Forrest Gump:
Management Accounting at the Movies

Hollywood accounting can be every bit as creative as a good movie script. At least, that is what some lawyers and journalists seem to be telling us. According to news reports, the hit movie Forrest Gump, which won “Best Picture of 1994” honors at the Academy Awards, claimed a worldwide theatrical gross of $661 million through May of 1995. That amount excludes videocassette and soundtrack revenues, and it doesn’t include licensing fees of Forrest Gump products such as wristwatches, ping-pong paddles and shrimp cookbooks. Yet, according to Paramount Studios, the film project lost $56 million dollars on a box office gross of $382 million through December, 1994 (see Exhibit 1).

Forrest Gump is the latest of a string of hit movies to report a loss. Other losers include Batman, Rain Man, Dick Tracy, Ghostbusters, Alien, On Golden Pond, Fatal Attraction, and Coming to America. Each of these motion pictures grossed well over $100 million, but in each case, costs were reportedly greater than revenues.

The production costs for a film, part of what the studios refer to as “negative costs”, represents only part of the cost of the project. In addition, studios add promotion and distribution costs, advertising overhead, and distribution fees to the total negative costs to get the total cost of the project. A significant portion of the negative costs is the payments made to “gross participants” on the basis of a percentage of gross revenues. This leads to what Hollywood accountants and lawyers refer to as the “rolling break.” Two of the costs (the amount retained by the theaters and the gross profit participation) may be discontinuous for some motion pictures and change with changes in the amount of the box office gross or with time. Alex Ben Block, executive editor of The Hollywood Reporter explains:

“A rolling break means that the break-even point – that point at which a movie has gone from a loss to a profit – changes after the release of the film, depending on the payments made to the star talent involved. A picture that has a big profit participation by a star actor, director or producer is never considered by studio accounting to break even.”

How can the studios be losing so much money on their most successful projects? Sometimes what is referred to as a loss isn’t really a loss at all. Typically, profits are calculated based on contracts between the studios and the film’s “net profit participants.” In a typical net profit participation contract, “profit” is calculated after deducting a distribution fee paid directly to the studio, studio overhead (some of which is allocated to the film as a percentage of the gross). One studio executive, Rob Friedman of Warner Bros., explains the accounting this way:

“What you are looking at is not the profit and loss statement of the overall accounting of the motion picture. What you’ve got there is a statement reflecting a contractual agreement of contingent compensation for a particular individual. So whether it’s Batman or any other motion picture, an accounting statement always reflects an individual arrangement based upon certain agreed-upon conditions. It’s the studio’s obligation to fairly and accurately comply with the contractual arrangement agreed upon by both the studio and that individual.”

In recent years, reported losses on hit motion pictures have resulted in lawsuits being filed by the net profit participants. In 1988 Art Buchwald and Alain Bernheim were awarded $900,000 by the Los Angeles Superior Court to cover their 19% participation in the net profits of Coming to America, even though the studio claimed the film never made money. Reported losses of more than $20 million on the movie Batman prompted a series of lawsuits from the net profit participants.

Winston Groom, the author of Forrest Gump, retained an attorney to get a share of the profits from the film, even though Paramount is reporting a loss. Groom was paid $350,000 for the movie rights to the book and is entitled to 3% of the film’s net profits. Paramount says it expects Forrest Gump to eventually show a profit, and has advanced Groom $250,000 against his net profit participation.

At issue in these lawsuits is the way the studios calculate “net profit.” Critics argue that some of the costs (such as the distribution fee), listed in a net profit participant statement like Exhibit 1, aren’t really costs at all; instead, they are studio profits disguised as costs. Overhead allocations such as “studio overhead,” and “advertising overhead” are based on arbitrary allocations, which, some have argued, are much greater than the actual overhead costs which are attributable to the film. In addition, some of the lawsuits have questioned whether the net profit participants should lose compensation because of cost overruns, which are largely under the control of the director, the stars, and the studio.

Will Paramount ever report a profit for the film, Forrest Gump? That depends upon how you define profit and whose perspective you’re taking. Actor Tom Hanks and director Robert Zemeckis have already made more than $20 million each, including a share of the “gross.” But from the point of view of the “net profit” participants (e.g., Winston Groom), the film may or may not break even.

Questions: 1. What are the variable and fixed costs? 2. What box office gross revenue is required before Forrest Gump earns a profit according to the “net profit participation” contract? 3. How much in additional box office revenue must be collected before Winston Groom receives any additional net profit participation beyond the $250,000 advance paid by Paramount? 4. What amount of box office revenue is required before Forrest Gump earns a profit for Paramount?

5. What concerns you may have regarding the variable overhead cost and fixed overhead cost that you had used in the above calculations?

6. If you were in Hollywood, what precautions would you take before entering into a profit sharing agreement?

Exhibit 1

Statement of Profit and Loss for Net Profit
Participants on the Motion Picture
Forrest Gump, through December 31, 1994

Box Office Revenues | | | $382 | Amount retained by movie theaters (50%) | | | 191 | Paramount’s gross revenues | | | $191 | | | | | Negative Costs: | | | | Direct Costs | | | | Production Costs | $66.8 | | | Gross profit participation by director, actors, etc. (16% of Paramount gross revenue) | 30.6 | | | Total direct costs | $97.4 | | | Studio Overhead (allocated – 15% of direct costs) | 14.6 | | | | | | | Total negative costs | | $112.0 | | | | | | Promotion and distribution costs | $67.2 | | | Advertising overhead (allocated – 10% of promotion and distribution costs) | 6.7 | | | Distribution fee (32% of Paramount gross revenues) | 61.1 | 135.0 | | Total Costs | | | $247 | | | | | Profit (loss) through December 31, 1994 | | | ($56) | | | | ==== |

Guidelines for completing the case:

1) Case report is due BEFORE CLASS on February 22nd. Please submit only one report per group. If you have disagreement within your group, you will have to work it out. I don’t want multiple reports. It is O.K to present different views but you as a group should pick one view and clearly say that this is what the group “thinks”. 2) Report needs to be typed and I need a hard copy before class begins. 3) Show all relevant calculations to back up your arguments/conclusions. 4) There is no page limit. Write only what you think is relevant. Including irrelevant material is not going to help you. 5) Include the names of all the members of the group in the cover page in alphabetical order. 6) Generally speaking, I would like you to avoid asking clarification questions. If something is not clear, then you as a group need to make the necessary assumptions to make sense out of what is in the case document (Interpreting the data and facts is part of the case!). 7) There is no page limit for the case report. All other things remaining the same, I prefer a brief report. I have provided you a list of questions. That does not mean that I am looking for only the “answers” for these questions. You may want to go beyond these questions and discuss what you think as relevant.