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Are these the last days of Hollywood accounting? A pair of legal decisions are casting a dark shadow of doubt over the time-dishonored Hollywood tradition of making sure that every blockbuster hit ends up losing money for accounting purposes.
First, Walt Disney (NYSE: DIS ) was hit with $270 million in damages over allegedly hiding profits of the megahit TV show Who Wants to be a Millionaire under bogus fees paid by ABC to other Disney-owned business entities. Disney immediately decried the defeat and vowed to gun the appeal engines, and it may take years before the whole saga is played out. Hours after the Disney decision, actor Don Johnson gained a cool $23 million from a similar award involving his Nash Bridges TV show.
The seeds of change have been sown.
So-called Hollywood accounting is a danse macabre designed to conserve profits for the studios instead of sharing royalties with contributors like writers, directors, or actors. Contracts written to distribute net profits rather than gross takes make sense on the surface -- after all, the concept is known as profit sharing and not revenue sharing -- but the legions of movie industry professionals who work under these deals are often left out in the cold.
The onrushing sea change in the movie industry's accounting practices is underscored by a leaked income statement for the Time Warner (NYSE: TWX ) hit Harry Potter and the Order of the Phoenix, which shows a neat little net loss for a movie that collected more than $900 million in worldwide box office receipts.
The statement shows huge fees for distribution, advertising, and interest that all went right back to the Time Warner mothership. The more complicated the accounting practice, the easier it is to hide profits. This is why Fools tend to distrust the easily massaged earnings figure -- lower earnings equal lower taxes, and there's about a billion ways to raise or sink the bottom line to where you want it to be. Cash flows are much harder to disguise, reshape, or delete.
James Cameron made $350 million from the movie Avatar despite what I assume to be News Corp.'s (NYSE: NWS ) best efforts to pull the wool over his eyes. As director, producer, and writer of the $2.7 billion cash cow, Cameron made sure to sign a contract that grabs a gross percentage rather than net, making him richer than both Oprah and King Croesus. A second run in IMAX (Nasdaq: IMAX ) 3-D theaters will add to that haul later this year. This is just another example of how Cameron breaks the typical Hollywood mold.
So if you're investing in Disney, Sony (NYSE: SNE ) , or Viacom (NYSE: VIA ) based on their ability to collect generous margins on their theatrical releases, you may want to revisit that investment thesis. Winds of change are blowing in Hollywood.