Accounting for Art Galleries (#297)
/In this podcast episode, we discuss unique accounting issues pertaining to art galleries. Key points made are noted below.
Background on Art Galleries
A little background on art galleries. Most of them make very little money, usually less than $200,000 of revenue per year. Half of that goes to the artists, so they don’t have much money left over to pay for the rent and utilities and employee pay. Which is why most of them only have a couple of people on staff. However, about 15% of the galleries generate more than $1 million of revenue per year. These galleries are in the sweet spot of the industry, because they’ve been able to attract the best artists, whose works sell for a lot more money.
Most artists enter into representation agreements with art galleries, where they commit to sending in a certain amount of artwork each year, in exchange for giving half the sales to the gallery, and getting their own show at the gallery once every couple of years. Depending on the artist, they can sell every single piece that’s displayed in these shows, and sometimes it’s even sold in advance. That’s because most artists have a following of collectors, who want access to their artwork before anyone else can buy it. So that’s what happens – the collectors buy the artwork in advance, and then its displayed at the show, with a little red dot in the corner, which signifies that it’s already been sold.
Art Gallery Revenues and Expenses
So let’s get into some of the art gallery expenses. The first issue is the rent. Gallery owners like to set up shop in high-rent districts, because the people who buy their products are generally wealthy, and they tend to hang out in high-rent areas. In addition, gallery owners rent space at art fairs, especially if they deal with high-end works of art. This is really expensive. There’s the booth fee, and shipping charges to transport the artwork to and from these locations. And there’s the travel and entertainment cost to send staff to the fairs, and put them up at hotels. In short, both types of rent can take up a massive chunk of operating expenses.
And there can be substantial marketing expenses. Some of this is the cost of food and drinks at gallery events, but in addition, the gallery may pay for the shipping costs when artists are shipping new works to them.
And if it can’t sell something, it has to pay to ship the artwork back to the artist, so that it can clear out room to make way for new artwork coming from other artists. So – yes, freight can be a significant cost.
The biggest expense of all is that each sale has to be associated with a specific work of art, so that a commission can be calculated and sent to the artist. In addition, the gallery pays for framing costs once a painting arrives at the gallery, and then deducts the cost of the framing from the proceeds of a painting sale, before calculating the commission split.
There’s a whole different set of accounting issues associated with the other side of the gallery business, which is the secondary market. In this case, the gallery owner buys art at estate sales and auctions, or from private collections, and then turns around and sells it to collectors. Now in the prior case, where the gallery is representing artists, the inventory is on consignment, where the artist still owns it. But with secondary market transactions, the gallery owner is buying the artwork and trying to sell it at a profit, so now the gallery has to record its purchase cost.
And then we have other forms of revenue to account for. A gallery might create some quite fancy catalogs of artist works – which are usually for a show, but which can also be sold. Collectors like to keep them on the shelf. Another source of revenue is brokering the repair of artwork. For example, a painting might get water damage, so the gallery charges the owner to handle the repair work, which usually means sending it back to the original painter.
Another revenue source is home delivery and hanging services. They bring artwork to your home and hang it for you, and might even arrange to have lighting installed for it. Which is not free. And as another source, galleries sometimes rent out their space for private receptions, so there can be some rental revenue.
And finally, when a gallery represents an artist, it’s usually an exclusive arrangement within a certain territory, such as an entire state. If the artist’s works are then sold within this territory where the gallery wasn’t involved, then the gallery gets a cut of the sale. A fee of 20% of the sale price is pretty common. So in short, the revenue accounting has to deal with a lot of different sources of income.
Another accounting issue is sales taxes. Given the cost of artwork, a gallery may end up having to charge sales taxes in the hundreds or thousands of dollars on a single sale. Which means that it needs to have a sales tax license, track sales taxes, and remit them to whichever government is collecting it.
Another expense – and a large one – is insurance. A gallery contains a lot of expensive stuff, so of course the inventory insurance on the artwork is also very high. The insurance covers the in-transit period and while works are stored in the gallery, and transfers to and from art fairs, and while the works are being displayed at the fairs.
Not done yet. Many galleries also maintain off-site storage for excess inventory, which is climate controlled and heavily secured. Which means that it’s expensive.
And we can’t leave the expenses topic without covering professional services. There are a lot of them. An art gallery needs to hire art handlers, who take care of crating for deliveries, as well as customs forms for international shipments. And then there’s the attorney, who writes consignment agreements for artists, and the conservator, who may be needed to inspect and repair artwork – usually for items acquired on the secondary market. And then there’s the curator, who’s hired to set up an exhibit. To make the accounting a bit more difficult, curators might be paid a percentage commission on whatever is sold during the exhibition.
And finally, a gallery might even pay for scholar services. This is needed for authentication purposes, usually when the gallery owner suspects that something he’s about to buy on the secondary market is not the real thing. And, a scholar might be hired to write material for an exhibition or a catalog.
Profitability Reports
And after all these transactions are recorded, the accountant will probably be asked for two profitability reports. One is the profit per square foot of gallery space, because the rent is very expensive, and the owner needs to know if it’s paying off with increased sales.
The second profitability report is for art fairs. This is the same concept – was a fair profitable for the gallery? To do that, the accountant needs to track both the sales and the expenses for each fair that the gallery attends.
Entity Issues
Before I finish up, there is one more issue, which is the tendency of gallery owners to mix their personal assets in with those of the gallery. In particular, the owner might buy artwork from an artist and then keep it on display at the gallery, so it can be difficult to figure out which transactions are associated with the business and which ones are with the owner. This can be an interesting tangle to deal with when trying to create financial statements for the gallery.