Case Study: Hollywood Accounting

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 video cassette and soundtrack revenues, and it does not include licensing fees on Forrest Gump products such as wristwatches, ping-pong paddles, and shrimp cookbooks. Yet, according to Paramount Studios, the film project lost $62 million on a box office gross of $382 million through December, 1994 (see Table 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', represent only a fraction of the cost of the project. In addition, studios add advertising and promotion, distribution, and financing costs to the total cost of the project. A significant portion of the negative costs are the payments made to 'gross participants' on the basis of a percentage of the studio's 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 financing costs) may, for some motion pictures, change with changes in the amount of the box office gross and over 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." (McDougal, 1991, p. F6).

How can the studios be losing so much money on their most successful projects? Sometimes what is referred to as a loss is not 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), and interest on the unrecovered costs, whether or not the film was financed with debt. 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." (McDougal,

1991, p. F1).

Table 1. Statement of Profit and Loss for net profit participants on the motion picture, Forrest Gump, through December 31,1994 Box office gross revenues Amount retained by movie theaters (approx. 50%) Paramount's gross revenues Negative costs: Direct costs: Production costs Gross profit participation by director, actors, etc. (16% of studio gross revenues) Total direct costs Studio overhead (allocated 15% of direct costs) Total negative costs Promotion and distribution costs Advertising overhead (allocated 10% of promotion and distributiOn costs) Distribution fee (32% of studio gross revenues) Financing costs (calculated at 3% above prime. on unrecovered coststhe 'loss' below) Total costs Profit (loss) through December 31, 1994 $382 191 _$191 $112.0 135.0 E 253 ($62)