Summary of Questions
1. The issue presented in the question is that the movie Forrest Gump became a blockbuster hit and also received the academy awards in the year of 1994 and though it claimed to do a worldwide business of $661 million but Paramount claimed that it did not turn out to be a money-maker for the company. This is because according to the statements prepared by Paramount led to a net loss of 107 million.
|
Particulars |
Notes |
$ (in millions) |
$ (in millions) |
|
Box Office Gross Revenue |
1 |
382 |
|
|
Less: Amount kept the movie theatres (50%) |
2 |
-191 |
|
|
Gross revenue of Paramount |
191 |
||
|
Less: Negative Costs |
|||
|
Production Costs |
112 |
||
|
Gross participation of profit among the actors |
3 |
30.6 |
|
|
Production Overhead |
14.6 |
||
|
Cost of promotion |
67 |
||
|
Advertising Overhead Charge |
4 |
6.7 |
|
|
Distribution Fee |
5 |
61.1 |
|
|
Total Operating Costs |
292 |
||
|
Operating Profit (Loss) |
-101 |
||
|
Less: Interest amount charged by Paramount |
-6 |
||
|
Total Net Loss |
-107 |
Note 1 – The total gross revenue that is earned by the movie amounts to $382 million.
Note 2 – As stated in the contract, the total gross revenue earned by the movie has to be divided between the movie theatres and Paramount, therefore the total gross revenue is divided into half that is ($382 million/2) 191 million.
Note 3 – The gross participation of profit among the participants refer to the amounts that the actor Tom Hanks and the director Robert Zemeckis have received as a fee which amounts to $15.3 million each, therefore incurring a total of $30.6 million.
Note 4 – This is the advertisement overhead that amounts to 10% of the promotion expenses (10% * $67 million) that is $6.7 million.
Note 5 – The distribution fee amounts to $61.1 million that is calculated by 32% of gross revenue earned by Paramount that is (32% * $191 million).
2. The issue presented in the question is that in the original contract the actor and director of the movie Forrest Gump were scheduled to get $7 million and $5 million respectively. But due to the purpose of reducing down the budget both the actor and the director did agree to let go of their stipulated for a percentage of the film’s gross box office receipts. Therefore the new modified income statement should be as follows.
|
Particulars |
Notes |
$ (in millions) |
$ (in millions) |
|
Box Office Gross Revenue |
382 |
||
|
Less: Amount kept the movie theatres (50%) |
-191 |
||
|
Gross revenue of Paramount |
191 |
||
|
Less: Negative Costs |
|||
|
Production Costs |
112 |
||
|
Gross participation of profit among the actors |
1 |
30.56 |
|
|
Production Overhead |
14.6 |
||
|
Cost of promotion |
67 |
||
|
Advertising Overhead Charge |
6.7 |
||
|
Distribution Fee |
61.1 |
||
|
Total Operating Costs |
291.96 |
||
|
Operating Profit (Loss) |
-100.96 |
||
|
Less: Interest amount charged by Paramount |
-6 |
||
|
Total Net Loss |
-106.96 |
As can be observed from the above table the decision of the actor and the director of the movie to cut down on their fees did not have much effect on the income statement. The net loss decreased by an amount of only $0.04 million. Therefore Forrest Gump did not have a positive contribution margin even by reducing the gross participation of profit component.
Note 1 – Fees obtained by the actor and the director of the movie, Forrest Gump is (8% * $191 million) $15.28 million for each. Therefore the total amount to be distributed is $30.56 million.
3. As the issue presented in the question if Hanks and Zemeckis had been paid their original fees instead of taking a percentage of gross box office receipts then the modified financial statements would be as follows.
|
Particulars |
Notes |
$ (in millions) |
$ (in millions) |
|
Box Office Gross Revenue |
382 |
||
|
Less: Amount kept the movie theatres (50%) |
-191 |
||
|
Gross revenue of Paramount |
191 |
||
|
Less: Negative Costs |
|||
|
Production Costs |
112 |
||
|
Gross participation of profit among the actors |
1 |
12 |
|
|
Production Overhead |
14.6 |
||
|
Cost of promotion |
67 |
||
|
Advertising Overhead Charge |
6.7 |
||
|
Distribution Fee |
61.1 |
||
|
Total Operating Costs |
273.4 |
||
|
Operating Profit (Loss) |
-82.4 |
||
|
Less: Interest amount charged by Paramount |
-6 |
||
|
Total Net Loss |
-88.4 |
As observed in the above table, if Hanks and Zemeckis would have demanded their original fees instead of taking a percentage of gross box office receipts then the net loss incurred by Paramount would decrease by a major amount of $18.6 million. Therefore instead of making the payments of the director and the actor a variable component, making them a fixed component would be much more advantageous for Paramount.
Was Forrest Gump an accounting hit?
Note 1 – The total payment given to the actor and director of the movie is $(5+7) million that is $12 million.
4. As seen in the above table, Paramount still incurs an operating loss of $88.4 million, therefore the individuals who will receive a payment in accordance with a certain percentage of the net profit will receive nothing.
Therefore as there has been no profit, both Eric Roth and Winston Groom will receive the fixed part of their payment but the variable part of the payment cannot be paid to them .
5. Groom and Roth will only be able to receive money under net profit participation contract when the studio’s gross earnings are such that they exceed the total cost incurred by the studio for the movie Forrest Gump. In order to do this the total cost incurred by Paramount shall be calculated as follows.
|
Particulars |
$ (in million) |
|
Production Costs |
112 |
|
Gross participation of profit among the actors |
30.6 |
|
Production Overhead |
14.6 |
|
Cost of promotion |
67 |
|
Advertising Overhead Charge |
6.7 |
|
Distribution Fee |
61.1 |
|
Total Operating Costs |
292 |
Therefore the gross box office receipt that the studio should receive in order to ensure that Groom and Roth receive their net profit payment contract should be any amount more than the total operating cost as shown in the above table that is $292 million.
6. The directors and others associated with a film are the stakeholders of the particular studio promoting the movie. Therefore the studio would mostly prefer a type of contract that would mitigate the amount of risk undertaken by the particular studio company. The particular studio promoting a movie must at first evaluate and predict the gross earnings to be obtained by the particular movie and then decide whether to enter into a net profit percentage contract with the actors and the director of the movie or to pay them just a fixed amount as fees.
This is because if the studio correctly predicts that the movie would be able to earn a handsome amount of earnings then the studio would enter into a net profit percentage contract that is it would pay a fixed fee to the actor or director along with the a percentage of the net profit. Now the profit of the studio in such a contract lies in the fact that as it is committing to pay a part of the net profit to the actor or director therefore it can bargain and negotiate on the fixed component of the payment.
In case of a contract in which only a fixed amount is paid to the actor or director, the profit of the firm lies in the fact that if the movie is not able to do much business then no part of net profit has to be distributed among the actors and director or other individuals associated with the movie .
The actors, director and others on the other hand would always prefer a fixed amount plus a part of the net profit. Therefore they would also have to predict as to how much the particular movie would be able to earn.
References:
Cheatham C, Davis DA, Cheatham LR. Hollywood profits: Gone with the Wind?. The CPA journal. 1996 Feb 1;66(2):32.
Davis CE. Accounting is like a box of chocolates: a lesson in cost behavior. Journal of Accounting Education. 1997 Jun 1;15(3):307-18.
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