Film Cost Capitalisation - PwC

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 contractcosts under IAS 11? A guide to the relevant standard to apply is shown in Figure 1 followed byapplication examples.Our theoretical view when consideringthe first distinction – that is, betweenIAS 38 and IAS 2 – is that filmdevelopment and production generallyfalls more naturally under the remit ofIAS 38 (e.g. example 1), except incircumstances where a film company isproducing content that could be sold toanyone and for which the producerexpects to retain no or little intellectualproperty rights (e.g. example 2).However, the diversity in practiceamong film companies when presentingfilm costs as either intangible assets orinventories is driven less by thistheoretical distinction than by otherfactors, notably the treatment underlocal GAAP prior to transition to IFRS.We believe that the theoreticalclassification as either intangible assetsor inventory is generally of less concernthat the more critical practicaljudgements on when to start and stopcapitalising costs, which costs to include,and how to amortise them.(That said, we explain in theamortisation section of this paper thatfilm companies – indeed, all mediacompanies – should carefully examinethe amendments to IAS 38, effective1 January 2016, to ensure their selectedamortisation policy is compliant withthis new guidance.)In contrast, the distinction between IAS38/IAS 2 and IAS 11 (or IFRS 15) ishighly important since whereasintangible asset and inventory costs arecapitalised on to the balance sheet, costsdeveloping content under a constructioncontract are recognised in the incomestatement as incurred with thecorresponding revenue booked at thesame time.5 MIAGIssue: 10Figure 1: Classifying film development and production costsExpenditurequalifies as asset?NotNo recognisedas assetAn asset is defined as: A resource (a)controlled by an entity as a result ofpast events; and (b) from which futureeconomic benefits are expected to flowto the entity.RecogniseNo under IAS 38(IntangibleAssets)Definition: ‘An identifiable non-monetaryasset without physical substance’YesThe asset isheld for sale in theordinary course ofbusiness?Example 1YesRecogniseCosts incurredNo under IAS 2specific to a contract(Inventory)with athird party?Definition: ‘Assets held for sale in theordinary course of business’Example 2YesRecogniseunder IAS 11(ConstructionContracts)Definition: ‘Contracts specificallynegotiated for the construction of anasset that are closely interrelated orinterdependent in terms of their design,technology and function or their ultimatepurpose or use’Example 3

Example 1: Film productionwhere certain rights are retainedExample 2: Film production forsale with no rights retainedExample 3: Film productionfor hireFilm producer A, from a non-Englishmarket, is creating and producing aniche film that it intends to distributelocally and worldwide in theatres andsubsequently as DVDs and via digitalplatforms. Producer A also intends toretain and license the post-releasetelevision broadcast rights in its owncountry to a national broadcaster, butwill sell to another party the (muchsmaller) international televisionbroadcast rights.Film producer B produces documentaryfilms with the primary intention to sellthem to studios for distribution. At thetime of development and productionthere is no sales arrangement in placebut producer B has a successful trackrecord of producing and sellingdocumentary films. Producer B does notexpect to retain any rights to the filmdocumentaries following their sale.Producer C is commissioned by a filmstudio to develop and produce a film andearns a fixed fee for the service.Producer C retains no rights to the film.How should the film development andproduction costs be classified?In this case, the film costs would meetthe definition of an asset (assuming allasset recognition criteria are met), whilethe revenues generated from theatres,DVDs, digital platforms and retainedlicensing of national television broadcastrights are likely to be much higher inthis instance than the internationalbroadcast television rights. The mostappropriate treatment in our view wouldbe to recognise an intangible asset underIAS 38 (although in practice some filmcompanies might present this asset asinventory).How should the film development andproduction costs be classified?The documentary films are identifiablenon monetary assest without physicalsubstance, but are produced for sale inthe ordinary course of business. Giventhat there is no specific arrangement inplace with a third party (i.e. not an IAS11 construction contract), producer Bwould probably account for theproduction costs as inventory inaccordance with IAS 2.(In practice, more complex fundingapproaches exist e.g. the film productionmight be part-funded by a third party inexchange for a large advance or majorityshare of outcomes, which mightsometimes leave the film producer withminimal rights in practice. In such ascenario, an assessment is required as towhether the film costs are more properlyclassified as intangible assets orinventory or fall under example 3 below.)How should the film development andproduction costs be classified?The rights to the finished film areidentifiable non monetary assets withoutphysical substance that are produced forsale in the ordinary course of business,but they are also specific to one contract.Assuming that the outcome can beestimated reliably, costs are recognisedas incurred and revenues are recognisedbased on the percentage of completionunder IAS 11. Projects within the scopeof IAS 11 will be considered in aseparate MIAG publication on the newrevenue standard IFRS 15.In summary, where the costs relate tothe development and production of afilm that will be sold in full with norights retained, the film costs might beclassified as inventory under IAS 2; andwhere the production company retainsthe rights to the film and will be able toexploit these rights over a period oftime, the expenditure is probably anintangible asset under IAS 38. Inpractice, there is diversity in balancesheet presentation but the more criticaljudgements are scope and timing of costrecognition and amortisation, as set outin the rest of this paper.Issue: 10MIAG6

Film cost capitalisationWhen and which costs?Having determined the appropriate standard to follow, at what point should film costs start to becapitalised and which costs should be capitalised? (This section considers projects within the scope ofIAS 38 and IAS 2 only. ‘Construction’ and ‘service’ projects will be considered in a separate MIAGpublication on IFRS 15.)Figure 2: Stages of film development, production and sales production costsCapitalise costsExpense costsPitchingPre-productionProductionCommercial sales Story outlineDraft script/screeplaySearch for talentFeasibility studiesFinalise screenplayPrepare budgetConfirm talentFilming and release scheduleFilmingEditing and visual effectsMusic compositionRegister rightsTheatrical release (domestic)Theatrical release (global)DVD releaseTV broadcastDigital platformsSelling: promotion and marketingWhen should costs becapitalised? (And when shouldthey cease?)As described earlier, IAS 38 and IAS 2set out similar criteria that must be metin order to capitalise contentdevelopment costs. The fundamentalpremise under both standards is it mustbe probable that the asset capitalisedwill bring future economic benefit of atleast the amount capitalised.Determining the point at which the assetrecognition criteria are met will usuallyrequire judgement and will bedependent on past experience.Selling, promotion and marketing costsare always expensed. Although suchexpenditure is intended to generatefuture economic benefits, these benefitsare not separable from overall businessdevelopment and do not meet thedefinition of an asset. Similarly, costsincurred as a result of sales (e.g. leadactors participating in a share of thefilm’s revenues or profits) are alsousually recognised as expenses whenthe revenue is earned.7 MIAGIssue: 10The following examples illustrate theapplication of the capitalisation criteria tofilm development and production costs.Film development andproduction costsIn this scenario a film producer createsand produces a film that is intended tobe distributed globally, and retains theintellectual property rights i.e. theinternational format, distribution andancillary rights, etc. Figure 2 sets out thedevelopment and production stages forthis film.(In more complex real-life scenarios, thedistributor might have provided anadvance and the residual intellectualproperty rights will only have value ifand when the distributor can recoup itsinitial outlay.)The start point of capitalising costsoccurs when there is evidence that allthe recognition criteria set out in the‘background’ section above are met.On the assumption that the filmproducer has the access to the financingand other resources to complete anddistribute the film and the systems tomeasure reliably the expenditure, thekey judgements will include both whichcosts to capitalise and the forecastrevenues. Provided the film is expectedto generate profits, the film producer islikely to have the intention and ability tocomplete and distribute the film.The pitching phase is likely to be‘research’ that is undertaken with theprospect of understanding the potentialmarket for such a film and theavailability of talent to direct and star init. As no intangible asset will arise fromresearch phase any cost shall beexpensed as incurred.

The ability to complete the film andreliably generate profits is likely to come atsome point between the start and the endof pre-production phase, but before actualfilming starts. Considerations for the startpoint of capitalisation may include: Ability to complete the project: e.g.commitment of key talent and scriptwriters, or ‘locking-in’ of financingsuch that all or most budgeted costsare now funded Existence of a market: e.g. priorevidence of successful filmproductions. Generate profits: e.g. history ofaccurate forecasts of revenues fromtheatres, DVDs, licensing, etc.Once the recognition criteria arefulfilled, directly attributable internaland external costs must be capitalised.The point of starting to capitalise filmcosts might vary between producers. Forsome, the internal approval process maymean that an idea for a film is neverprogressed unless there is high degree ofcertainty of success, which means thatcapitalisation of film costs may startrelatively early in the process. Forothers, there may be multiple smallerfilm projects where there is no certaintyof success until near the end of theprocess and hence film costs may neverqualify for capitalisation.Capitalisation of eligible costs shouldcease when the asset is capable ofoperating in the manner intended. Inpractice this means that film costcapitalisation would usually cease oncethe film is ready for release.Capitalised costs for cancelled films arerecognised as an immediate expense inthe period of cancellation.Film sequelsWhen a sequel is developed, a producercan look to historical experience withthe feasibility and success of theprevious title, plus the generalexperience of successful sequels. Inaddition, funding will be easier to obtainand key talent might be locked inalready. Therefore, capitalisation ofcosts might start earlier in the process.Which film costs can becapitalised?Examples of ‘directly attributable’ filmcosts that can be capitalised could include: Direct labour: e.g. actors,film crew, security Production costs: e.g. editing,visual effects Production overhead costs: e.g. studiorent, costumes, catering Production-related administrativecosts: e.g. insurance Interest costs: if directly attributable(see scenario 3 below)The following four scenarios exploresome of the judgements in these areas.Scenario 1: What costs should be includedin the production overhead allocation?The identification of productionoverhead costs to be included in suchoverhead pool requires carefuljudgment. There is diversity in practiceon what gets included in overheaddepending on the studio’s size, structureand operating practices.Production overheads are notspecifically defined in IFRS but canreasonably be expected to align with theUS GAAP concept as being the ‘costs ofindividuals or departments withexclusive or significant responsibility forthe production of films’. In other words,labour and overhead costs that areclosely aligned with, and closely relatedto, production activities should becapitalised. Labour costs would includeboth cash and share-based payments.The following film activities and costs aregenerally not considered capitalisable: Corporate senior management costse.g. finance director and othernon-production-related seniormanagement costs, because such costsare considered general andadministrative Central costs e.g. human resources Marketing expenses, sellingexpenditures, and distribution costs Costs associated with overall deals(see scenario 2 below)Scenario 2: How should overall dealsbe treated?An ‘overall deal’ is fairly common in thefilm industry; it is one in which thestudio compensates a producer orcreative talent for the exclusive use ofthat party’s creative services. An overalldeal likely covers several films and canentail a significant time commitment.A studio would expense the costs ofoverall deals that cannot be identifiedwith specific projects as they areincurred; a reasonable proportion of coststhat are specific and directly related to acertain film can be capitalised.Issue: 10MIAG8

In determining whether activities andcosts are specific and directly related toa film, a studio should generallyconsider the following factors relative tothe producer’s or creative talent’s role ona particular project: Participation in the review andapproval of scripts and screenplaysand the identification of othercreative talent Direct supervision of productionactivities and participation inproduction related decisions Direct supervision of post-productionactivities such as review and approvalof film editing Performance that is measured basedon specifically identified filmsTo the extent a producer’s or creativetalent’s activities are determined to bespecific and directly related to a project,a reasonable allocation of costs based ona consistently applied methodologywould generally be appropriate. A filmproducer should not re-capitaliseamounts it expensed in previous years.Scenario 3: Should interest be capitalised?IFRS requires film producers to accountfor interest costs in accordance with IAS23. The standard requires interestcapitalisation where there are specificfinancing arrangements or where thoseborrowing costs would have beenavoided if there had been no expenditureon the asset. This requires judgementsince even interest arising on generalborrowings should be considered forcapitalisation into the cost of the film.9 MIAGIssue: 10Assuming the film costs are themselvesbeing capitalised, then interestcapitalisation should generallycommence and cease in the periodswhen film production begins (i.e. film isset for production) and ends (i.e. film issubstantially complete and ready fordistribution), respectively. Generally,the interest cost subject to capitalisationincludes stated interest, imputedinterest, and interest related to capitalleases as well as amortisation ofdiscounts, premium, and other issuecosts on debt. Unless there is a specificnew borrowing that can be attributed tothe financing of the film, a weightedaverage capitalisation rate shouldgenerally be applied.Scenario 4: How should film tax credits beaccounted for?Film tax credits arise where national orlocal government agencies provideincentives for producing films that meetcertain criteria. There is often a timedelay in receiving these benefits and, asthey are large in nature, the timing ofrecognition can significantly affect theincome statement from one period toanother. The terms of tax credit schemescan vary widely so they warrant carefulconsideration to determine theappropriate accounting. Some creditschemes are effectively governmentgrants recoverable through the taxsystem (that is, they are availableregardless of the level of a company’staxable profits) while others offer taxcredits that are only recoverable if theentity has sufficient taxable profits (andliabilities) against which the credit canbe applied.Tax credits that are really governmentgrants (because they are availableregardless of taxable profits) are withinthe scope of IAS 20 Government Grants,which permits two treatments: The tax credit can be deducted fromthe intangible assets held in relation tothe production costs; or The tax credit can be recognised asdeferred income and then recognisedin the income statement evenly overthe period of amortisation of therelated film asset.Both treatments spread the benefitreceived from the tax credit over theuseful economic life of the film. In thefirst treatment, the benefit is recognisedover time via a reduction in amortisation;in the second, as other income.In contrast, tax credits that depend ontaxable profits are within the scope ofIAS 12 Income Taxes. Investment taxcredits are scoped out of IAS 12 andalthough not specifically defined in IAS12 they are usually considered to be taxbenefits received for investment inspecific qualifying assets. In this case,there is generally an accounting policychoice whether to recognise the taxcredits in the period in which the taxdeduction is earned or to treat as akin togovernment grants and defer to thebalance sheet (either as a deduction inasset value or as deferred income).Whichever treatment is adopted, cleardisclosure of the policy choice and itsimpact will be key.

Application in practice: policiesand proceduresApplication in practice:identifying costs to capitaliseIn summary, judgement is required indetermining when to start (and stop)capitalising costs and which costs toinclude. Factors that can help inpractice include:Companies often have an authorisationprocesses at each stage of filmdevelopment and production. These‘gates’ can help set a suitable start pointfor cost capitalisation. However,gathering all the cost data to quantifycapitalisation can be a challenge, forexample because: Establish a clear policy regarding thethreshold, start point and nature ofcost capitalisation Communicate this policy Where appropriate, include a list offactors to consider t

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).