You know the old joke about keeping two sets of books, one for the IRS and one for yourself? In Hollywood, it's more like three sets of books: one for the IRS, one for the movie studio and one for the net profit participants, the people or entities owed a percentage of a project's profits once costs are recouped. It's no secret that in Hollywood, net profit participants will never see a dime. It's all part of something known as Hollywood accounting.
If you're picturing really glamorous accountants crunching numbers in the sunshine — well, that's probably an accurate image. But Hollywood accounting is really not about location; it's an accounting style that movie and entertainment studios use to keep a project's profits to themselves. Hollywood accounting can make some of the top-grossing films of a given year or, indeed, of all time seem unprofitable.
The numbers are laughable. How is it possible, for example, that "Return of the Jedi"is unprofitable? The movie ranks among the top 20 biggest blockbusters of all time and has earned more than $500 million on a $32 million budget — but, according to Hollywood accounting, it's still in the red [source: Rowles]. Of course the movie made and continues to make money for the studio. But the notion that it's unprofitable is all part of the system.
Entertainment studios tell a story about costs that don't really exist to funnel any profits back their way. In the end, they get away with it. Despite some high-profile cases challenging Hollywood accounting, most net profit participants never receive any profits [source: Abelson]. Yet "net points" continue to be given freely by the studios.
The next pages will examine how Hollywood accounting works, the types of movies affected — and why the system is likely to persist.
Behind the Scenes of Hollywood Accounting
The big difference between Hollywood accounting and typical corporate accounting is how people are paid. Shares of the film or "points" may be given to producers, directors, actors, writers, or anyone who worked on or helped with the production in a significant way. Most players in Hollywood get net points; in other words, they're supposed to receive some of whatever is left after the studio recoups the costs [source: Snyder].
The thing is, these people don't ever actually see any money from these shares. The reason net points are given so liberally is because they are, by all accounts, essentially meaningless. To ensure that there are no net profits in Hollywood, movies are contractually designed to be unprofitable, no matter how much they make.
It's really a game of paperwork. Each movie is set up like a corporation that's designed to lose money. Within the corporation are shell companies, those existing in name only, that are designed to siphon all of the profits from the movie and funnel them back to the studio. These shell companies handle things like advertising, marketing and distribution. They can even be set up to cover more general expenses for accountants, managers, travel and entertainment for studio heads, and so on.
Some of the fees that studios pay themselves through these shell companies might be legitimate, but they can also be outrageous. A distribution fee of 30 to 35 percent of every penny a movie makes goes directly to the studio [source: Davidson]. The studio charges the film exorbitant amounts for advertising and publicity in addition to financing and interest through shell companies. Every perk that comes with the job of working at a studio, it seems, is paid for by some movie or television show. Executives are said to charge the bulk of their expenses to whichever movie is grossing the most [source: Daniels et al.].
To be sure, shell companies aren't new. Corporations in other industries use them all the time to play accounting tricks. In other types of business, however, shell companies are typically used to hide losses to make a corporation's profits appear greater to shareholders and investors. It's the goal of hiding profits and not losses that makes Hollywood accounting unique.
Because there's no such thing as net profits in Hollywood, a handful of the biggest players in the industry demand a percentage of gross points or, more specifically, first-dollar gross. That means these people are getting a cut of the profits before most other costs are recouped. Sandra Bullock is said to have negotiated this rare type of deal for her role in the movie "Gravity." She received $20 million upfront and 15 percent of first-dollar gross. The actress stands to make at least $70 million from the deal [source:Galloway].
Why Does Hollywood Work This Way?
Hollywood didn't exactly design this accounting system. Instead, it seems to have evolved this way over time. There are conflicting stories about which star was the first to buck the traditional studio system, in which talent was under contract with the studio for a fixed weekly or monthly rate. Rita Hayworth is said to have had a William Morris agent who, in 1946, got her 25 percent net profit of her movies, along with script approval. Jimmy Stewart waived his usual upfront cash requirements to act in the 1950 movie "Winchester '73" for a piece of the net back-end profits [source: Daniels et al.]. Because these deals were new, the studios didn't know enough to rig the contracts, and they turned out to be lucrative for both actors.
In the 1960s and 1970s, actors, producers, directors and even writers took part in the gross and net profits of hit movies. Warren Beatty, for example, shepherded the production of and played the lead role in "Bonnie and Clyde." In addition to earning $200,000 upfront for his work, he also took 40 percent of gross profits. The movie was not expected to make much when the deal was struck, but it has since earned more than $150 million. That means he has earned about as much as Sandra Bullock would make on "Gravity" nearly 45 years later.
Beatty took a risk on the movie, and it made him a very rich man. His success even prompted studios to take a closer look at the over-generosity of its contracts. Two lessons were learned: Participation motivated those who were involved in the film, and the studios needed to tighten up their contractual reins. In the decades since, Tinseltown has made profit sharing seem like an enticing dream to more and more people, while, at the same time, reducing the actual profit shared [source: Stafford].
Like Beatty, today's power producers, directors and actors who get first-dollar gross might do it to take a chance on a riskier movie or an independent film. Leonardo DiCaprio is said to have taken a pay cut to act in "Inception," but his percentage of first-dollar gross earned him around $50 million [source: Bacardi]. Tom Cruise earned no upfront compensation for producing and acting in "Mission: Impossible II," but his production company received a rare deal for 30 percent of the film's adjusted gross [source: Epstein]. Those who don't rate first-dollar gross might instead receive a bonus payment, made regardless of profit.
That's the other benefit of Hollywood accounting: No one knows exactly how much anyone makes. It's a system based on rumor and innuendo, leaving people in Hollywood speculating about how much everyone else is actually making compared to what's in the contract. Even the distinction for a player who can get first-dollar gross can be substantial in building and maintaining a career.
Famous Hollywood Accounting Battles
There are many fun examples of famous blockbuster films that studios claim are still in the red: Peter Jackson's wildly successful "The Lord of the Rings" trilogy is said to be a net loser despite earning nearly $3 billion at the box office. The original "Batman" still shows a deficit of $36 million despite earning $411 million. (Way back in 1991, the Los Angeles Times called it "the movie that may never earn a profit," and, more than 25 years later, the prediction has apparently come true [source: McDougal].) Even a small movie such as "My Big Fat Greek Wedding," which cost only $6 million to make and earned more than $350 million, is said to have cost the studio $20 million in losses [source: Rowles].
Not everyone in Hollywood supports the local accounting practices, however. Over the years, there have been signs that the studios' clever tricks would catch up with them.
Filmmaker Michael Moore sued producers Harvey and Bob Weinstein over profits for his hugely successful 2004 documentary, "Fahrenheit 9/11." The movie grossed more than $228 million in theaters, and possibly twice that, considering DVD, television and other sales. Moore said he was supposed to get 50 percent of the profits; the Weinsteins said he was a profit participant. Moore earned $19.8 million from his film and sued for an additional $2.7 million in profits [Source: Garrahan]. The parties settled out of court in 2012 for an undisclosed amount.
Writer Art Buchwald won $900,000 from Paramount for his work writing the story treatment that inspired the 1988 Eddie Murphy comedy "Coming to America." The movie had made $288 million when Buchwald sued in 1990, but it still had not seen a net profit.
Hollywood accounting extends beyond movies to television, videos, books, music and other projects designed to hide net profits. Actor Don Johnson sued the company Rysher Entertainment in 2010 over his share of profits from the show "Nash Bridges." The company claimed it was so expensive to produce, that the show was left $40 million in the red. The jury disagreed and awarded Johnson more than $23 million, which the judge increased to $50 million to account for interest. The settlement was eventually reduced on appeal. In the end, Johnson is said to have received $19 million [source: Gardner].
And in 2008, Deborah Gregory, author of the popular young-adult fiction series "Cheetah Girls," complained that she had never seen a penny of the 4 percent net profits she was promised by Disney from the movies, DVDs and merchandising surrounding her book.
Despite the grumbling, there are no real signs that Hollywood accounting practices will change anytime soon. David Geffen, Jeffrey Katzenberg and Steven Spielberg founded the studio Dreamworks SKG in the mid-1990s with a plan to really change how studio profits were shared [source: Abelson]. But Geffen has since departed, and the studio has had a tough time keeping up with cash flow [source: Epstein]. Today, the studio relies on Disney for most of its distribution, and reforming Hollywood accounting no longer seems to get a mention as part of the Dreamworks story [source: Dreamworks].
Indeed, Hollywood outsiders would be hard-pressed to find many vocal critics from within the Hollywood accounting system. But if you follow insider podcasts and interviews closely, you can find stories like that of Scott Derrickson, the director of "The Exorcism of Emily Rose." In an interview with fellow director Kevin Smith, Derrickson explained how his net profit deal for directing the hit horror film was worth less than a ham sandwich [source: Masnick]. Regardless of whether the system can be changed, it should be ready for its close up.
Author's note: How Hollywood Accounting Works
The most bittersweet part of reporting this story was learning about David Prowse, the actor who played Darth Vader in first three "Star Wars" movies in the 1970s and 1980s (James Earl Jones played the voice, Prowse was the body). He owns a percentage of "Return of the Jedi," but because they are net points, he routinely gets letters explaining that the movie still has not turned a profit [source: Sciretta].
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