Film Cost Capitalisation, Amortisation and Impairment
www.pwc.com/miag MIAG Issue: 10 Media Industry May 2016 Accounting Group
Making sense of a complex world Film cost capitalisation, amortisation and impairment
This paper explores some of the key considerations under IFRS for film cost capitalisation, amortisation and impairment.
Contents
Introduction to MIAG 1
Film cost capitalisation, amortisation and impairment 2
Background 3
Classification: IAS 38 or IAS 2 or IAS 11? 5
Film cost capitalisation: When and which costs? 7
Film cost amortisation 11
Film cost impairment reviews 13
Conclusion 16
Publications/further reading 17
Contacts 20 Introduction to MIAG
Our Media Industry Accounting Group (MIAG) brings together our specialist media knowledge from across our worldwide network. Our aim is to help our clients by addressing and resolving emerging accounting issues that affect the entertainment and media sector.
With more than 4,200 industry- future topics of debate for the MIAG dedicated professionals, PwC’s global forum, and very much look forward to entertainment and media (E&M) our ongoing conversations. practice has depth and breadth of experience across key industry sectors Best wishes including: television, film, advertising, publishing, music, internet, video and online games, radio, sports, business information, amusement parks, casino Deborah Bothun gaming and more. And just as significantly, we have aligned our media PwC US practice around the issues and challenges that are of utmost Global leader, importance to our clients in these PwC Entertainment and Media sectors. One such challenge is the increasing complexity of accounting for transactions and financial reporting of results – complexity that is driven not just by rapidly changing business models but also by imminent changes to the world of IFRS accounting.
Through MIAG, PwC1 aims to work together with the E&M industry to address and resolve emerging accounting issues affecting this dynamic sector, through publications such as this one, as well as conferences and events to facilitate discussions with your peers. I would encourage you to contact us with your thoughts and suggestions about Deborah Bothun
1 PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity
1 MIAG Issue: 10 Film cost capitalisation, amortisation and impairment
The costs of developing and producing films can be significant and the outcomes unpredictable. Our 10th MIAG paper explores some of the key considerations under IFRS for film cost capitalisation, amortisation and impairment.
PwC’s Global entertainment and media and reporting practices can tell their We hope that you find this paper useful outlook 2015-2019 forecasts global film story in a clear and compelling manner, and welcome your feedback. revenues to grow at 4.1% annually, building public trust in their reaching US$105 billion in 2019. Strong performance with stakeholders such as Best wishes growth will be seen in China and in investors, analysts, employees, Latin America, but even global leader suppliers, partners and audiences. the US, with one-third of market spend in 2014, will see above-average annual This paper explores the critical considerations relating to the growth of 4.6%. But while Hollywood Sam Tomlinson remains at the heart of film, a trend in classification, capitalisation, PwC UK the forecasts for many markets, from amortisation and impairment of film China to Western Europe, is the costs under the applicable IFRS Chairman, PwC Media Industry increased significance of local films in standards IAS 38 Intangible Assets and Accounting Group boosting country box office revenue. IAS 2 Inventories. The examples in our paper are clearly not designed to be The accounting for spend on film exhaustive; but they will hopefully development and production presents provide food for thought for film challenges such as which IFRS standard companies when considering how to to apply; when to start and stop account for their own film development capitalising costs; which costs to and production costs. In addition, the capitalise; how to amortise them; and impact of financing arrangements – i.e. how to conduct impairment reviews of is the film company producing at its own these film assets. The costs of developing risk or does it have third party backing and producing films, particularly via an advance or shared outcomes – is blockbusters, are significant and the considered briefly in this paper and will outcome of the film as a hit or miss can be covered in more detail in a separate be unpredictable. Appropriate, MIAG publication. consistent treatment of film development and production costs is Sam Tomlinson therefore key. Companies that are adept at navigating the intricate accounting
Issue: 10 MIAG 2 Background
PwC’s Media Industry Accounting Group (MIAG) is our premier forum for discussing and resolving emerging accounting issues that affect the entertainment and media sector – visit our dedicated website: www.pwc.com/miag
At its heart, the film industry is about great content – that is, developing and producing films to capture an audience that can be monetised through theatrical release or DVD sales and by licensing to distribution channels such as television or digital platforms. It is the timeless appeal of this content – of great films – that continues to drive film industry growth. PwC’s Global entertainment and media outlook 2015-2019 forecasts global film revenues to grow at 4.1% annually, reaching US$105 billion in 2019.
Accounting for the significant film development and production costs, and their unpredictable outcomes, is a significant issue for film producers (and also, increasingly, for producers of high-end scripted television too). Specifically, which costs should be capitalised, and when do you start and end? How should the resulting asset be amortised? And how should impairment reviews be conducted if there are indications a film will not be as successful as anticipated?
What is the relevant IFRS The two key standards that provide The threshold for capitalising content guidance? guidance for cost capitalisation are IAS development costs is to demonstrate all of: IFRS addresses accounting for 38 and IAS 2: • The technical feasibility of capitalisation of product development completing the intangible asset so IAS 38 Intangible Assets, defined as costs, including guidance on the nature that it will be available for sale; non-physical resources controlled by an of costs, timing of cost capitalisation and entity for which they will generate • The intention to complete the asset method of cost recognition in the future economic benefit. Under IAS 38, and use or sell it; income statement as amortisation. costs incurred in the ‘research phase’ are • The ability to use or sell the asset; However, IFRS does not include specific expensed as incurred, while costs industry guidance so in practice • The way in which the intangible incurred in the ‘development phase’ are application of the relevant standards asset will generate probable future capitalised once the recognition criteria requires careful consideration of the economic benefits i.e. the existence are met. ‘Development’ is the application specific facts and circumstances. of a market for the asset; of research or other knowledge to a plan • The availability of adequate or design for the production content Fundamental to the concept of technical, financial and other before the start of commercial sale. capitalising costs is that they must meet resources to complete the the definition of an asset i.e. a resource development and to sell the (a) controlled by an entity as a result of asset; and past events; and (b) from which future • The ability to measure reliably the economic benefits are expected to flow expenditure attributable to the asset to the entity. during its development.
3 MIAG Issue: 10 Once these criteria are met IFRS requires How does film financing affect The examples in this paper also touch on capitalisation of development costs; the accounting? IAS 23 Borrowing costs and IAS 36 there is no option to expense such costs. For the most part, this paper assumes Impairment of assets. the cost of development and production IAS 2 Inventories, defined as assets Are there any tax implications? (i.e. the ‘film financing’) is being funded held for sale or in the process of production by the film company itself. Where Like all MIAG publications this paper is or to be consumed in that process. financing is being part-funded by a third concerned primarily with accounting, Inventory costs are capitalised once the party in exchange for a share of which should be consistent across general asset criteria are fullfilled: revenues and/or profits, the hurdles for companies reporting under IFRS, rather • The entity has control of the capitalisation change: for example, the than tax, which will vary with each inventory. ability to complete is more certain; country’s local laws and tax regulations. • The inventory will generate probable assessments of future profitability must However, corporation tax deductions future economic benefits. incorporate future payments to the often mirror accounting expenses. So funding party; and, depending on the • The ability to measure reliably the judgements about film cost exact financing terms, there might be an expenditure attributable to the asset capitalisation, amortisation and amount to be recognised as a liability or during its development. impairment can affect the timing of tax non-controlling interest or reduction in It will be clear that the capitalisation cash payments. And many countries the film costs. Financing arrangements criteria under IAS 38 and IAS 2 are have specific tax legislation relating to will be considered in more detail in a similar but not identical. These film production, such as ‘film tax credits’ separate MIAG publication. similarities and differences are explored to encourage domestic and international in the next section. Judgement is Is there any other applicable film producers to shoot and edit in required when determining which guidance? that country. In such cases, the standard to apply, whether to capitalise accounting treatment adopted for cost In addition to IAS 38 and IAS 2, film film development and production costs recognition should in theory be tax development and production costs can and if so when and which ones. These neutral, since tax is governed by specific also fall under the scope of IAS 11 judgements can have a significant rules. But even here there is an Construction Contracts, which applies impact on both statutory operating accounting judgement about the when a film is being made for a single profit and adjusted measures such as presentation of such film tax credits, customer under a single contract. Under earnings before interest, tax, which we discuss later in this paper. IAS 11, such costs and revenues are depreciation and amortisation (EBITDA). usually recognised in the income We would always recommend This paper first focuses on determining statement based on the percentage of consulting with a local tax expert to the relevant standard to apply to internal completion. The application of IAS 11 is determine possible tax consequences of and third party costs associated with film broadly scoped out of this paper since it such judgements. development and production. It then goes is being replaced by the new such on to consider cost capitalisation, standard IFRS 15, which will be the amortisation and impairment scenarios subject of a forthcoming MIAG in the film industry. publication.
Issue: 10 MIAG 4 Classification: IAS 38 or IAS 2 or IAS 11?
The first question in accounting for film development and production costs is which standard to apply. Do the costs qualify as an intangible asset under IAS 38, inventory under IAS 2, or are they contract costs under IAS 11? A guide to the relevant standard to apply is shown in Figure 1 followed by application examples.
Our theoretical view when considering Figure 1: Classifying film development and production costs the first distinction – that is, between IAS 38 and IAS 2 – is that film development and production generally falls more naturally under the remit of Not An asset is defined as: A resource (a) recognised controlled by an entity as a result of IAS 38 (e.g. example 1), except in Expenditure No qualifies as asset? as asset past events; and (b) from which future circumstances where a film company is economic benefits are expected to flow producing content that could be sold to to the entity. anyone and for which the producer expects to retain no or little intellectual Yes property rights (e.g. example 2). However, the diversity in practice among film companies when presenting The asset is Recognise Definition: ‘An identifiable non-monetary film costs as either intangible assets or held for sale in the No under IAS 38 asset without physical substance’ ordinary course of (Intangible Example 1 inventories is driven less by this business? Assets) theoretical distinction than by other factors, notably the treatment under local GAAP prior to transition to IFRS. Yes We believe that the theoretical classification as either intangible assets Recognise Definition: ‘Assets held for sale in the or inventory is generally of less concern Costs incurred No under IAS 2 ordinary course of business’ that the more critical practical specific to a contract Example 2 with a (Inventory) judgements on when to start and stop third party? capitalising costs, which costs to include, and how to amortise them. Yes (That said, we explain in the Recognise Definition: ‘Contracts specifically amortisation section of this paper that under IAS 11 negotiated for the construction of an film companies – indeed, all media (Construction asset that are closely interrelated or Contracts) interdependent in terms of their design, Example 3 companies – should carefully examine technology and function or their ultimate the amendments to IAS 38, effective purpose or use’ 1 January 2016, to ensure their selected amortisation policy is compliant with this new guidance.)
In contrast, the distinction between IAS 38/IAS 2 and IAS 11 (or IFRS 15) is highly important since whereas intangible asset and inventory costs are capitalised on to the balance sheet, costs developing content under a construction contract are recognised in the income statement as incurred with the corresponding revenue booked at the same time.
5 MIAG Issue: 10 Example 1: Film production Example 2: Film production for Example 3: Film production where certain rights are retained sale with no rights retained for hire Film producer A, from a non-English Film producer B produces documentary Producer C is commissioned by a film market, is creating and producing a films with the primary intention to sell studio to develop and produce a film and niche film that it intends to distribute them to studios for distribution. At the earns a fixed fee for the service. locally and worldwide in theatres and time of development and production Producer C retains no rights to the film. subsequently as DVDs and via digital there is no sales arrangement in place platforms. Producer A also intends to but producer B has a successful track How should the film development and retain and license the post-release record of producing and selling production costs be classified? television broadcast rights in its own documentary films. Producer B does not country to a national broadcaster, but expect to retain any rights to the film The rights to the finished film are will sell to another party the (much documentaries following their sale. identifiable non monetary assets without smaller) international television physical substance that are produced for broadcast rights. How should the film development and sale in the ordinary course of business, production costs be classified? but they are also specific to one contract. How should the film development and Assuming that the outcome can be production costs be classified? The documentary films are identifiable estimated reliably, costs are recognised non monetary assest without physical as incurred and revenues are recognised In this case, the film costs would meet substance, but are produced for sale in based on the percentage of completion the definition of an asset (assuming all the ordinary course of business. Given under IAS 11. Projects within the scope asset recognition criteria are met), while that there is no specific arrangement in of IAS 11 will be considered in a the revenues generated from theatres, place with a third party (i.e. not an IAS separate MIAG publication on the new DVDs, digital platforms and retained 11 construction contract), producer B revenue standard IFRS 15. licensing of national television broadcast would probably account for the rights are likely to be much higher in production costs as inventory in In summary, where the costs relate to this instance than the international accordance with IAS 2. the development and production of a broadcast television rights. The most film that will be sold in full with no appropriate treatment in our view would (In practice, more complex funding rights retained, the film costs might be be to recognise an intangible asset under approaches exist e.g. the film production classified as inventory under IAS 2; and IAS 38 (although in practice some film might be part-funded by a third party in where the production company retains companies might present this asset as exchange for a large advance or majority the rights to the film and will be able to inventory). share of outcomes, which might exploit these rights over a period of sometimes leave the film producer with time, the expenditure is probably an minimal rights in practice. In such a intangible asset under IAS 38. In scenario, an assessment is required as to practice, there is diversity in balance whether the film costs are more properly sheet presentation but the more critical classified as intangible assets or judgements are scope and timing of cost inventory or fall under example 3 below.) recognition and amortisation, as set out in the rest of this paper.
Issue: 10 MIAG 6 Film cost capitalisation When and which costs?
Having determined the appropriate standard to follow, at what point should film costs start to be capitalised and which costs should be capitalised? (This section considers projects within the scope of IAS 38 and IAS 2 only. ‘Construction’ and ‘service’ projects will be considered in a separate MIAG publication on IFRS 15.)
Figure 2: Stages of film development, production and sales production costs
Expense costs Capitalise costs
Pitching Pre-production Production Commercial sales • Story outline • Finalise screenplay • Filming • Theatrical release (domestic) • Draft script/screeplay • Prepare budget • Editing and visual effects • Theatrical release (global) • Search for talent • Confirm talent • Music composition • DVD release • Feasibility studies • Filming and release schedule • Register rights • TV broadcast • Digital platforms
Selling: promotion and marketing
When should costs be The following examples illustrate the On the assumption that the film capitalised? (And when should application of the capitalisation criteria to producer has the access to the financing they cease?) film development and production costs. and other resources to complete and As described earlier, IAS 38 and IAS 2 distribute the film and the systems to Film development and set out similar criteria that must be met measure reliably the expenditure, the production costs in order to capitalise content key judgements will include both which development costs. The fundamental In this scenario a film producer creates costs to capitalise and the forecast premise under both standards is it must and produces a film that is intended to revenues. Provided the film is expected be probable that the asset capitalised be distributed globally, and retains the to generate profits, the film producer is will bring future economic benefit of at intellectual property rights i.e. the likely to have the intention and ability to least the amount capitalised. international format, distribution and complete and distribute the film. Determining the point at which the asset ancillary rights, etc. Figure 2 sets out the The pitching phase is likely to be recognition criteria are met will usually development and production stages for ‘research’ that is undertaken with the require judgement and will be this film. prospect of understanding the potential dependent on past experience. (In more complex real-life scenarios, the market for such a film and the Selling, promotion and marketing costs distributor might have provided an availability of talent to direct and star in are always expensed. Although such advance and the residual intellectual it. As no intangible asset will arise from expenditure is intended to generate property rights will only have value if research phase any cost shall be future economic benefits, these benefits and when the distributor can recoup its expensed as incurred. are not separable from overall business initial outlay.) development and do not meet the The start point of capitalising costs definition of an asset. Similarly, costs occurs when there is evidence that all incurred as a result of sales (e.g. lead the recognition criteria set out in the actors participating in a share of the ‘background’ section above are met. film’s revenues or profits) are also usually recognised as expenses when the revenue is earned.
7 MIAG Issue: 10 The ability to complete the film and Capitalised costs for cancelled films are Production overheads are not reliably generate profits is likely to come at recognised as an immediate expense in specifically defined in IFRS but can some point between the start and the end the period of cancellation. reasonably be expected to align with the of pre-production phase, but before actual US GAAP concept as being the ‘costs of filming starts. Considerations for the start Film sequels individuals or departments with point of capitalisation may include: When a sequel is developed, a producer exclusive or significant responsibility for • Ability to complete the project: e.g. can look to historical experience with the production of films’. In other words, commitment of key talent and script the feasibility and success of the labour and overhead costs that are writers, or ‘locking-in’ of financing previous title, plus the general closely aligned with, and closely related such that all or most budgeted costs experience of successful sequels. In to, production activities should be are now funded addition, funding will be easier to obtain capitalised. Labour costs would include and key talent might be locked in both cash and share-based payments. • Existence of a market: e.g. prior already. Therefore, capitalisation of evidence of successful film costs might start earlier in the process. The following film activities and costs are productions. generally not considered capitalisable: Which film costs can be • Generate profits: e.g. history of • Corporate senior management costs capitalised? accurate forecasts of revenues from e.g. finance director and other theatres, DVDs, licensing, etc. Examples of ‘directly attributable’ film non-production-related senior costs that can be capitalised could include: management costs, because such costs Once the recognition criteria are • Direct labour: e.g. actors, are considered general and fulfilled, directly attributable internal film crew, security administrative and external costs must be capitalised. • Production costs: e.g. editing, • Central costs e.g. human resources The point of starting to capitalise film visual effects • Marketing expenses, selling costs might vary between producers. For expenditures, and distribution costs some, the internal approval process may • Production overhead costs: e.g. studio mean that an idea for a film is never rent, costumes, catering • Costs associated with overall deals progressed unless there is high degree of • Production-related administrative (see scenario 2 below) certainty of success, which means that costs: e.g. insurance capitalisation of film costs may start Scenario 2: How should overall deals relatively early in the process. For • Interest costs: if directly attributable be treated? others, there may be multiple smaller (see scenario 3 below) An ‘overall deal’ is fairly common in the film projects where there is no certainty The following four scenarios explore film industry; it is one in which the of success until near the end of the some of the judgements in these areas. studio compensates a producer or process and hence film costs may never creative talent for the exclusive use of qualify for capitalisation. Scenario 1: What costs should be included that party’s creative services. An overall in the production overhead allocation? Capitalisation of eligible costs should deal likely covers several films and can entail a significant time commitment. cease when the asset is capable of The identification of production operating in the manner intended. In overhead costs to be included in such A studio would expense the costs of practice this means that film cost overhead pool requires careful overall deals that cannot be identified capitalisation would usually cease once judgment. There is diversity in practice with specific projects as they are the film is ready for release. on what gets included in overhead incurred; a reasonable proportion of costs depending on the studio’s size, structure that are specific and directly related to a and operating practices. certain film can be capitalised. Issue: 10 MIAG 8 In determining whether activities and Assuming the film costs are themselves Tax credits that are really government costs are specific and directly related to being capitalised, then interest grants (because they are available a film, a studio should generally capitalisation should generally regardless of taxable profits) are within consider the following factors relative to commence and cease in the periods the scope of IAS 20 Government Grants, the producer’s or creative talent’s role on when film production begins (i.e. film is which permits two treatments: a particular project: set for production) and ends (i.e. film is • The tax credit can be deducted from • Participation in the review and substantially complete and ready for the intangible assets held in relation to approval of scripts and screenplays distribution), respectively. Generally, the production costs; or and the identification of other the interest cost subject to capitalisation creative talent includes stated interest, imputed • The tax credit can be recognised as interest, and interest related to capital deferred income and then recognised • Direct supervision of production leases as well as amortisation of in the income statement evenly over activities and participation in discounts, premium, and other issue the period of amortisation of the production related decisions costs on debt. Unless there is a specific related film asset. • Direct supervision of post-production new borrowing that can be attributed to Both treatments spread the benefit activities such as review and approval the financing of the film, a weighted received from the tax credit over the of film editing average capitalisation rate should generally be applied. useful economic life of the film. In the • Performance that is measured based first treatment, the benefit is recognised on specifically identified films Scenario 4: How should film tax credits be over time via a reduction in amortisation; in the second, as other income. To the extent a producer’s or creative accounted for? talent’s activities are determined to be Film tax credits arise where national or In contrast, tax credits that depend on specific and directly related to a project, local government agencies provide taxable profits are within the scope of a reasonable allocation of costs based on incentives for producing films that meet IAS 12 Income Taxes. Investment tax a consistently applied methodology certain criteria. There is often a time credits are scoped out of IAS 12 and would generally be appropriate. A film delay in receiving these benefits and, as although not specifically defined in IAS producer should not re-capitalise they are large in nature, the timing of 12 they are usually considered to be tax amounts it expensed in previous years. recognition can significantly affect the benefits received for investment in income statement from one period to specific qualifying assets. In this case, Scenario 3: Should interest be capitalised? another. The terms of tax credit schemes there is generally an accounting policy choice whether to recognise the tax IFRS requires film producers to account can vary widely so they warrant careful credits in the period in which the tax for interest costs in accordance with IAS consideration to determine the deduction is earned or to treat as akin to 23. The standard requires interest appropriate accounting. Some credit government grants and defer to the capitalisation where there are specific schemes are effectively government balance sheet (either as a deduction in financing arrangements or where those grants recoverable through the tax asset value or as deferred income). borrowing costs would have been system (that is, they are available regardless of the level of a company’s avoided if there had been no expenditure Whichever treatment is adopted, clear taxable profits) while others offer tax on the asset. This requires judgement disclosure of the policy choice and its credits that are only recoverable if the since even interest arising on general impact will be key. borrowings should be considered for entity has sufficient taxable profits (and capitalisation into the cost of the film. liabilities) against which the credit can be applied.
9 MIAG Issue: 10 Application in practice: policies Application in practice: Application in practice: and procedures identifying costs to capitalise treatment in the cash flow statement In summary, judgement is required in Companies often have an authorisation determining when to start (and stop) processes at each stage of film Costs qualifying for capitalisation as capitalising costs and which costs to development and production. These inventory under IAS 2 should be include. Factors that can help in ‘gates’ can help set a suitable start point classified as an operating item. But the practice include: for cost capitalisation. However, treatment of costs qualifying for • Establish a clear policy regarding the gathering all the cost data to quantify capitalisation as an intangible asset threshold, start point and nature of capitalisation can be a challenge, for under IAS 38 is less clear. Depending on cost capitalisation example because: how the company defines its operating • Contributing costs can come from a cycle, the cash flows may be classified as • Communicate this policy number of different general ledger either operating or investing. • Where appropriate, include a list of codes, or be a part of a general ledger factors to consider to help staff apply code. This is frequently the case with this guidance payroll cost where individuals may be working on a number of different • Set up the systems, month end and projects at different stages, some year end processes to reflect the policy capitalisable and others not. in the accounts • The relevant approval to move to a • Once the policy is set, insist it is capitalisation is unlikely to fall neatly followed consistently on a reporting period end date, which requires additional processes or amendments to a system to ensure all relevant data is captured appropriately.
Issue: 10 MIAG 10 Film cost amortisation
Does cost classification impact company. If that pattern cannot be What revenues should be amortisation? measured reliably the straight-line included when assessing amortisation methods? In practice, regardless of whether film method must be used. Under IAS 2 costs producers present their capitalised film are recognised in the income statement Under the approach outline above - of costs as intangible assets under IAS 38 as revenue is earned. These approaches accelerating amortisation based on the or inventories under IAS 2, they select are theoretically different but decline in asset value - we would expect the amortisation method that most historically have often generated the that film producers will continue to appropriately reflects underlying same result in practice provided the model expected revenues to help them economic reality subject to pragmatic method of amortisation used reflects the assess appropriate useful economic lives constraints such as simplicity of underlying economic reality. and to support the carrying value of film application and the availability of cost assets at each reporting date. An amendment to IAS 38, effective 1 reliable data. In that sense, the January 2016, introduced a rebuttable presentation as inventories or intangible Generally, film revenues should include presumption that revenue-based assets is irrelevant. estimates of revenues from all markets amortisation is not appropriate for and territories where persuasive However, although the timing and intangible assets.To rebut the evidence exists that such revenue will magnitude of the related expense is presumption, film companies would occur e.g. because the film producer can unaffected, its disclosure can vary. The need to show that the consumption of demonstrate a history of earning such cost associated with an intangible asset the economic benefit of the intangible revenues. These revenues can typically is invariably described as ‘amortisation’ asset, and the resulting revenues include revenues associated with whereas those film producers who generated, are ‘highly correlated’. theatrical release of the film, DVD sales, classify capitalised film costs as Revenue is affected by other inputs licensing sales to broadcast or cable inventories sometimes do refer to them (sales, marketing, etc.) so ‘highly networks and release via digital as being amortised but sometimes use correlated’ is a high hurdle; it is not platforms. In some instances, revenues other terms (e.g. ‘content costs’) and enough to simply demonstrate a from other sources – such as video sometimes do not separately disclose the relationship between the revenues and games and other merchandising related expense at all. Comparing the intangible. revenues from the sale of consumer EBITDA between companies is a products – may be included, if they can A common industry practice is to use an complex and hazardous task, with some be reasonably estimated based on accelerated amortisation profile for film reversing such amortisation out of historical experience with similar films. costs based on the observable decline in EBITDA while others leave it in. value of the film asset after its initial or (Throughout this paper, we use early showings. This practice continues ‘amortisation’ to refer generically to to be an acceptable and conceptually the expensing of capitalised film costs sound approach, based on an analysis of in the income statement, even where the remaining useful economic life and they are classified on the balance sheet the recoverable amount of the as inventories.) underlying film cost asset. Such an approach - of accelerating amortisation How should the film cost based on the decline in asset value - does intangible asset be amortised? not fail the IAS 38 prohibition on Has this changed with the revenue-based amortisation because it is amendment to IAS 38? not based on direct matching of revenue Under IAS 38 amortisation is defined as and amortisation. the systematic allocation of the depreciable amount of an intangible asset over its useful economic life. The allocation method should reflect the pattern in which the asset’s future economic benefits are consumed by the
11 MIAG Issue: 10 How long should the forecast When should revenue from Judgment is required in determining period be? licensing arrangements be what revenues to include in forecasts included in the forecasts? There is no time limit on the forecast when licensing contracts are entered period, but its use must be supportable The inclusion of licensing revenue can into contemporaneously with the based on historical evidence from be a challenging issue, as these production and release of a film. For previous experience. The period is likely scenarios illustrate: example, a new blockbuster film using to differ depending on the type and pre-existing library characters may expected success of a film and could Scenario 1: Licensing to fast-food include an overall marketing campaign vary depending on the film genre (e.g. restaurant that includes the production and sale of blockbusters, animation films, action toys specific to the film. It might then be films, comedies, etc.). The period of time Film producer A enters into a licensing reasonable to include revenues from for which revenue is included in the arrangement with a fast-food restaurant these toys in the revenue forecasts. forecast model is, by definition, the to license characters from a soon-to-be- useful economic life of the asset for released film to be used on the children’s Scenario 3: New intellectual property accounting purposes. meal box. Exploitation of the characters by generated from a film the fast-food restaurant begins two weeks The useful economic life of an asset is before theatrical release of the film and Film producer C creates a film with new required to be reassessed in accordance ends six weeks after theatrical release. characters and simultaneously enters with IFRS at least at each financial year into a licensing arrangement with a end. Where this results in a change in Since the arrangement is closely linked third party to produce and sell toys estimate, this is required to be to the soon to-be-released film, we representing the characters accounted for prospectively from the believe this revenue should be included contemporaneously with the film’s date of reassessment. in the forecasts, provided they can be release. The film is a box office success, reasonable estimated. and the initial one-year licensing IAS 38 explicitly states that film contract is extended to five years. publishing assets will not have a residual Scenario 2: Pre-existing contracts value on the basis that there is not an involving ‘library’ characters Consistent with the fast-food restaurant active market for a film as each title is example, we believe that licensing unique. Therefore, the film asset will Film producer B creates a film involving revenues expected to be earned from amortise to zero over the useful characters that reside in its intellectual contracts entered into as part of the economic life. property library. The producer has overall exploitation strategy for the film longstanding pre-existing license can be included in the forecast film arrangements with a fast-food revenues. However, subsequent renewals restaurant involving these characters, of licences involving these characters are which were entered into without specific less straightforward. Judgment is consideration of the new film. required to determine when the characters move from being created by In this scenario, we believe it would be the film to being part of the producer’s inappropriate to include these revenues library of intellectual property. in the forecasts since these licensing arrangement significantly predated the film.
Issue: 10 MIAG 12 Film cost impairment reviews
When is an impairment We would expect that, in many cases, an of reserves for anticipated sales review required? individual film will be the appropriate returns), licensing sales to broadcast, An impairment test is performed when level at which to assess the carrying release via digital platforms and an event or change in circumstance value. However, consideration should be merchandising revenues from the sale indicates that the carrying amount of given to the level of interdependence of of consumer products. unamortised film costs may exceed their revenue earned between films and with Cash outflows generally include all recoverable amount. The recoverable other assets. additional future distribution, amount is the higher of the estimated What cash flows should be advertising, marketing, and other fair value less costs to sell or value in use. included in the recoverable exploitation costs as well as cash Any write-off is calculated as the amount? flows associated with participations carrying amount by which unamortised The recoverable amount of a film and residuals. capitalised film costs exceed the represents its greatest value to the The following also should be considered recoverable amount. producer in terms of the cash flows that in an evaluation of the nature and extent it can generate. That is the higher of: The impairment indicators can be of such cash flows. • fair value less costs to sell (the amount external or internal. Examples include: for which the asset could be sold in an • Cash inflow or outflows associated • An adverse change on the expected arm’s length transaction between with the film to date performance of a film prior to release knowledgeable and willing parties, net • Historical experiences associated with of estimated costs of disposal); and • Actual costs substantially in excess of similar films budgeted costs • value in use (the present value of the • Film reviews and observable future cash flows that are expected to • Substantial delays in completion or public perceptions release schedules be derived from the asset. The expected future cash flows include those from The cash flow projections require • Changes in release plans, such as a the film’s continued use by the company management’s judgments which should reduction in the initial release pattern over its useful economic life and based be based on realistic assumptions and • Insufficient funding or resources to on present value calculations). which should be applied consistently. The cash flows should be based on the complete the film and market The value in use methodology is usually most up-to-date budgets and forecasts it effectively used to determine the impairment of that have been formally approved films, since it is easier to determine the • Actual performances subsequent to by management. release (e.g. poor box office value to that film producer than its performance or weak DVD sales) fails hypothetical value to another. Can a producer restore all or a to meet that which had been expected portion of the film costs that The value in use represents the future prior to release were written off in interim period cash flows expected to be generated by due to changes in a film’s • Restrictions under media law affecting the film over its useful life discounted to estimated net cash flows? the usability of films present value. IAS 36 requires that the number of years included in the The film producer should assess at each The impairment test should be discounted cash flow model is limited to reporting date whether there is any performed at the individual asset level; the remaining useful economic life of indication that any film cost impairment and where the recoverable amount the film, indicating that no terminal recorded in a previous period either no cannot be determined for an individual value should be included. longer exists or has decreased. asset, the test is done at the level of a ‘cash generating unit (‘CGU’). A CGU is Cash inflows should include all sources If there is any such indication the film the smallest identifiable group of assets of reasonably estimable revenues. Such producer should first estimate the that generates cash inflows largely sources might include theatrical releases revised recoverable amount. The film independent of the cash inflows from in one market or multiple markets, producer can then restore all or a other assets or group of assets. revenues associated with DVD sales (net portion of the film costs and based on
13 MIAG Issue: 10 the revised cash flow projection increase What discount rate should be What are the considerations for a the carrying value of the film to the used in determining a film’s value ‘pre-release’ write-down? in use? carrying value that would have been Prerelease write-downs generally occur recognised had the original impairment The discount rate for value in use when there is an adverse change in the of film not occurred (i.e. after taking calculations should be calculated on a expected performance of a film prior to account of normal amortisation). Due to pre-tax basis and applied to pre-tax cash release. Such adverse changes typically the amortisation effect, any impairment flows. The rates are adjusted to take are associated with: reversals will not be as large as the account of the way in which the • Film costs that have significantly original impairment charge. producer would assess the specific risks exceeded budgeted amounts in the estimated cash flows for that film If there is an indication that a previously and to exclude risks that are not relevant • Market conditions for the film that recognised impairment charge has or for which the estimated cash flows have changed significantly due to decreased or ceased to exist, the film have already been adjusted. timing or other economic conditions producer should also consider if the • Screening, marketing, or other similar useful life or amortisation method of the In the determination of the appropriate activities that suggest the performance film should be reviewed and adjusted. discount rate to use in a film valuation, of the film will be significantly the discount rate is principally impacted How should costs related to a film different from previous expectations by whether the film has been released producer’s distribution system be into the theatrical market. Prior to a • A significant change to the film’s included in a discounted cash film’s release, there is significant risk release plan and strategy flow model to determine a film’s related to whether the film will perform value in use? • Other observable market conditions, to its expectations and be generally such as those associated with similar A key consideration in determining the accepted by critics and the film-going recent films in the marketplace, that net outflows involves the remaining public. After a film’s theatrical release, indicate a write-down may be necessary distribution costs. The major film the timing and amount of cash flows are producers have mature distribution generally known with a strong level of In such situations, an estimate of networks with minimal incremental certainty based on initial reactions and recoverable value of the film is distribution costs for individual films; the producer’s prior history. necessary. This analysis will be based on whereas for an independent producer’s the determination of the value in use of perspective, the cash outflows from Accordingly, we believe that the the estimated net present value of future distribution could be significant because discount rate used for valuing an cash flows related to the non-released it will be need to pay a distribution fee unreleased film (e.g. in a pre-release film. The future cash flows should (typically 8-15% of revenues, often in write-down valuation) would generally include an estimate of the future cash the form of an advance funding be higher than the discount rate used for flows expected to be incurred before the payment from the distributor that will valuing a released film. film will be released and the expected be recouped from theatre and cash inflows and outflows once the film broadcast revenues). is released. An impairment write-down would then be necessary for the amount This variation in distribution costs by which the carrying value of the film indicates that a value in use calculation cost exceeds its recoverable value. can lead to different values depending on who is producing and distributing it. The judgements inherent in a value in use calculation will include the company-specific estimated costs of distribution efforts. The model should then be applied consistently to the valuation of films in similar situations for that film producer.
Issue: 10 MIAG 14 15 MIAG Issue: 10 Conclusion
The costs of developing and producing The answers for complicated real life films, particularly blockbusters, are arrangements will depend on the significant and the outcome of the film as specific facts and circumstances in each a hit or miss can be unpredictable. case. Where transactions are significant, Companies that are adept at navigating management should include disclosures the intricate accounting and reporting in the financial statements that enable practices can tell their story in a clear and users to understand the conclusions compelling manner, building public trust reached. As always, planning ahead can in their performance with stakeholders prevent painful surprises. such as investors, analysts, employees, suppliers, partners and audiences. We hope you find this paper useful and welcome your feedback. This paper has explored the critical considerations relating to the To comment on any of the issues classification, capitalisation, highlighted in this paper please amortisation and impairment of film visit our dedicated website costs under the applicable IFRS www.pwc.com/miag or contact standards IAS 38 Intangible Assets and your local PwC entertainment and IAS 2 Inventories. The examples in our media specialist. paper are clearly not designed to be exhaustive; but they will hopefully provide food for thought for film companies when considering how to account for their film development and production costs.
Issue: 10 MIAG 16 Publications/further reading
www.pwc.com/miag www.pwc.com/miag MIAG Issue: 3 MIAG Issue: 4 Media Industry April 2012 Media Industry June 2012 Accounting group Accounting group
Making sense of a Making sense of a complex world complex world Broadcast television: Accounting for royalty Acquired programming arrangements – issues rights for media companies
This paper explores the This paper explores some critical considerations of the key challenges under under IFRS relating to the IFRS in accounting for recognition, presentation, royalty arrangements by both amortisation and licensors and licensees. impairment of acquired programming rights.
EP6-2012-01-23-02 32-SW_MIAG Issue 4v7.indd 1 22/06/2012 17:13:40
MIAG Issue: 3 MIAG Issue: 4 MIAG Issue: 5
Broadcast television: Acquired Accounting for royalty arrangements Content development and cost programming rights – issues for media companies capitalisation by media companies
This paper explores the critical This paper explores some of the key This paper explores the critical considerations under IFRS relating to considerations under IFRS in considerations relating to the the recognition, presentation, accounting for royalty arrangements by classification, capitalisation and amortisation and impairment of both licensors and licensees. amortisation of content development acquired programming rights. spend under the applicable IFRS standards IAS 2 Inventories and IAS 38 Intangible Assets, focusing on the television production, educational publishing and video game sectors.
17 MIAG Issue: 10 www.pwc.com/miag www.pwc.com/miag MIAG Issue: 7 MIAG Issue: 8 Media Industry May 2014 Media Industry May 2015 Accounting Group Accounting Group
Making sense of a Making sense of a complex world complex world Revenue recognition: Online gaming: Real payments to issues in virtual worlds customers – issues for media companies
This paper explores some This paper explores of the key IFRS revenue recognition issues in the some of the key IFRS world of online gaming. accounting considerations for payments by media companies to their customers.
MIAG Issue: 6 MIAG Issue: 7 MIAG Issue: 8
Revenue recognition: principal/agent Revenue recognition: payments to Online gaming: Real issues in virtual arrangements – issues for media customers – issues for media worlds companies companies This paper explores some of the key This paper considers the assessment This paper explores some of the key IFRS revenue recognition issues in the of the key principal/agent IFRS accounting considerations for world of online gaming, covering considerations in various practical payments by media companies to their principal/agent considerations, virtual examples, covering physical books, customers, covering the purchase of items and virtual currencies, and eBooks, television content and film advertising space, physical and digital multiple element arrangements. production. ‘slotting fees’, outsourced advertising sales and video game prizes.
Issue: 10 MIAG 18 www.pwc.com/miag MIAG Issue: 9 Media Industry June 2015 Accounting Group
Making sense of a complex world Media investments in technology companies
This paper explores some of the key IFRS accounting issues that can arise when making investments in technology companies.
MIAG Issue: 9
Media investments in technology companies
This paper explores some of the key IFRS accounting issues that can arise when making investments in technology companies.
19 MIAG Issue: 10 Contacts
Global leader Australia Mexico Deborah Bothun Rosalie Wilkie Miguel Arrieta [email protected] [email protected] [email protected] +1 646 471 9048 +61 2 8266 8381 +55 5263 6000 Ext 5857 UK leader Brazil Netherlands Phil Stokes Estela Vieira Ennel van Eeden [email protected] [email protected] [email protected] +44 20 7804 4072 +55 11 3674 3802 +31 88792 4540 MIAG leader Canada Russia Sam Tomlinson Lisa J. Coulman Natalia Yakovleva [email protected] [email protected] [email protected] +44 20 7804 0726 +1 416 869 8685 +7 495 967 6395 China Singapore Wilson Chow Charlotte Hsu [email protected] [email protected] +86 755 8261 8886 +65 6236 7668 France South Africa Richard Bejot Vicky Myburgh [email protected] [email protected] +33 1 5657 6039 +27 11 797 4305 Germany Spain Christoph Gruss Inmaculada Izarra [email protected] [email protected] +49 69 9585 3415 +34 915 68 5176 Hong Kong Switzerland Cecilia Yau Patrick Balkanyi [email protected] [email protected] +852 2289 1385 +41 587 922 676 India United Kingdom Smita Jha Sallie Deysel [email protected] [email protected] +91 98 1114 1190 +44 20 7212 5845 Italy United States Andrea Samaja Bob Barrett [email protected] New York +39 2 6672 0555 [email protected] +1 703 283 7040 Japan Hideaki Zenba [email protected] +81 80 3158 6368
Issue: 10 MIAG 20 This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
© 2016 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.
160601-124601-AG-OS