Question

According to the 2017 video, an audit found that Chinese theaters were shortchanging Hollywood movie studios. These studios have been releasing major blockbusters with both storylines and characters that are meant to specifically target Chinese audiences. In fact, studios depend on these overseas audiences to save critically slammed blockbusters.

Auditors at PriceWaterhouseCoopers (PwC) found that about 9% of ticket revenues were unreported or skimmed and that this amounted to at least $40 million in revenue for the six major studios.

Issues noted in the audit resulting in missing revenue included: Sales listed as concessions, incorrect audience numbers, and screenings that were completely unreported.

This was part of an investigation on behalf of the Motion Picture of America Association (MPAA). The auditors examined the 29 biggest blockbuster movies released in China in 2016 and looked at 125 screen locations run by 27 different movie chains.

At the time of the video and the report, the U.S. motion picture industry was renegotiating a revenue sharing agreement with China, since the original five-year agreement ended. At question were the push by Hollywood to have more market access, as well as the Chinese to boost product from their growing movie industry.

The investigation was only a sample of screens. In fact, China has the largest number of screens in the world, numbering about 43,000.

Prior to renegotiating the WTO agreement on revenue sharing, U.S. studios officially grossed $1.87 Billion and took home $470 M.

1. What events or agreements in 2017 indicated that audits between studios and the Chinese movie market would become more important?

2. What was the revenue sharing percentage prior to renegotiation of the 2017 WTO agreement?

3. According to the textbook, revenue recognition is more problematic with respect to audit inherent risks in some industries, as compared to others. Would this be the case in the movies industry in China? Why?

4. Revenue recognition in Chinese movie theaters is also problematic with respect to audit control risks. Why?

Answer 1

We have to find the revenue sharing percentage by the Chinese theaters and the U.S. motion picture industry.

Official grossed revenue by U.S. studios prior to renegotiation was $1.87 Billion whereas their take home was $470 Million which is 25.13 % of the gross revenue generated by the U.S. Studios. According to the auditing firm, PwC, around 9% of the revenue were either unreported or skimmed amounting to at-least $ 40 million due to several reasons including

• Incorrect audience numbers reported by the Chinese theaters
• Undervalued sales revenue to get benefits in the taxation purpose
• Non-listing of revenues in the financial statements in order to reduce overall sales revenue

As per the auditor firm PwC, if the 9% of the sales revenue is amounting to at-least $40 million then 100% of the sales revenue can be calculated as $40 million*100/9= $444.44 million revenue from the Chinese theaters. To calculate the revenue shared by the Chinese theaters we need to divide total number of screens in China by the total revenue generated i.e. 444.44 million/43000 number of screens in china which is equal to $10325.58 revenue per screen in the China

Revenue sharing percentage between the US motion picture industry and Chinese theaters can be calculated by the official gross revenue by the U.S. studios and total revenue generated by China theaters as per auditor firm PwC i.e. 444.44 million/1.87 billion*100 = 23.76% revenue after the renegotiation of the 2015 WTO agreement as the revenue reduces from $470 million to $444.44 million as per the information and auditing done by the PricewaterhouseCoopers (PwC) after the renegotiation of the 2015 WTO agreement in the year 2016 since the original 5 year agreement between the Chinese theaters and the U.S. motion picture industry has ended, they need to renegotiate certain terms of agreement including revenue sharing percentage.

As per the information provided revenue sharing has reduced from 25.13% to 23.76% after the original 5-year agreement period has ended. In case the auditing firm information is correct then we have to add 9% of the missing revenue which was unreported or skimmed, hence the total revenue generated in that case will $444.44 million + $40 million = $484.44 million and revenue sharing percentage will increase to 25.90 % after the renegotiation of original agreement between both the parties.

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