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Case
ACCOUNTING
IS LIKE A BOX OF CHOCOLATES:
LESSON IN COST BEHAVIOR
Charles E. Davis
BAYLOR UNIVERSITY
Abstract: This case is designed to be used in an introductory managerial accounting class to
illustrate cost behavior and break-even analysis in a non-manufacturing setting. Revenue and
expense information related to P a r a m o u n t Pictures' hit movie Forrest Gump is provided and
students are required to prepare a traditional income statement, identify fixed and variable
costs, prepare a contribution format income statement, and consider the effects of changing
from a variable cost structure to a fixed cost structure. While not a primary focus of the case,
the material does allow for a discussion comparing internal reporting to external financial
reporting and the applicability of G A A P in each setting. The short length of the case allows it
to be distributed, read and solved within a single 90-minute class period. Suggestions for
cooperative learning assignments are also presented. 1997 Elsevier Science Ltd
INTRODUCTION
Forrest Gump was one of the biggest movie hits of 1994. The movie's
fortunes continued to climb in 1995, as it took home Oscars in six of the
13 categories in which it was nominated, including best picture, best
director and best actor. One analyst has estimated that the film could
generate cash flow as much as $350 million for Viacom, Inc., Paramount
Pictures' parent company. Such success has insured the film a place among
the top grossing films of all times. This is quite an accomplishment for a
movie that took nine years to make it to the big screen and whose script
was not considered material likely to guarantee a runaway hit movie.
But was Forrest Gump a money maker for Paramount in 1994? Films
are typically distributed to theaters under an agreement that splits the
gross box office receipts approximately 50/50 between the theater and the
movie studio. Under such an agreement, Paramount had received $191
million in gross box office receipts from theaters as of December 31, 1994.
Paramount reports that the film cost $112 million to produce, including
approximately $15.3 million each paid to star Tom Hanks and director
Robert Zemeckis, and 'production overhead' of $14.6 million. This
production overhead is charged to the movie at a rate equal to 15% of
other production costs.
307
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c.E. Davis
Not included in the $112 million production costs were the following
other expenses associated with the film. Promotion expenses incurred to
advertise, premiere, screen, transport, and store the film totaled $67
million at the end of 1994. An additional $6.7 million 'advertising
overhead charge' (equal to 10% of the $67 million promotion expenses)
was charged to the film by Paramount. These charges represent the film's
allocation of the studio's cost of maintaining an in-house advertising
department. Paramount also charged the film a 'distribution fee' of 32%
of its share of gross box office receipts. This fee is the film's allocation of
the costs incurred by Paramount to maintain its studio-wide distribution
services. Finally, $6 million in interest on the $112 million in production
costs were charged to the film by Paramount.
Required
1. Was Forrest Gump an 'accounting' hit in terms of net income, as
computed by Paramount?
2. In their original contracts, actor Tom Hanks and director Robert
Zemeckis were to receive $7 million and $5 million, respectively, for
their work on Forrest Gump. However, after the studio asked the
producers for budget cuts, both Hanks and Zemeckis agreed to
forego their standard fee for a percentage of the film's gross box
office receipts. Sources estimate that the new agreement guaranteed
each of the two 8% of the studio's share of gross box office receipts
from the film. Using the information available about the costs of
making the film, did Forrest Gump have a positive contribution
margin? Assume that all costs not specifically identified as variable
are fixed.
3. If Hanks and Zemeckis had demanded their original fees up front
instead of taking a percentage of gross box office receipts, would
Forrest Gump have made money in 1994?
4. Other individuals associated with the film signed contracts based on a
percentage of 'net profits' rather than gross box office receipts, net
profits being the film's profit after the recouping of all the studio's
expenses. For example, Winston Groom, who wrote the novel on
which the movie was based, received $350,000 plus 3% of the film's
net profits. Eric Roth, the screenwriter, signed a similar contract with
a fixed fee plus 5% of the film's net profits. Based on your
calculations above, how much did these two individuals receive from
their share of the film's net profits? How much in gross box office
receipts will the studio have to receive from theaters before Groom
and Roth receive any money under their net profit participation
contract?
309
TEACHING NOTES
310
C.E. Davis
Teaching Approaches
The case lends itself to several teaching methods. First, it may be used
as an outside assignment. Selected students, either individually or in
groups, could present their solutions to the class. Alternatively, the case
may be used as an in-class exercise. If distributed at the beginning of class
as an in-class exercise, approximately 45-50 minutes should be allowed for
solution preparation. Discussion of solutions requires an additional 2025 minutes, and may be done within the same class period or during the
following class.
Additionally, the case lends itself to the use of several cooperative
learning techniques. In the 'jigsaw' structure (Aronson et al., 1978),
students can be assigned to one of four expert learning groups: calculation
of net income, identification of variable costs, identification of fixed costs,
and calculation of net income effect resulting from the change to a fixedfee contract for Hanks and Zemeckis. One person from each group would
then join to form a team to complete the case. A 'within-team jigsaw'
(Stone, 1989) could also be used with a team being divided into two
groups. One group would prepare a functional income statement and the
other team would prepare a contribution format income statement. The
teams would reconvene and compare net incomes. Any differences would
be reconciled within the teams. The teams could then complete the
remaining assignments. Finally, the 'discovery method' (Davidson, 1990)
could be employed where students are given a basic introduction to cost
behavior and break-even analysis and are then divided into teams to solve
the case. In addition to the citations for the individual methods, see Cottell
& Millis (1993) for further discussion on using cooperative learning
techniques in accounting.
Suggested Solutions
Question 1:
311
$191.0
112.0
79.0
67.0
6.7
61.1
6.0
$(61.8)
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c.E. Davis
Question 2:
This question requires that students identify each cost of the film as
variable or fixed and then prepare a contribution format income statement
for the film, as shown in Table 2. Based on the information provided, the
film did have a positive contribution margin.
Students' biggest problem with this question is identifying variable costs.
An important thing for them to remember is that the unit of volume for
identifying variable costs is gross box office receipts, or number of tickets
$191.0
15.3
15.3
4.6
61.1
$94.7
76.8
67.0
6.7
6.0
$(61.8)
313
Question 3:
With 8% Contracts
$15.3
15.3
66.8
$97.4
14.6
$112.0
$191.0
7.0
5.0
66.8
11.8
61.1
67.0
6.7
6.0
$(40.4)
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C.E. Davis
At what level of gross box office receipts would Tom Hanks have been
indifferent between receiving his regular fixed fee of $7 million or receiving 8%
of the gross box office receipts? At what level of gross box office receipts would
Robert Zemeekis have been indifferent? At what level of gross box office receipts
would Paramount Studios have been indifferent?
To find these points of indifference, students must realize that at the
point of indifference, payments from the fixed-fee contract and the
participation contract are equal. Thus, the indifference points for these
three parties are:
Hanks:
Zemeckis:
Paramount:
Question 4:
315
$94.7
$191
= 49.6%
$156.5
Break-even point in sales dollars = ~
= $315.5 million
.496
Break-even analysis of this sort is generally performed 'before the fact'
as a means of evaluating decision alternatives. While the above
calculations are based on 'after the fact' actual costs and revenues,
break-even analysis could have been performed based on the film's budget.
For example, G r o o m and Roth could have performed break-even analysis
using budgeted costs and revenues to determine the level of gross box
office receipts required before their net profit participation contract would
begin paying off. Such an analysis may have led them to negotiate a
different contract with Paramount.
It is interesting to note that after G r o o m ' s lawsuit against P a r a m o u n t
was filed, P a r a m o u n t advanced G r o o m $250,000 against future gross box
office receipts. At the time of the advance, Forrest G u m p had generated
approximately $330 million in gross box office receipts for Paramount,
putting the film above the calculated break-even point.
At the heart of the problems for G r o o m and Roth was a
misunderstanding of the definition of 'net profits' in their contracts,
which was different from the normal definition used by accountants. This
misunderstanding highlights the importance of accurate use of accounting
terms and the need to clarify terms between parties. For instance, a
c o m m o n misuse of terms occurs when students use the term 'cost' when
they actually mean 'price.'
Question 5:
The preference for a given type of contract will depend on the party's
expectations for the film's success. In most instances, a contract based on
net profits would result in the studio paying the least amount to those
involved in the making of the movie. As illustrated by Forrest Gump, an
incredibly successful movie often shows a net loss based on the studio's
internal accounting methods. The next preferred contract from the studio's
standpoint would be a fixed-fee contract. This type of contract results in
no uncertainty about the cost to produce the film. If the film is a success,
the fixed fee will likely result in lower payments than one based on a
percentage of gross box office receipts.
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C.E. Davis
317
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wind'? The CPA Journal, February, 32-34.
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Davidson, N. (1990). Cooperative learning in mathematics." A handbook jor teachers. Menlo
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Financial Accounting Standards Board (FASB). (1981). Statement ~[ Accounting Standards
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C . E . Davis
Lippman, J. (1995). Star and director of 'Gump' took risk, reaped millions. Wall Street
Journal, March 7, BI, BI 1.
Munk, N. (1995). Now you see it, now you don't. Forbes, June 5, 42-43.
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Wechsler, D. (1990). Profits? What profits? Forbes, February 19, 38-40.
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