Hollywood accounting Featured

9:06am EDT January 31, 2006
Studio honchos are fond of a practice known as Hollywood accounting. This method distributes profits earned by a project to corporate entities, which are typically owned by the same institution. The net result is that a project’s profit is reduced, which in turn trims down payments to profit participants.

The difference between generally accepted accounting principles and the Hollywood version, says Marcia Harris, a partner in Alschuler Grossman Stein & Kahan LLP’s Entertainment & Media Department, is significant. “In studio accounting, it’s whatever the contract says,” she explains. “They are not in any way limited or hampered by generally accepted accounting principles.”

Smart Business spoke with Harris about how movie studios benefit from this practice, some of the legal issues that are raised and how disputes are settled through arbitration.

What does Hollywood accounting consist of?
It consists of whatever the contract says. Most of the studios have definitions of their profit participations, whether you call them adjusted gross, contingent proceeds or however you define it.

There are 20- to 30-page definitions that describe how the studios will account to participants. It has nothing to do with generally accepted accounting principles, it has to do with what the parties negotiate. Unless you are a very heavy player you don’t get too much chance to negotiate many protections in those definitions.

How can a movie studio benefit from this practice?
They can assess expenses to a film or television show that more properly would be part of the studio’s general overhead in operating as a studio. If they can charge it off to a film or television show, that takes it off of their financial statement.

They can create fictions, where instead of reporting all of the revenues from the distribution of home video or DVDs, they pay a royalty from one of their entities to another entity. Thus the participant only participates in the royalty, not the full pot of revenues.

In the studios that have multiple distribution channels and production channels, they can deal with each other and manipulate the license fees among their affiliated entities so that the participant receives less revenue than might otherwise be the fair market value.

How can players in the business secure agreeable contracts from studios?
If they can get a deal that is pure gross or a gross at the source deal, that is the way. The more attenuated you get with distribution fees, distribution expenses and production costs, that just leaves more areas of potential abuse.

The first thing they can do is try to be very successful so that they don’t have to worry about some of the usual manipulations. Also, they should have good representatives that know what they’re doing when they’re negotiating these agreements, because the more protections that they can negotiate in, the fewer problems there will be down the line.

What are some legal issues that are raised by this accounting method?
Breach of contract is one of the usual claims. In the last few years, whether or not a distributor owes a fiduciary duty to participants has been litigated.

In a case that went up to the Court of Appeals, Gary Wolf vs. Disney, having to do with Who Framed Roger Rabbit, the court found that there was no fiduciary duty between a participant and a distributor in arms-length transactions. However, they said if the relationship between the studio and the participant was akin to a joint venture, then they may find a fiduciary duty.

Another claim that is litigated frequently is the implied covenant of good faith and fair dealing, which basically alleges that the studio denied the plaintiff the benefit of his bargain.

If a case goes to an arbitrator, what does the arbitration process consist of?
It’s as varied as there are arbitrators. I had one arbitration that was supposed to last three days. Instead we had 21 days of testimony and it lasted for (more than) two years. Other times it’s much speedier.

The studios have, in the last few years, tried to get their participants to agree that if there is a dispute concerning participation accounting, it goes to arbitration to avoid a jury and avoid all of the discovery that you would be entitled to in court. Most arbitrations for studio accounting have to do with whether the studios are self-dealing among their affiliated entities.

How has the advent of DVD sales and rentals affected Hollywood accounting and the studios’ revenue models?
It has certainly added to their revenue streams. DVDs, have in many instances, generated more revenues than a film’s theatrical distribution. They’ve also distributed DVDs of television shows like the entire Sex and the City series. These revenue streams continue to be extremely important to the studios, and to a lesser degree, the participants.

Marcia Harris is a partner in Alschuler Grossman Stein & Kahan LLP’s Entertainment & Media Department. Reach her at