Case Study: HollywoodAccounting 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 theAcademy Awards, claimed a worldwide theatrical gross of $661 million through May of 1995. That amount excludes video cassette and sound track 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 (seeTable 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 GoldenPond, Fatal Attraction, andComing 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 asthe '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 profitchanges 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 un recovered costs, whether or not the film was financed with debt. One losses-of 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).

In recent years, reported lesson 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 more than $20 million on the movie Batman prompted a seriesof 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 Gumpto 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(seeTable 1), are not really costs at all; instead, they are studio profits disguised as costs. Overhead allocations such as 'studio overhead'and 'advertisingoverhead'are basedon arbitrary allocations which, some have argued, are much greater than the actual overheadcosts which are attributable to the film. In addition, some of the lawsuits have questioned whether the net profit participants should lose compensation becauseof cost overrunswhich are largely under the control of the director, the stars, and the studio. Will Paramount ever report a profit for the film, Forrest Gump?Thatdepends upon how you define profit and whose perspective you are taking. Actor Tom Hanks and director Robert Zemeckishave already made more than $20million each,including a share of the'gross'.

However,from the point of view of the 'net profit participants' (e.g., Winston Groom), the film may or may not break even. Scenario:You are hired byWinston Groom, the author of Forrest Gump, and whois entitled to 3% of the film's net profits. He is thinking about suing the studioand needs your help to show to the court that the movie is already profitable. Your memo should have the following structure:1-Give anoverview of the issues presented in the case;2-Explainwhy theseissuesarehappening;3-Provide another way to calculate the profit/lossof the movie with strong arguments.