0. Revenue and cost recognition
Filmed Entertainment
Revenue and cost recognition

1. 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

2. Recap – Life cycle of a film or TV show

3. Current release windows of a film
Licensing and Merchandising
Free TV
(network & syndicated)
Pay TV
PPV/VOD
Home Entertainment (DVD, Blu-ray)
Digital Media
Theatrical 3 6 9 12 15 18 21 24 27 30 33 36
(months)

4. TV show markets Network Digital Media Cable Home entertainment
Syndicated TV
New media

5. Revenue recognition

6. 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

7. 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

8. 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

9. 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

10. 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)

11. 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

12. 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

13. 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

14. 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

15. Revenue recognition – other considerations
Cross collateralization
If cannot allocate, recognized on an “earn out” basis

16. Ultimate revenues

17. 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

18. 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

19. Cost amortization

20. 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

21. Amortization calculation
Year 1
Year 2
Yr. 1 revenues
Ultimate revenues
Ultimate
costs
Costs to
amortize
Ult costs
to go
Yr. 2 revenues
Ult revs to go
Costs to
amortize

22. Amortization calc – Example – Yr 1
Yr. 1 Ultimate Revenues (total) $ 60 Ultimate Costs (total) 40 Ultimate Gross margin 20 Actual Revenues: 20
Yr. 1 revenues
Ultimate revenues
Ultimate
costs
Costs to
amortize 20 60 40 13

23. Recording amortization – Year 1
Cost of revenues (Amortization expense) $13
Capitalized film costs (Accumulated amort) $13
Record Year 1 amortization expense

24. Amortization calc – Example – Yr 2
Yr 1 Yr 2 (to go) Ultimate Revenues (total) $ 60 $ 40 Ultimate Costs (total) Ultimate Gross margin Actual Revenues: Actual Costs Amortized: 13 ?
Ult costs
to go
Yr. 2 revenues
Ult revs to go
Costs to
amortize 15 40 27 10

25. Recording amortization – Year 2
Cost of revenues (Amortization expense) $10
Capitalized film costs (Accumulated amort) $10
Record Year 2 amortization expense

26. Amortization calc – Example – Yr 2 (revised ultimate)
Yr. 1 Ult Yr. 2 Ult Yr. 2 (to go) (revised) (revised) Ultimate Revenues Ultimate Costs Ultimate Gr. margin Actual revenues: Actual costs amortized 13 ?
Ult costs
to go
Yr. 2 revenues
Ult revs to go
Costs to
amortize 15 35 27 12

27. Recording amortization – Year 2 (revised ultimate)
Cost of revenues (Amortization expense) $12
Capitalized film costs (Accumulated amort) $12
Record Year 2 amortization expense – revised ultimate

28. Case Study part 2

29. Participations

30. 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)

31. 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

32. 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

33. Sample participation calculation

34. Participation calculation example

35. Participations – Example – Yr 1
Yr. 1 Ultimate Revenues (total) $ 567,500 Ultimate Participation Costs 30,200 Actual Revenues: 362,000
Yr. 1 revenues
Ultimate revenues
Costs to
amortize
Ultimate
costs
362
567.5
30.2
19.3

36. Recording participations
Costs of revenues (Participation exp) $19.3
Accrued participations $19.3
Record Year 1 participation expense and related liability

37. Residuals

38. 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

39. 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

40. Residual rates – Motion pictures

41. Residual rates – TV shows

42. 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

43. 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

44. Residuals calculation

45. Residuals – Example – Yr 1
Yr. 1 Ultimate Revenues (total) $ 567,500 Ultimate Residuals Costs 11,800 Actual Revenues: 362,000
Yr. 1 revenues
Ultimate revenues
Ultimate
costs
Costs to
amortize
362
567.5
11.8
7.5

46. Recording residuals Costs of revenues (Residuals expense) $ 7.5
Accrued residuals $ 7.5
Record Year 1 residuals expense and related liability

47. Other expenses

48. 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 (SOP 93-7)
Expense as incurred or
Upon first airing

49. Ultimate costs

50. 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

51. Tax incentives and Credits

52. 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

53. Impaired films and TV Shows

54. 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

55. 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

56. Development cost write downs

57. 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)?

58. Case Study Part 3