Darth Accountus: Hollywood Accounting Explained
James Earl Jones is a household name. The actor gained global fame for lending his rich, resonant voice to powerful heroes and villains alike. Perhaps his most iconic role is the voice of Darth Vader in the Star Wars saga. But while Jones shot to stardom, his co-actor David Prowse did not. Prowse was the man in the Vader suit, lending the character an imposing height and gait. Though the combination of the two men created arguably the greatest villain of all time, Prowse did not receive a single dollar for his work, because of the ‘Hollywood accounting’ syndrome.
Hollywood is synonymous with dizzying lights and glamour. Double-entry accounting, though one of the wonders of the business world, is anything but. Hollywood accounting is the practice of using financial chicanery to manipulate the books of a successful movie production (or any creative venture) to portray it as a loss-making entity on paper.
Why do this?
At the heart of the issue lies the concept of gross profit versus net profit. Gross profit for a movie is typically a measure of the revenue the movie generates in box office and other sales, minus the cost of shooting, production and other expenses involved with creating the film (typically the film’s budget). Net profit, on the other hand, is what is left of the profit after subtracting distribution costs, marketing expense and other payouts in the form of taxes and royalties. Companies in all industries routinely load expenses onto their books (like interest on debt) that legitimately decrease their bottom lines to reduce tax burden. Hollywood has an additional reason to do this. Several actors, including Prowse, make the mistake of signing contracts linking their compensation to a percentage of net profits. And there lies the problem.
In this glitzy industry, actors’ egos are not the only thing inflated. Studios frequently increase paper costs to circumvent profit-sharing payouts. There are several ways to do this, two particularly popular. In the subsidiary method, a studio creates a shell subsidiary company to perform a service (distribution, marketing, post-production, etc) for the movie. The company can charge the parent an exorbitant fee. While this significantly reduces profitability for the film, the cash remains within control of the studio, flowing from one pocket to another. The other common method is cross-collateralization of accounting from two different projects. Simply put, this method allows studio executives to load the losses from an unprofitable film onto the Profit & Loss (P&L) Statement of a successful film, reducing net profit and all its linked payouts.
Let’s look at a simple numeric example. Assume Studio X has a new film that grosses $10 million against a budget of $3 million. After accounting for weighted average distribution fees of $3 million, the company makes a net profit of $4 million.
If the total payout to actors was 10% of net profits, the actors would receive $400,000 in total. But studios can also reduce the payout to actors while increasing their own collections. The studio could run an expensive marketing campaign which would boost revenue (an increased $5 million sales from a $3 million investment in our example) and add an expense that reduces net profit. Although this is perfectly legitimate, the studio could also employ Hollywood accounting to further trim its liability. For instance, in a superhero movie, the project might license the right to use the characters from a parent or subsidiary entity that holds the intellectual property for use of these characters. This creates the facade of a legitimate expense but is really just a related-party transaction.
These simple maneuvers now reduce the actors’ payout to $100,000 while simultaneously increasing the film’s revenue and payout to the studio. Which is precisely why Prowse, who worked for a percentage of the net profits, never got paid for his work. Despite the details being unclear, Return of the Jedi, the final arc of the original Star Wars trilogy has, according to Lucasfilm, never made a profit despite earning $475 million at the box office against a budget of $32.5 million.
Prowse’s misfortune might have gone under the radar, yet Hollywood accounting has gained notoriety in several other high-profile cases. Perhaps most infamously, Stan Lee, the co-creator of Spiderman (among hundreds of other Marvel characters) had a contract which would pay him 10% of all net profits of any production based on his characters. The 2002 Spiderman film grossed over $800 million in revenue, but the producers claimed a loss and Lee received nothing. Luckily, Lee had enough visibility to successfully sue Marvel Comics and claim $10 million in damages.
If lawsuits contesting these accounting tactics are gaining prevalence, attitudes are changing as well. At the end of the day, movie production is a business and actors must be seen as employees. Most corporate employees have variable pay and bonuses linked to sales rather than profitability (if they didn’t, unprofitable tech behemoths like Uber and Slack would find it very hard to attract top talent). Similarly, most actors worth their salt today negotiate contracts that pay them a large lumpsum amount, or a variable fee that is linked to the movie’s gross revenue rather than net profits. Luckily for Star Wars fans, James Earl Jones refused a share of net profits and instead negotiated a lumpsum payment. Unfortunately, Jones underestimated the impact the movie would create and settled for a paltry $7,000 for the first installment of the series. The series took off, Jones became a legend and no amount of Hollywood accounting shenanigans could touch him again.
