Hedge funds don't use this kind of accounting, but it is pervasive in the US entertainment sector as well as in existence in other parts of the US economy.
In accountancy, Hollywood accounting is the practice of distributing the profit earned by a large project to corporate entities which, though technically distinct from the one responsible for the project itself, are typically owned by the same people. This has the net result of reducing the project's reported profit by a substantial margin, sometimes eliminating it altogether. This is most often done to reduce the amount which the corporation must pay in royalties or other profit-sharing agreements.
Hollywood accounting can take several forms. In one form, a subsidiary is formed to perform a given activity and the parent entity will extract money out of the subsidiary not in terms of profits but in the form of charges for certain "services." The specific schemes can range from the simple and obvious to the extremely complex.
Three main factors in Hollywood accounting reduce the reported profit of a movie, and all have to do with the calculation of overhead:
- Production overhead -- Studios, on average, calculate production overhead by using a figure around 15% of total production costs.
- Distribution overhead -- Film distributors typically keep 30% of what they receive from movie theaters ("gross rentals").
- Marketing overhead -- To determine this number, studios usually determine about 10% of all advertising costs.
All of the above means of calculating overhead are highly controversial, even within the accounting industry. Namely, these percentages are assigned without much regard to how, in reality, these estimates relate to actual overhead costs. In short, this method does not, by any rational standard, attempt to adequately trace overhead costs.
Due to Hollywood accounting, it has been estimated that only about 5% of movies officially show a net profit, and the "losers" include such blockbuster films as Rain Man, Forrest Gump, Who Framed Roger Rabbit, and Batman, which all took in huge amounts in box office and video sales.
Because of this, net points are sometimes referred to as "monkey points," a term attributed to Eddie Murphy, who is said to have also stated that only a fool would accept net points in his or her contract.
All of this shows why so many big-name actors insist on "gross points" (a percentage of some definition of gross revenue) rather than net profit participation. The saying in Hollywood is "a percentage of the net is a percentage of nothing."
This practice reduces the likelihood of a project showing a profit, as a production company will claim a portion of the reported box-office revenue was diverted directly to gross point participants.