The Securities and Exchange Commission is inquiring about the way Cannon Group accounts for its film revenue and costs, the Los Angeles-based film maker and theater operator disclosed Tuesday.
The manner of accounting for the cost of films can have a substantial effect on a movie firm's profit or loss reports, according to persons familiar with film industry accounting.
Cannon, which disclosed the SEC inquiry in a new 10Q filing with the SEC, said it is cooperating with the "informal" SEC request for "information relating principally to the amortization of film costs."
The filing added that the firm is reviewing its methods of allocating certain film costs and "the impact, if any," on past earnings periods. It said it may take several months to complete its review "and resolve the issue" with the SEC staff.
Although the filing did not say how long ago the company received the SEC request, Barry Lublin, chief financial officer, said in response to a question that it was "in the last few months." He did not say what other information the SEC has requested.
Cannon, sometimes called a "mini-major" film company, has been controversial in Hollywood under Chairman Menahem Golan and President Yorum Globus, who together control about 40% of the stock.
The company has encountered skepticism at major studios and in a segment of the securities industry. The doubts have centered on Cannon's own estimates of realizable revenue on individual films, especially since it has had a notable lack of box-office success since last year.
According to film accounting specialists, the percentage of revenue that is recognized, or accounted for, in a fiscal period is the amortization rate or ratio; this figure then is used to calculate the amount of costs that are to be recognized in the same period.
Cannon's recent 65% amortization rate, according to the specialists, means in effect that the company is estimating that it will get back $1 in revenue for every 65 cents of expenses on a picture.
Accounting rules for the movie industry are unusual in that they permit companies themselves to estimate future revenue on a film, which some analysts say makes profit reports highly subjective and, therefore, questionable.
Jay Shapiro, a partner and specialist in entertainment industry accounting for the accounting firm of Laventhol & Horwath here, said Tuesday that Cannon's amortization policy has been "somewhat puzzling." He said the company's amortization rate has generally been lower than that of other movie studios.
If its films prove not to be as successful as Cannon had estimated, the company could be forced to take big writeoffs in later periods.
Cannon's Lublin said Tuesday in response to questions: "We really believe that our numbers are correct and our amortization policy is one of the top (ones) in the industry." He said the company was not required to disclose the inquiry "because it is informal," but he added that the company decided to report the probe in its 10Q because it preferred to put out the information itself rather than have it disclosed by others.
A formal SEC inquiry usually is accompanied by an order suspending trading in a firm's stock.
Cannon said Monday that it had achieved record earnings of $5.7 million in the second quarter, but its detailed 10Q report was not available here until Tuesday.
Among other things, the document disclosed that the company had a working capital deficiency of $105.5 million at the quarter's end on June 28. The company raised $207 million in a Wall Street offering earlier this year. It also has bank lines of credit totaling about $100 million, of which some $27 million had been used by June 28.
Some Wall Street analysts and other observers note that Cannon's outside auditors are a relatively small firm for a company that has grown as large as Cannon ($184 million in revenue in the first six months of 1986). Lublin went to Cannon as chief financial officer after handling its account for the same accounting firm, Mann Judd Landau of Beverly Hills.