The costs of producing a film are generally capitalized when they are direct and incremental to the production and are expected to provide future economic benefit. These capitalized costs become part of the film’s asset base and are amortized over the period the film is expected to generate revenue.
Understanding Film Production Cost Capitalization
The process of capitalizing film production costs is a complex accounting exercise dictated by accounting standards, primarily ASC 926, Entertainment—Films, in the United States. This standard governs the recognition, measurement, presentation, and disclosure of film costs. The fundamental principle is that costs directly attributable to the film’s production, which will benefit future periods through revenue generation, should be capitalized rather than expensed immediately. This alignment with the matching principle allows the costs to be recognized as expenses (amortized) over the film’s revenue-generating lifespan.
The Capitalization Threshold
Determining which costs qualify for capitalization requires careful evaluation. Expenses that are directly related to the production and are expected to generate future revenues are typically capitalized. These include, but are not limited to:
- Direct Costs: These are costs directly attributable to the production, such as cast and crew salaries, set construction, location fees, film stock, editing costs, and music rights.
- Indirect Costs: Certain indirect costs, such as production overhead, may also be capitalized if they are incremental to the production. This means they would not have been incurred if the film was not being made.
- Interest Costs: Interest expenses incurred during the production period on debt directly attributable to the film’s financing may be capitalized.
Costs that are generally not capitalized include general and administrative overhead that is not specifically related to the film, script development costs incurred before the project is considered viable, and marketing and distribution expenses (these are typically expensed as incurred).
Amortization: Recognizing the Expense Over Time
Once capitalized, film production costs are amortized over the film’s estimated useful life, typically using the individual-film-forecast-computation method. This method allocates the capitalized costs proportionally to the revenues generated by the film in each period. The amortization is calculated based on the ratio of current period revenues to total estimated lifetime revenues. Regular review and updates of the revenue forecast are crucial for accurate amortization. If the estimated future revenues are significantly reduced, an impairment charge may be necessary to write down the film asset’s value.
Frequently Asked Questions (FAQs) About Film Cost Capitalization
FAQ 1: What is the difference between capitalization and expensing film production costs?
Capitalizing film production costs means treating them as an asset on the balance sheet. These costs are then systematically amortized (expensed) over the film’s revenue-generating life. Expensing, on the other hand, means recognizing the cost as an expense on the income statement in the period it is incurred. Capitalization aligns with the matching principle, while expensing recognizes costs immediately. The key differentiator lies in the expectation of future economic benefit – capitalized costs are expected to generate future revenue, while expensed costs are considered period costs.
FAQ 2: How do you determine if a cost is directly related to film production and therefore eligible for capitalization?
A cost is considered directly related if it is specifically and demonstrably attributable to the film’s production. This requires a clear cause-and-effect relationship. For instance, the salary of a camera operator working exclusively on the film is a direct cost. General administrative expenses of the production company, not directly tied to the film, would not qualify. Careful documentation and cost tracking are essential to accurately identify direct costs.
FAQ 3: Can marketing and distribution costs be capitalized?
Generally, marketing and distribution costs are expensed as incurred. ASC 926 specifically excludes these costs from capitalization. The rationale is that these costs are incurred to generate immediate revenue, and their benefit is not considered to extend over the film’s entire life. While some argue that certain costs, like advertising production, could be argued for capitalization in limited circumstances, the prevailing practice is to expense them.
FAQ 4: What happens if a film never gets released after all the production costs have been capitalized?
If a film is abandoned or unlikely to generate future revenues, an impairment loss must be recognized. This involves writing down the capitalized costs to their fair value (usually zero), with the loss recognized on the income statement. This ensures that the financial statements accurately reflect the film’s current economic value. The assessment of impairment should be performed regularly, especially if there are significant changes in market conditions or the film’s prospects.
FAQ 5: How are abandoned script development costs treated?
Costs incurred in developing a script that is ultimately abandoned are generally expensed immediately. These costs do not meet the criteria for capitalization because they are no longer expected to generate future economic benefits. However, if the abandoned script is later revived, and a film project becomes viable, these costs may be reevaluated for capitalization.
FAQ 6: What is the individual-film-forecast-computation method, and how is it used for amortization?
The individual-film-forecast-computation method is the standard method for amortizing capitalized film production costs. It allocates the costs based on the ratio of current period revenues to total estimated lifetime revenues. For example, if a film generates $10 million in its first year and is expected to generate a total of $50 million over its lifetime, 20% ($10M / $50M) of the capitalized costs will be amortized in the first year. Accurate revenue forecasting is critical for this method to provide a fair representation of the film’s profitability.
FAQ 7: How often should revenue forecasts for film amortization be reviewed?
Revenue forecasts should be reviewed at least annually, and more frequently if there are significant changes in market conditions, audience reception, or distribution agreements. Changes to the forecast can impact the amortization expense recognized in each period. Regular review ensures that the amortization schedule accurately reflects the film’s projected revenue stream.
FAQ 8: Are there different accounting rules for independent films compared to studio films?
The fundamental accounting principles outlined in ASC 926 apply to all films, regardless of whether they are produced by independent filmmakers or major studios. However, the complexity of the accounting and the level of scrutiny may differ. Larger studios often have dedicated accounting teams specializing in film production accounting, while independent filmmakers may rely on external consultants.
FAQ 9: How is interest capitalized in film production, and what are the limitations?
Interest costs incurred during the production period on debt directly attributable to the film’s financing can be capitalized. This is in accordance with general accounting principles related to interest capitalization. The amount of interest capitalized is limited to the interest actually incurred during the period and the total capitalized cost of the film cannot exceed its estimated net realizable value.
FAQ 10: What documentation is required to support the capitalization of film production costs?
Thorough documentation is crucial for justifying the capitalization of film production costs. This includes detailed invoices, contracts, payroll records, time sheets, and any other documentation that supports the direct and incremental relationship between the cost and the film production. Maintaining accurate and comprehensive records is essential for audit purposes and for ensuring compliance with accounting standards.
FAQ 11: How does film tax credit accounting interact with capitalization?
Film tax credits can significantly impact the capitalization of film production costs. Tax credits received or receivable are typically treated as a reduction of film production costs. This means that the capitalized cost base is reduced by the amount of the expected tax credit. The accounting for tax credits can be complex and depends on the specific regulations of the jurisdiction offering the credits.
FAQ 12: What are the common mistakes made in film cost capitalization?
Common mistakes include improperly classifying costs (e.g., capitalizing general overhead), failing to adequately document costs, using unrealistic revenue forecasts, and neglecting to perform impairment tests when necessary. These errors can lead to inaccurate financial statements and potential regulatory issues. Proper planning, detailed cost tracking, and consultation with qualified accounting professionals are essential to avoid these mistakes.