The 495 million National league franchise fee, the 450 million National Hockev League franchise fee, rumors that the NFL will be asking for up to 4125 million for a chance to join their league--are all clear signs that indicate the value of sports investments have reached all- time highs. Meanwhile, professional atheletes grumble for more money while national television networks complain about disappointing ratings, a glut of sports programming, and steep broadcast licensing fees. Financial World magazine recently published a stud? which estimated a value for each of the 102 major sports franchises as of June 30, 1991. With the average baseball team estimated to be worth approximately 4121 million, the average football team worth approximately $132 million, the average basketball team worth approximately 470 million, and the average hockey team worth approximately 444 million, owners have seen the value of their franchises soar over the last several years. Some may believe that there has never been a better time to cash in on their sports investments and sell.

Spurred by growth of the cable television industrv and fierce competition for quality programming by major television networks, the sports industry enjoyed tremendous growth and profitability during the 1980s. Today, baseball revenue and football revenue alone amount to well over 41 billion.

For those bullish on the sports industry, it is an opportune time for buyers to realize their life-long dream of owning a professional franchise. However, others may not be so optimistic; newspapers are filled with stories about losses some major networks have sustained with sports programming. Just recently, it was announced that the National Football League has agreed to lower some fees due to be paid by the television networks, because of lower than expected TV ratings. Rumors have it that certain networks may not even bid to retain their broadcasting rights unless the asking prices come down to a level where a profit can be made. At one time the strategy was to use sports programming as a way to attract viewers to non-sports programming. Many believe that this strategy did not work; some claim it has backfired to the point where network executives are now hoping that their non-sports programming will. attract viewers to their sports programming.

ACCOUNTING CONSIDERATIONS OF A SPORTS FRANCHISE

Whether it is believed that the top of the profitability charts has not yet been reached in the sports industry or the time to sell has arrived, all investment decisions regarding sports franchises will revolve around a franchisee's financial statements and projections. But even with teams in the same sport that play in the same league, the financial statements can be quite different. Financial statements of a sports franchisee are often clouded by related party transactions, differences in accounting policies, varying levels of vertical integration, variations in accounting for uncertainties and contingencies, and the effects of purchase accounting adjustments. To fully understand the financial statements of a sports franchisee, it is important to understand the breadth of franchised operations, become familiar with its accounting practices, and read the financial statements very carefully.

Related Party Transactions

The existence of related party contractual arrangements on stadium leases, concession agreements, and local television contracts are common within the sports industry. It is not uncommon to have the ownership of a franchise as part of the marketing strategy of an owner's unrelated business. With the prices being sought by owners today, rarely can the purchase of a sports franchise be justified on its own separate-entity merits. Having a sports franchise connection usually has a significant benefit to nonsports businesses that directly or indirectly benefit from the sports investment. For example, the Atlanta Braves, Atlanta Hawks, and Chicago Cubs games are broadcast on television properties which are owned by the owners of the respective teams. Sports programing adds a certain level of attraction and stability to these television properties' line-ups.

The stadium concessions and associated advertising value were clearly one of the motivating factors of the Coors Brewing Company's interest in the new Denver baseball franchise, the Colorado Rockies, which will begin play in the National League in 1993. The ownership of the St. Louis Cardinals by AnheuserBusch is an example of how one company has historically used a sports connection as part of its marketing efforts. Due to the interrelationship of its sports operations and its extensive beer operations, it may be difficult to clearly distinguish where a company's product marketing ends and its sports operations begin.

A reviewer of the financial statements of sports franchises with related party arrangements must assess if the agreements among an owner's businesses were entered into on terms equivalent to an arm's- length basis and, therefore, whether the financial statements are truly reflective of prevailing market conditions. This is not easy. Transactions involving related parties cannot be presumed to be carried out on an arm'slength basis. SFAS 57, Related Party Disclosures, does require that the nature of related party transactions be disclosed in financial statements along with 1) information deemed necessary to an understanding of the effects of the related party transactions on the financial statements, 2) the dollar amount of related party transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period, and 3) amounts due to or from related parties as of the date of each balance sheet and their terms and manner of settlement. However, while financial statement disclosure requirements may be met, the level of disclosure supplied by a franchisee in its financial statements may not be sufficient for a reader intent on making an investment decision.

Readers Beware ! Ownership may have motivations for making one segment of its business look better than another. Because each related party arrangement will likely be unique in its marketplace, an extensive analysis is required to determine what an independent contractual arrangement would be. It is often difficult to project what is likely to happen if a new arrangement were to be negotiated with a third party. Such analysis is highly judgmental in nature and may require significant industry expertise.

As an example, the cash flow statement for a team owned by a large conglomerate may be different from a team not so owned. Intercompany borrowing and centralized cash management procedures put in place by the parent company can distort the actual availability and funds flow for a franchisee to the point where cash flows would not be comparable with teams that have to rely on independent lenders for financing. Interest expense, cash balances, and the current ratio are likely to be markedly different between the two teams.

There is a lack of uniformity in the accounting policies used by sports franchisees. One complex area of accounting, which results in one of the most diverse in accounting practice, is player contracts. In 1990, player salaries in the four major sports totalled over $1.3 billion making accounting for player compensation a significant issue. A quick glance by even the most casual fan indicates that these amounts are on the rise. Player contracts are getting richer, more complex, and are now tailored to a specific player's or team's financial objectives. Consideration must also be given to league guidelines, most notably the National Basketball Association's salary cap. Player contracts today are often structured to include significant signing bonuses and deferred compensation arrangements. Most teams capitalize signing bonuses and amortize them over the contract term, but certain franchises expense bonuses when paid.

Certain franchisees will establish players' contract assets and liabilities upon signing. Such contract assets are written off over their terms while liabilities will be reduced when paid. This practice has a tendency to inflate the level of assets and liabilities of a franchisee, and the effect could be significant if a franchisee has many players signed to long-term agreements. While the amount of the liabilities committed under such contracts could be significant, such information could be disclosed in the footnotes, without "grossing up" the franchisee's assets and liabilities.

There is also diversity in the recording of compensation agreements which defer payments to future years. While GAAP suggests recording the expense for deferred compensation at its present value during the period that the amounts are earned (i.e., when the player plays), certain teams historically expense the compensation when paid or record the compensation at its nominal amount rather than at its present value. Such diversity of accounting practices can take the comparability out of compensation expense and reported results.

Vertical Integration

To help meet the industry's skyrocketing payrolls, many teams have undertaken various forms of vertical integration to enhance revenues. While ticket revenues and broadcasting rights constitute the majority of revenues for most franchisees, some teams are looking for the extra revenue available from luxury boxes or improved concessions. Other teams are retaining certain radio broadcast rights for sale on their own. The ability of each franchisee to take advantage of these opportunities will vary depending on the team's on field performance and the size of the market in which they play. Few teams own their stadium, but usually franchisees are often tenants under generous long-term leases with municipal landlords.

Own the Facilities. First, a franchisee that owns its facility will have significantly more employees and payroll expense than one which does not. Its tangible assets and charges for depreciation will be greater. It will not have a large rent expense but will probably pay significant property. taxes. Overall, its financial statements will look markedly different from those that do not own their facilities. Wherever possible, such franchisees today are making the capital expenditures required to build luxury suites and take in the premium revenues these suites command. In doing so, they will be further increasing the tangible asset amount on their balance sheet and likely increasing their debt capitalization. The suites are often subject to long-term leases, which are usually accounted for as operating leases.

Franchisee tenants seem to be using their political leverage or making other arrangements with their landlord to capitalize on the trend toward luxury suites. Such leasehold improvements will be amortized over the life of the stadium lease, or their useful life, whichever is shorter.

Some venues are old, difficult to reconfigure, and are not easily filled with attractive luxury suites, Franchisee management may want to move. The potential market for luxury suites could be so attractive in some markets that building a new stadium or arena may be warranted just to have luxury suites to offer. Lease payment receipts from such suites can go a long wax, toward paying for the construction costs, as was the case in financing The Palace at Auburn Hills, home of the Detroit Pistons.

Improve the Quality of the Food Similar expansion projects can be undertaken to capitalize on improved concessions. While fans will always relish their hotdog at the ballpark, adding sophisticated bars and restaurants with more tasty fare can spice up a team's profitability. Luxury suites and new concession facilities were major parts of the recent refurbishment of Madison Square Garden.

The extent to which franchisees make the investment required to obtain these new lucrative revenue streams will significantly affect the types of revenue and expenses they report and their level of debt and capital assets.

The Importance of Winning

The Players Perhaps no industry is subject to more uncertainties and contingencies than sports. Even if an organization plans its budget, signs its players, and manages its operations flawlessly, in most cases its bottom line results will hinge on the on-field performance of the team. The public loves a winner and is willing to pay to see them. There is no amount of financial or accounting skills that can substitute for success between the lines, on the court, or on the ice.

The Fans. Fans' fickle behavior cannot be accounted for. Attendance can fluctuate markedly from year to year. Gate revenue must be recorded in the period in which the fans attend games, even if tickets are purchased well in advance in accordance with a season ticket plan, and matched against such period's costs. In addition, revenues from concessions will fluctuate with attendance. In certain' leagues, the visiting team shares in the gate receipts of the home team; this practice will tend to have a smoothing effect on the bottim line as well.

The Media Broadcasting revenues, which typically are under long-term contracts (which may include an up-front "bonus" payment) are usually recognized as games are played. This has a smoothing effect, thereby assuring some teams of a steady stream of income year-to-year despite what may be a poor on-field performance. It is not unusual, however, to incorporate provisions of a broadcasting transaction so as to justify the immediate recognition of advances made at the beginning of the contract period. Such contracts further complicate comparibility. of financial reporting among teams.

The Risks of Losing

The road has been far from smooth when it comes to accounting for uncertainties and contingencies in the sports world. Sports franchisees are subject to further uncertainties because they operate in a most litigious environment. While the commissioners have been empowered to rule with iron hands, most of the issues of the day go beyond such power, and are settled in the courtroom or at the arbiter's table. Baseball was subject to a major contingency for years when it faced, and ultimately lost, a collusion case. The NFL has a full slate of open issues centering around the absence of a collective bargaining agreement with its players, such as the lawsuit brought against the NFL by New York Jets running back Freeman McNeil. McNeil, an 11 year veteran, is entangled in an anti-trust suit with the league and is scheduled to be heard on June 15, 1992. There are many issues in the area of licensing as well.

Accounting for contingencies is governed by SAS 5. The pronouncement requires that a charge to income be made if 1) information available prior to the issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and 2) that the amount of the loss can be reasonably estimated. If no accrual is made because both conditions (1) and (2) are not met, or if exposure to a loss exists in excess of the amount accrued, disclosure should be made when there is at least a reasonable possibility that a loss or an additional loss may have occurred.

As a result of this pronouncement accounting for uncertainties will always be subject to significant judgment. Most sports franchises are independent organizations operating within their league. Not only will franchisees view the underlying issues necessary to do the accounting differently, but each will likely differ with other members of the league as to what is probable and can be reasonably estimated. With different year ends, franchisees in the same league can be forced to make accounting decisions at different points in time, causing further lack of uniformity. To appropriately prepare financial statements, industry issues and uncertainties of the day must be understood. Those who are to rely on the financial statements must obtain an understanding as to how such issues were handled to get the true picture of financial position and results of operations.