), this earnings statement could be perceived as misleading at best and downright erroneous at worst. This sort of accounting treatment has lead to numerous lawsuits against the studios which, unfortunately, have had mixed success in the courts. The problem is that the studios aren't obligated to report based on GAAP for revenue sharing arrangements. If the actors could manage to make this a requirement it could end this longstanding farce.