China Box Office Audit Results Are In – Now What?

China box office numbersAs reported by numerous media outlets, the MPAA-requested audit of the Chinese box office numbers is complete and the numbers ain’t pretty. Chinese theaters underreported 2016 box office results by 9%, which given the 25% revenue share for quota movies, means that US studios have been underpaid by about $40 million.

I don’t know anyone who follows the Chinese movie business who was surprised by these results. No, I take that back. Many people (myself included) were surprised the number wasn’t considerably higher. One possible explanation is that PricewaterhouseCoopers conducted the audit, and after the Oscars debacle they were probably triple-checking their results and eliminating anything they couldn’t justify six ways from Sunday. And even with that, they still found a 9% discrepancy.

The full audit results haven’t been publicly released; all we know is that the auditors looked at data for 29 films in a handful of theaters and then extrapolated the results across China’s more than 40,000 screens. Such extrapolation, based on statistical sampling, is commonplace and perfectly normal, but I have to wonder what a full audit would have found. Without putting too fine a point on it, a lot of strange things happen in China’s third and fourth-tier cities. Even as it is, the audit found a whole host of irregularities, including unreported screenings, unreported ticket sales, and counting box office revenue as concession sales. No word on whether the audit turned up more instances of ascribing ticket sales from US films to Chinese films – which is what happened in 2015 when an alleged $11 million in ticket sales for Terminator: Genisys were instead attributed to the Chinese propaganda film The Hundred Regiments Offensive.

So what now? One argument is that the audit helps the United States in its ongoing negotiation to increase the quota and the revenue share, but it’s also likely that it hurts. China already knew it had massive problems with movie accounting and had taken steps earlier this year with a very public punishment of 326 cinemas for box office fraud. Being called out in the press like this by foreigners is a tremendous loss of face. Then again, $40 million is a lot to leave on the table.

It’s easy to understand the studios’ frustration that led to the audit. Box-office fraud in China has been rampant for years, and even the box-office revenue that is reported takes eons to get paid. And as China’s box office continues to grow, the revenue share becomes an increasingly important part of studios’ bottom line. Long gone are the days when revenue from China is just a nice bonus for US studios; indeed without China, some movies wouldn’t be made at all.

I’m reminded of the opening lines of Annie Hall: “There’s an old joke. Two women are at a Catskill mountain resort, and one of ’em says, ‘Boy, the food at this place is really terrible.’ The other one says, ‘Yeah, I know; and such small portions.’” That’s essentially how the studios feel about their relationship with Chinese movie theaters – full of underreported revenue and unhappiness, and they hope it never ends.

Of course, if the studios actually see the $40 million in additional revenue, the audit will be worth it. Either way, we can expect to see more of them.

And it’s not like the US studios are the only ones who should be conducting audits. We work with accounting firms that audit Chinese film and television productions on behalf of Western investors, and the extent (and creativity) of the financial shenanigans is astounding. For most of these audits, there’s no political or reputational element; it’s just common sense.

If you’re dependent on your Chinese partner to account for and remit revenues (be it in the movie industry or otherwise), an audit should be part of your repertoire too.

This article was written by Matthew Dresden and published on China Law Blog. Original Post: http://www.chinalawblog.com/2017/10/china-box-office-audit-results-are-in-now-what.html      

View the original article here.

Matthew Dresden

Matthew focuses on international and China law, with a focus on technology and entertainment law and Chinese transactional and IP work. He represents a wide range of companies, from start-ups to NYSE-traded companies. His work has included matters for film studios, cable channels, film and television production companies, video game developers, magazines, restaurants, wineries, international design firms, product manufacturers, outsourcing companies, and computer hardware and software companies.