Julio Dalla Costa: It’s a big change from how we did it before. ASU 2019-02 specifically applies to entities in the media industry. FASB issued ASU 2019-02, which impacts film assets, film costs related to broadcasters as well as films on license agreements. Basically ASU 2019-02 helps organizations align the accounting for production costs of films and episodic content for television and streaming services. As you can see, Jim, as a follow up to what we were talking about last week regarding how the subscription economy is dominating how we as consumers consume not just media content but as well as coffee and vehicles and all that and all other stuff. This guidance came out specifically for media and entertainment content to make sure that it’s keeping up to date with how we as consumers are now consuming goods and services. So we can go into some more detail on that, Jim.

Jim Hunt: I’m curious about the types of companies that are affected. Obviously there are big streaming names, Netflix and Amazon and so on that we all know, but oftentimes with these changes there are other companies that are impacted. They might not consider themselves necessarily in the streaming entertainment business, but they do have digital content that could be affected by these changes.

Julio Dalla Costa: Yes. You have all the big players, like you said, Netflix and Amazon; don’t forget about Disney. If I as a television station, I have media company and use content from others, such as from a movie studio. Basically these are the costs that we are talking about and what FASB has done is align with how we traditionally handle production costs for films. So, if I’m making a big movie, as you build out the movie and produce the movie, you hire actors, you have payroll costs. you have stage costs, you have location vehicles. All of these things are allowed to be capitalized under film accounting guidance.

Julio Dalla Costa: However, the flip side of that is before ASU 2019-02, if you were making a TV series, for instance Friends, or whatever TV series you enjoy watching and they made 10 episodes per season. Basically FASB said previously that you were not allowed to capitalize these production costs because you were subject to a constraint. Because when you were making a TV series, you had to capitalize costs in relation to your contracted revenues from the initial and secondary markets. So let me break that down for the non-accountants listening today, when we have a film, any of those costs can be capitalized. So if I hire actors for $25 million, I can capitalize those costs aligned to that movie. However, if I was making a TV series, Friends for instance, and one of the actors makes $10 million a year, basically I was not allowed to capitalize those costs unless I can prove that I had a secondary market.

Julio Dalla Costa: So, what does the secondary market mean? It means reruns. So essentially what the FASB has done no, is to say even if I have reruns or I don’t have reruns, for a TV series, I am allowed to capitalize those costs just as film was allowed to do. The reason the change came about is again, because we as consumers put on Netflix and we basically binge watch an entire series in one day. So essentially it was not aligned to how making a film was where basically any costs you could capitalize and amortize over the estimated life of that movie on TV, it was very different. Even though I spent $25 million for a series, I was not allowed to capitalize at $25 million unless I could prove that there was value beyond the initial series run.

So for instance, I bring up Friends a lot because Friends came out when I was in college 25 years ago. But, even today, my kids, 12 years old, they watch friends. So what does that mean? That means there’s still tremendous value in the reruns of Friends or any of the TV series. So back in those days, Friends would not have been able to capitalize those costs unless they can prove that there would be some type of monetization of the entire TV series. Then ASU 2019-02 came out and the nuances between film and TV have gone away. Essentially you no longer have that constraint. So therefore, whenever I incur cost to make a movie or TV series, I can capitalize that and I can amortize that. So, it’s very important that we talk about the second piece of this because the second piece of this relates to amortization.

There are basically two ways to amortize this cost. So picture you make one of those blockbuster movies for $100 million. That hundred million dollars goes on your company’s balance sheet at $100 million. That’s how you capitalize costs. Now, FASB says that just like any other intangible asset, you have to amortize. So the question is you have to amortize over what period? So FASB has two different methodologies to come up with, depending on the way you monetize it. So basically, let’s say I have a TV series that I am going to monetize. I think that the life of this TV series is basically two years or, however I expect based on the new consumption model. That is a big change. FASB is basically saying you have to estimate the amortization of that $100 million film based on consumer expected consumer usage.

Julio Dalla Costa: So for instance, in my example, if I have a television series and I expect it to be over two years, however you can do straight-line. So I say, okay, 50 million one year and 50 million another year. Or, you can actually say, I expect that this TV series will it be consumed within the first 12 months at 75% and in the second half the next year at 25%. This allows me to amortize that based on consumer usage. So in that example, I am going to amortize 75 million in year one and 25 million in year two. So it’s a very big change, especially for the television series industry. And I think a lot of companies now have been struggling to come up with how they need to change their accounting processes because before, for these television series, you basically expensed as you incurred. So there was no way to really capitalize unless you had that proof to show that there would be value for the first run and secondary runs of these TV series.

Julio Dalla Costa: Now, that constraint has gone. So what do you have to do? Let’s say you’re a large TV company and you have all this media content, these TV programs on your balance sheet, but it’s up to you. It’s been three years, five years, and I amortizing only the piece that I can prove to my auditors and my executive team that it’s going to have value beyond the initial run of that series. Well guess what? Now, I have to come up with the accounting change. Accounting change says I have to look at all of my content that I have on my balance sheet and say, okay, before I could only capitalize 25% but going forward, I’m allowed to capitalize 100%. So for companies, that translates into additional money that’s now going to be deferred. So they end up in a larger cost deferral, which would actually mean for companies that they will have less expense and more EBITDA.

Jim Hunt: So they’re bottom line from a revenue and profit standpoint is enhanced by the change.

Julio Dalla Costa: Yes, exactly – by capitalizing more. So that’s the first change. The second change is now companies are struggling because this is a prospective change, which means that you are allowed to change from the point going forward. So even though I was amortizing based on whatever methodology I was using, let’s say I was using straight lane. No, I have to say what is the methodology that I’m using based on this note, new consumption model. So in a consumption model says maybe I’m not doing it strictly, maybe I’m, I expect to consumers to consume my TV series front loaded rather than evenly. So therefore I have to recognize more [inaudible] upfront. So how am I going to do that? So for a lot of companies, they’ve already programmed within the ERPs I’m going to do this straight line. I am going to look at this, you know, over five years or two years, 50/50. Well now FASB is requiring that you have to analyze all your current content on your balance sheet and basically look at what is the predominant monetization strategy.

Julio Dalla Costa: So what does that mean? That means that upon commencement of capitalization costs for each asset, the ASU requires an entity to determine the predominant monetization strategy of each show. So basically the question is whether a title would be monetized predominantly on its own or together with other films. So in a streaming service or cable network, there’s a lot of significant judgment that will be required to determine whether the units of account is a film or film group, especially when the film can be monetized in multiple ways. So Jim, that’s a lot to really consume in the last ten minutes I’ve been talking. So what questions would you have?

Jim Hunt: Well, a couple of questions and thank you, that’s a great overview. One question: we’re going to talk a little bit about time-frames for implementation. I think from our previous discussion it’s essentially fiscal years that start after December of 2019 but going to what you were just talking about, let’s take a kind of a straw man example. Suppose that I have media that I’ve created. It’s a television series. I had a previous rule that set it up for five years of straight line amortization. I’m two years into that. Now the change comes, what do I have to look at to recalculate, or do I reach back and recalculate things that have already started.?

Julio Dalla Costa: So this is a prospective, methodology so that means we are only going to essentially change the accounting going forward from that period onwards. So essentially what happens is, let’s say I’ve only capitalized 10% because of the rules. Now that constraint is gone. I am allowed to, if I have recurring costs for that TV series, I’m allowed to book more different charges on my balance sheet, reducing my expense. And then I have to revalue it using my amortization method. How is my customer base going to use, or how am I as a, as a, as a producer going to monetize these TV series? If the answer is accelerated and I’ve been using straight line, I am going to change the way I amortize. So essentially what’s going to happen is I am going to have more amortization upfront if I believe program by program that it’s going to be consumed in that manner.

Julio Dalla Costa: If I still believe that my straight-line methodology which is over even periods over the same time that it means that my methodology will stay the same but I am going to have a bigger capitalized amount. There’s one other thing I wanted to talk about Jim, just before we wrap up the summary of this is now, I’ve capitalized more costs and that requires impairment testing to be done. So basically what does the impairment testing mean? Let’s go back to my $100 million example. We have basically I have $100 million of cost. If I am making DC comics movies as a group, I have to decide whether this movie is going to be grouped individually just for this movie or is it going to be part of a bigger group of movies? And then I have to calculate and assess whether this impairment testing model is going to be done on a title by title basis or group basis.

Julio Dalla Costa: So let’s say all the DC comics movies as one impairment unit, or is it going to be one unit per movie? So that’s very important as well because it’s going to say every year now, because I’m capitalizing more cost on the balance sheet. Your auditors are probably going to look at is this $100 million really recoverable based on my expected revenues from this movie or is it going to be impaired? So as we move forward prospectively, we’re going to have three changes for all these contents. You’re going to be able to capitalize more, which means that your earnings could potentially be impacted favorably. You’re going to look at the way in which you amortize your newly capitalized costs. Is it going to be on a straight line method or an accelerated method based on the monetization of this TV content? And lastly, you’re going to have your impairment. It’s very important that companies really assess how they’re going to look at the impairment model. Is it going to be on a title by title basis or is it going to be on your group basis, which is very similar how we impair fixed assets right now.

Julio Dalla Costa: Lastly, Jim, I always talk about how there are new disclosure requirements that are going to tell the reader how you as a film and media company have adopted the new standard. What changes have you done, how are you looking at capitalization of costs? What is your methodology for amortization? And lastly, how are you going to explain what is the impairment methodology that you plan to use on these assets? And Jim, just to kind of bring it all together, this again, it really comes about as how we as consumers have really looked at how we consume this content. And it’s really the growth of the subscription online video that has taken place alongside structural changes in the wider home entertainment landscape. You know, you have the accessibility of high speed media, the erosion of the traditional multi channel TV and a rising number of people who cut the cord and all they have now is broadband-only homes. So way we consume these programs is directly affecting the way companies will produce these programs can capitalize, amortize and impair these new media content.

Jim Hunt: Oh absolutely. And there’s a lot more cross licensing of content between streaming services and so on. I mean there’s still sorting out who are competitors and who are partners, but that cross licensing really impacts the decision one was going to make on capitalization and amortization, impairment, etc.

Julio Dalla Costa: Yes, definitely. It’s an exciting time Jim. And, you know, because of how we’ve changed the way we consume technology, fortunately the FASB accounting guiding body has basically come up to the times and changed the way that we as accountants have to account for these things. So I applaud the FASB for coming up with the times and really changing the way that we account for these things.

Jim Hunt: Right. Just one really quick question before we wrap up. And that has to do with timing. You mentioned disclosure reports. Often times CFOs have a thousand things going on, so when push comes to shove, that’s a really important date for them. So when are companies first going to have to disclose their reporting under these changes?

Julio Dalla Costa: So, yeah, so they’re going to do this in 20 20. A lot of companies right now have to disclose all that I just told you in 2020 and the problem companies are having is they have to change their depreciation key. So their depreciation key was doing straight line and now they have to change based on data analysis of their content and how consumers actually use and consume their content. They now have to accelerate the amortization of these programs. So that actually means two things, they have to change the accounting, but more importantly they have to change the way they analyze. And their control environment is changed as well because now you have to say okay, I have $100 million, it’s five years, it’s $20 million a year. Well guess what? Now, I have to link my amortization schedule to how I expect my consumers to consume this and therefore how I as a company expect to monetize this content. So therefore I could move from straight line to 35% year one, 20% year two, 10% year three and so on. So therefore I am going to change the way I account for my amortization. So I have to change my internal control environment. I have to change the way I account for it. And guess what I have to disclose to my consumers and investors, especially public companies, how I’ve done this change, similar to RevRec and leasing.

Jim Hunt: Right. And there’s no time to waste because streaming companies that have lots of content and continue to produce lots of content, they need to get moving, not only with the changes to comply, they need to, as you say, analytics will be really important. They need to move to integrate so that it’s not just a one off compliance they’re trying to handle outside of their core systems.

Julio Dalla Costa: Yeah, and that’s right, Jim. I mean I think it’s going to be more, because immediate entertainment industry has been really begging for this change because the accounting was not aligned. You know when you do one thing for film and then another thing for the TV episodes, you know, it wasn’t aligned. So I think no, as we do for RevRec and leasing, there’s more transparency is more comparability between films and episodic content, such as TV series.

Jim Hunt: This has been great. Julio, this is fascinating. I could go on all day about it, but we don’t have that much time and I really appreciate your input on this. I think we’re going to have to schedule something in the future for ERP and system impacts to really look in more detail at this. But this has been a great overview. I really appreciate your time. Thank you very much.

Julio Dalla Costa: Have a good day, Jim.

Jim Hunt: You too. Thank you. Bye.