Pergamon
Journal of Accounting Education, Vol. 15, No. 3, pp. 307--318, 1997
© 1997 Elsevier Science Ltd. All rights reserved
Printed in Great Britain
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Case
ACCOUNTING
IS LIKE A BOX OF CHOCOLATES:
LESSON IN COST BEHAVIOR
A
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
308
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?
Lesson in Cost Behavior
309
5. Based on what you now know about contracts in the movie industry,
which type of contract would a studio prefer actors, directors, and
others associated with a film to have? Why? Which type of contract
would the actors, directors and others prefer to have? Why?
TEACHING NOTES
Introduction and Purpose
This case gives students the opportunity to analyze costs and perform
break-even analysis in the film-making industry using cost data about a
film that many students will have seen, Paramount's Forrest Gurnp. Cost
behavior and break-even analysis are topics covered in most introductory
managerial accounting courses. These topics are typically presented from a
manufacturing viewpoint with 'volume' being measured in units of
product. However, these techniques also are useful in non-manufacturing
settings, as demonstrated in the case.
The case is designed for use in an introductory managerial accounting
class following discussion of cost behavior, break-even analysis, and C V-P
analysis. It may also be modified slightly to illustrate allocation of
common costs in a segment reporting setting.
Facts in the case were gathered from public sources (Lippman, 1995;
Munk, 1995; Weinraub, 1995), some of which contained seemingly
contradictory information. In speaking with the author of one of the
articles, it became apparent that some of the numbers were estimates based
on other information gathered from various sources. As can be imagined,
studios and entertainment lawyers are reluctant to divulge all the specifics
associated with the costs of producing a particular film. Therefore, while
trying to remain true to the reported performance of Forrest Gurnp, the
numbers presented in the case may not be the actual results recorded by
Paramount. The numbers do, however, serve to illustrate the effect that
cost behavior can have on reported income and on contract selection. The
accounting methods used for this film led novelist Winston Groom, the
creator of Forrest Gump, to file a lawsuit against Paramount for
additional payment from the movie. The case was eventually settled out
of court after G r o o m received a seven-figure commitment for the movie
rights to a Forrest Gurnp sequel that also included a gross profit
participation clause.
Accounting in the motion picture industry is an interesting, and often
confusing, topic. Instructors desiring additional details concerning
common accounting practices in this industry may wish to see Cheatham
et al. (1996) and SFAS No. 53 (FASB, 1981). Pfeiffer et al. (1997) also
offer additional background information on motion picture accounting, as
310
C.E. Davis
well as additional information concerning the accounting for Forrest
Gump.
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:
Was Forrest Gump an 'accounting' hit in terms of net income
as computed by Paramount?
To answer this question, students should prepare a functional income
statement for the film as of December 31, 1994, using the revenue and cost
information provided in the case, as shown in Table I. As mentioned
earlier, the sources of the expense information contained contradictions
and heavy use of rounding. For consistency and ease in calculation, the
amounts in the suggested solution have been rounded to one decimal
Lesson in Cost Behavior
311
Table 1. Functional Income statement for
Forrest Gump (in $millions)
Revenue
Less:
Production costs 1
Gross m a r g i n
Less SG and A:
Promotion expenses 2
Advertising overhead
Distribution fee
Interest
Net income (loss)
$191.0
112.0
79.0
67.0
6.7
61.1
6.0
$(61.8)
1These costs are typically called 'negative costs' in the
motion picture industry. However, the term 'production
costs' is used in this case to avoid confusion and to use
standard accounting terminology.
2These costs are typically called 'distribution expenses' in
the motion picture industry. However, the term 'promotion
expense' is used in this case to avoid confusion with 'distribution fee'.
place. Instructors desiring more accuracy should adjust the solution
accordingly.
Students have difficulty with this question in understanding why
P a r a m o u n t is paying itself a distribution fee and interest on the funds
tied up in production costs. They generally feel that if P a r a m o u n t is
paying itself, it is not an expense of the movie. Two points must be made
clear to the students concerning these costs. First, P a r a m o u n t is preparing
an income statement for the film Forrest Gump, not for P a r a m o u n t as a
whole. In other words, the costs reported in the movie's income statement
are analogous to those contained in a job order cost sheet for the typical
manufactured product. Second, the Forrest Gump income statement is for
internal purposes only, not for external financial reporting purposes.
Therefore, G A A P is not an issue in the preparation of the statement.
Acknowledgment of this point can be used as a springboard to discuss
internal reporting requirements versus external financial reporting requirements.
The fact that the income statement is for the movie, and not the studio,
raises the issue of allocation of c o m m o n costs to the individual movie. For
example, instructors may ask students how P a r a m o u n t determined the
advertising overhead charge of 10% of promotion expenses and the
distribution fee of 32% of gross box office receipts. Apparently these are
arbitrary allocation methods that have no relation to the actual activities
used and resources c o n s u m e d by the film Forrest Gump. Students may be
asked to provide more appropriate cost assignment bases, and instructors
may include a discussion of activities and cost drivers as well as the
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c.E. Davis
difference between assigning costs based on cause-and-effect as compared
to allocations of joint or c o m m o n costs.
The impact of arbitrary allocations of a studio's c o m m o n costs to
specific movies is apparent from the movie Coming to America. The
distribution fees of $42.3 million charged to this movie in 1987 were more
than the annual cost of maintaining P a r a m o u n t ' s worldwide distribution
network for an entire year Cheatham et al. (1996). This example also
provides a compelling illustration why arbitrary allocation of common
costs can drastically distort true product costs.
Question 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 .[or budget cuts, both Hanks
and Zemeckis agreed to forego their standard .fee ./'or a
percentage of the film's gross box qffice 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.
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
Table 2. Contribution format income statement for
Forrest Gump (in $millions)
Revenue
Less variable costs:
Payment to Tom Hanks
Payment to Robert Zemeckis
Variable production overhead
Distribution fee
Contribution margin
Less fixed costs:
Production costs
Promotion expenses
Advertising overhead
Interest
Net income (loss)
$191.0
15.3
15.3
4.6
61.1
$94.7
76.8
67.0
6.7
6.0
$(61.8)
Lesson in Cost Behavior
313
sold at individual theaters. Once this is understood, it should be fairly easy
to identify H a n k s ' s and Zemeckis's salaries, as well as the distribution fee,
as variable costs. However, it is more difficult for the students to recognize
the variable production overhead. Since the studio calculates production
overhead as 15% of production costs, and since these salaries are variable
production costs, 15% of the variable salaries becomes variable production overhead. This is equal to 2.4% of gross box office receipts. The
actual amount of variable production overhead as of December 31, 1994,
is thus $4.6 million [($15.3 + $15.3) x 15%],
Question 3:
If Hanks and Zemeckis had demanded their original fees
upfront instead of taking a percentage of gross box qffice
receipts, would Forrest Gump have made money in 1994?
I f H a n k s and Zemeckis had kept their fixed-fee contracts, their salaries
would have been fixed costs. The associated production overhead would
also have been fixed. These changes would have resulted in the income
statement presented in Table 3.
Summary of Production Costs:
Payment to Hanks
Payment to Zemeckis
Other Production Costs
Subtotal
15% Production Overhead
Total Production Costs
With 8% Contracts
$15.3
15.3
66.8
$97.4
14.6
$112.0
With Fixed-fee Contracts
$7.0
5.0
66.8
$78.8
11.8
$90.6
This question presents an opportunity to discuss the merits of a variable
cost structure versus a fixed cost structure, as well as the risks associated
with each. The discussion can also be used as a lead into question 5.
An additional area of discussion at this point could be the indifference
point between a fixed-fee contract and a participation contract for each
Table 3. Income statement for Forrest Gump
assuming fixed-fee contracts (in $mUlions)
Revenue
Less:
Payment to Tom Hanks
Payment to Robert Zemeckis
Other production costs
Production overhead
Distribution fee
Promotion expenses
Advertising overhead
Interest
Net income (loss)
$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
party. F o r instance, students could be asked to answer the following
questions:
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:
$7 million=8% * (Gross Box Office Receipts)
Gross Box Office Receipts=S87.5 million ($175 million in theater
receipts)
$5 million =8% * (Gross Box Office Receipts)
Gross Box Office Receipts=S62.5 million ($125 million in theater
receipts)
$12 million = 16% * (Gross Box Office Receipts)
Gross Box Office Receipts=S75 million ($150 million in theater
receipts)
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 qf
the film's net profits? How much in gross box office receipts
will the studio have to receive .from theaters be/ore Groom and
Roth receive any money under their net profit participation
contract?
Based on the net loss reported in the income statements prepared in
questions 1 and 2, Roth and G r o o m have received no payments based on
their share of net profits. Break-even analysis can be performed to
determine how much Forrest Gump must generate in gross box office
receipts before Roth and G r o o m can participate in net profits. Based on
the contribution format income statement prepared for question 2, Forrest
Gump must generate $315.5 million in gross box office receipts for the
studio before the film will show a profit.
Lesson in Cost Behavior
315
Total Fixed Costs = $156.5 million
Contribution Margin Ratio =
$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:
Based on what you now know about contracts in the movie
industry, which type of contract would a studio prefer actors,
directors, and others associated with a film to have? Why?
Which type of contract would the actors, directors and others
prefer to have? Why?
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
The preferences of individuals associated with the film are likely
opposite those from the studio's standpoint. If the film is thought to be a
potential hit, it may be in the party's best interest to negotiate a contract
based on gross box office receipts. However, this type of contract can
backfire, as Arnold Schwarzeneger found out with Junior, when he
deferred his usual $15 million fee for profit participation. If the party is
risk-averse and/or the success of the film is questionable, a fixed-fee
contract may be preferred. It is unlikely that given a choice, anyone
associated with the film would prefer a contract based on net profits. In
fact, it was this type of contract that led G r o o m to question Paramount's
accounting practices and file legal action against the studio. In addition,
Forrest Gump is not the first film that has caused Paramount accounting
nightmares. Similar practices led Art Buchwald to sue the studio based on
the performance of Coming to America (Wechsler, 1990).
Additional Discussion Opportunities
As mentioned in the solution to question 1, much of the costs assigned
by Paramount to Forrest Gump are based on arbitrary allocations of
common costs. These costs are necessary costs of running a film studio
and must ultimately be recovered through the films produced by the
studio. However, the issue is the method for charging these costs to a
specific film for profit determination. One might even argue that
Paramount is using the current allocation method to 'hide' the profitability
of blockbuster hits in order to reduce the payouts based on net profit
participation contracts. While not originally intended as a major point of
discussion for this case, the case certainly allows the flexibility of
addressing this issue, either concurrently or at a later point in time.
Instructors wishing to explore the common cost allocation issue could
ask students to respond to the following question:
Assume that you are the judge presiding over a suit brought against Paramount
by Groom over the lack o f their share o f net profits.from Forrest Gump. What
information would you request for use in your decision .[or or against
Paramount? How would this information assist you in reaching your decision?
Students could be assigned roles as either plaintiff or defendant
attorneys and asked what information they would use to support their
arguments before the judge. Any information that would assist in
determining the costs actually attributable to the making of Forrest
Gump would be of benefit to the judge. Specific information concerning the
total of the studio's common costs allocated to all movies produced during
the yem- and the total actual costs incurred by the studio would uncover
any over-allocation of these costs such as the example from Coming to
A m e r i c a discussed in question 1. A judge would also benefit from details of
Lesson in Cost Behavior
317
the contract negotiation process, including the disclosure of computational
procedures to the contracting parties prior to the signing of the contract.
Additionally, were these contracts reconsidered after Hanks and Zemeckis
agreed to a percentage of gross box office receipts?
If time permits, an interesting avenue for discussion is how individual
theaters decide which films to screen and how long to schedule the film's
run. While the gross box office receipts average a 50/50 split between the
studio and the theater, the actual split is based on a sliding scale
depending on how long the film has been shown in the theater. For
example, in the first two weeks a film is shown, theaters may keep only
30% of the gross box office receipts, while after a film has shown for 12
weeks, the theater may keep 90% of the gross box office receipts (see
Biederman et al., 1992, pp. 518--519). This sliding scale is used because the
longer the film is shown at a particular theater, the smaller the gross box
office receipts. The higher percentage given to the theaters in the later
weeks encourages the theater to continue to show the film with the lower
attendance.
The interesting issue with this sliding scale is how multi-screen theaters
decide which films to screen and how long to continue showing a
particular film. The problem can be viewed as a product mix problem,
where the various films have differing contribution margins depending on
the length of the films' runs. The theater would also need to consider
concessions as part of the product mix issues. This example can illustrate
to the students that most organizations do not operate in a single-product
world, and break-even and C - V - P analysis can be more difficult in the real
world than typical textbook problems may indicate.
Acknowledgements--The author gratefully acknowledges the comments of Bob Capettini,
Elizabeth Davis, Becky Jones, Charlene Spoede, participants at the AAA 1996 Management
Accounting Conference, and the anonymous reviewers on earlier versions of this case.
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