Losing like Forrest Gump: winners and losers in the film industry.

Sale, Martha Lair ; Parker, Paula Diane

ABSTRACT

There are a number of high-profile cases where films that by most standards of revenue minus cost are very successful, but are reported as providing net losses to the studios. Most of the public attention on these cases arises from lawsuits brought by participants who contracted to receive payment based on a percentage of the profit of the film.

This paper highlights some of the unique costing practices in the film industry and examines several of these well-known "losers" in light of the difference between the gross receipts of the film and the direct costs of production. It provides some insight into the difference between what would be considered a rational indirect cost allocation basis for other industries and the apparently erratic allocation process used in film.

The analysis includes an examination of the relationship between the gross receipts and the production costs of films in a number of categories that might be considered measures of success in the film industry.

INTRODUCTION

In 1999, entertainment accounts for less than one percent of the gross national product of the United States (Berton & Harris, 1999). Despite its small percentage, the film industry gains much attention in the nineties because of its finances (Cheatham, Cheatham, & Davis, 1996). Buzzwords like "creative accounting" are used, and some accountants assert, "The accounting department is the most creative part of Tinseltown" (Cheatham et al., 1996, p. 1). Several major disputes aid in bringing the film industry's accounting practices into the limelight.

In one example (Pfeiffer, Capettini, & Whittenburg, 1997), the 1990 court case Art Buchwald v. Paramount Pictures Corporation, Art Buchwald claims that Paramount's movie Coming to America is based on a film treatment that Buchwald wrote. Not supprisingly, since the studio had contracted with Buchwald to use the material, the court agrees and rules in Buchwald's favor. It makes sense that he should receive the compensation set forth in his original contract with Paramount Pictures Corporation. In addition to a fixed fee, Buchwald's original contract awards him a share of the net profits of the film. According to this account, the film is a box office success. However, Paramount, reports it as a lost $18 million. Winston Groom, the author of the novel Forrest Gump, contracts to receive $350,000 and 3% of the net profits of the film for the rights to his book. When Groom tries to collect his 3%, he learns that Paramount is reporting a loss on the film. Forrest Gump earns millions at the box office in 1994, yet Paramount reports its profitability in the red. Also fueling the controversy is the fact that director Robert Zemeckis and actor Tom Hanks receives a percentage of the films fees, but they are awarded their money based on gross box office receipts instead of net profits (Pfeiffer, Capettini, & Whittenburg, 1997). Other popular films report losses, too. Batman shows a $20 million loss, and net profit participants sue Warner Brothers. Net profit participants of the movie JFK go to court after no net profits are reported for the film. (Goldberg, 1997). Rain Man, Dick Tracy, Ghostbusters, Alien, On Golden Pond, Fatal Attraction are all films grossing over $100 million in the 1990's for which no net profits were reported (Pheiffer, Capettini, & Whittenburg, 1997).

According to Cheatham, Cheatham, and Davis (1996), film costs contain four main components. First, distribution fees are paid to the distributor of the film. In many cases, film studios act as their own distributor (Pfeiffer, Capettini, & Whittenburg, 1997). If that is the case, the film studio simply pays itself this money, which usually is 20% to 27% of gross receipts. This method is simply a "positive cash flow item masquerading as an expense," according to Cheatham et al. (1996, p. 2). Pfeiffer et al. (1997), on the other hand, justify this as the studio earning a return for serving as the distributor of the film. In essence, the film studio generates revenue while the specific film incurs an expense.

In addition to distribution fees, distribution expenses are a cost of films, according to Cheatham et al. (1996). These expenses include promotion, advertising, physically moving the reels--everything that is needed to actually distribute the film. Interest expenses are attributed to a film when the film studio serves as the principal investor (Pheiffer et al., 1996). Investing in a film keeps the studio from investing in alternatives that will yield interest.

The actual production costs in a film are called the negative costs. Levine and Seigal (2001, p. 3) identify the following items included in negative costs:

 Film costs include all direct costs incurred in the physical
 production of a film, such as the costs of acquiring the story and
 scenario (film rights to books, stage plays, or original
 screenplays); compensation of cast members, directors, producers,
 and extras; costs of set construction, operations, and wardrobe;
 costs of sound synchronization; costs of rental facilities on
 location; and postproduction costs (music, special effects, and
 editing). Negative costs also include allocations of production
 overhead and capitalized interest costs.

Not only do Cheatham, Cheatham, and Davis (1996) contend that the film industry reports too many costs that might not normally be considered properly product cost, they also contend that it fails to report what in other industries would be revenues. First of all, major revenue comes from box office receipts. According to Davis (1997), on average film studios receive 50% of gross box office receipts and the movie theaters receive the other 50%. More specifically, film studios use a sliding scale to determine what percentage they will receive. Early in a film's release, film studios generally receive a large percentage of the box office receipts. For example, in the first two weeks, the film studio may receive 90%. At the sixth week, the percentage may be down to 60% and then drop to 10% by week twelve. The purpose of this sliding scale is to encourage movie theaters to show films for longer periods of time (Davis 1997).

Although gross box office receipts cannot likely be understated, supplementary income can. At the time "Hollywood Profits: Gone with the Wind?" (Cheatham, Cheatham, & Davis) is published in 1996, film studios only count 20% of videocassette sales as revenue for a film. Other ancillary income includes non-theatrical showings for groups such as airlines and armed forces, network television, music publishing, sound tracks, literary adaptations, computer games, and other merchandising like McDonald's happy meals. (Goldberg, 1997) Foreign markets are often minimized as well, in spite of the growing market (Cheatham, et al., 1996).

According to Cheatham, Cheatham, and Davis (1996), the combined effect of high expenses and low revenues result in understated profit. Goldberg (1997) seeks to unravel why film studios sanction this to happen. Goldberg focuses largely on gross profit participants, persons who receive a portion of gross profits for a film. Sought-after actors and directors are generally given a percentage of a film's gross profit in addition to a fixed sum of money. Studios offer gross profits to certain participants for several reasons. First, many actors require this kind of contract, and studios realize that actors draw audiences to movie theaters. A film featuring a popular star like Tom Cruise or Julia Roberts is much more likely to open well at the box office than a film featuring new talent. Even a director like Steven Spielberg can draw fans. Also, if an actor or director knows that his or her compensation is linked to the gross profitability of a film, he or she may be more likely to promote the film and go the extra mile to ensure its success at the box office (Goldberg, 1997).

Goldberg (1997) asserts that when gross profit participants become involved in films, net profits are likely to disappear. He cites examples like the 1993 movie Indecent Proposal, which reports a loss of $35 million after paying its five gross profit participants. Star Robert Redford reportedly receives over $20 million. Others cite similar examples like Hook, in which 40% of the film's gross profits were given to Julia Roberts, Dustin Hoffman, Robin Williams, and Steven Spielberg (Pfeiffer, Capettini, & Whittenburg, 1997). According to Goldberg (1997), Indecent Proposal and Hook are naturally doomed for net profit failure because of their large number of gross profit participants.

Lesser talent and participants often do not receive gross profit rights. Goldberg (1997) explains that Winston Groom, author of Forrest Gum, is a net profit participant. To net profit participants, Goldberg (1997) says that although the gross profit participants decrease the likelihood of receiving any percentage of the net profits, their involvement in a film may yield more profitable results for certain net profit participants. For example, although Winston Groom did not receive net profits, he experiences a huge increase in book sales after the release of the movie. Perhaps book sales would not have been as large if a major actor like Tom Hanks had not been recruited to star in the film.

The intriguing conflict surrounding the motion picture industry in the 1990's understandably brings attention to the accounting methods and practices of Hollywood. Changes are made in costing methods specific to the film industry in an attempt to rectify any misreporting. In the nineties, the film industry is surrounded by major public concern and controversy relating to its accounting methods and practices. Consequently, in September 1995, the Entertainment and Sports Industry Committee of the California Society of Certified Public Accountants requests the Financial Accounting Standards Board investigate the film industry methods and practices arising as a result of their prior issuance, in December 1981, of Statement of Financial Accounting Standards Number 53 which governs the film industry.

In June 2000, the findings from the investigation prompted the Financial Accounting Standards Board to issue the Statement of Financial Accounting Standards Number 139. This new standard rescinds the Statement of Financial Accounting Standards Number 53 and amends three other regulatory statements. According to the Financial Accounting Standards Board, the decision to repeal the Statement of Financial Accounting Standards Number 53 is based on the following matters and concerns. First, the film industry is continuously changes that affect their financial position and financial reporting; particularly regarding revenue recognition as film revenue increase through ancillary forms such as DVD's, private showings, TV, and international markets; second, film studios apply the Statement of Financial Accounting Standards Statement 53 differently; and third, the accuracy of the film industry's financial statements are questionable (Financial Accounting Standard Board, 2000).

In August 2000, the American Institute of Certified Public Accountants (AICPA) issues a news release titled "AICPA Issues New Rules for Film Industry" that states three major changes now exists for the film industry. These include advertising expenses, film amortization, and abandoned projects. Some of these changes discussed by Berton and Harris (1999) include advertising costs are now to be amortized against revenues for the appropriate market rather than against revenues for a specific film. Film amortization is to be based on ten years rather than the twenty-year standard previously used by most film studios. Finally, abandoned projects cannot be written off to the overhead pool as commonly done before.

ANALYSIS

Special accounting provisions aside, the actual revenue and cost reported for films is not difficult to relate to other products. The production budget for films includes all the classifications of actual costs accountants would generally associate with direct costs of a film. In this respect it is not a budget in the normally accepted definition of the word, it is a report of actual costs. Gross receipts is a relatively concrete number analogous to what would be considered revenues in accounting for most products, and is not amenable to easy "management." Once these two terms are defined, the controversy may be simplified to a question of what indirect costs should be assigned to individual films and what costs should be borne by the studio. Since major participants in the success of a film are paid on gross receipts it seems likely that the less powerful providers of contract services for the film industry are forced to bear a disproportionate burden of indirect costs.

In general GAAP requires that indirect costs be assigned in rational and consistent manner (Horngren, Foster & Datar, p. 486). In most products this rational and consistent manner would be based on some measure of the cost of the direct inputs. In spite of the film industry's unique costing methods, an examination of the relationships between profitability and the success of films as measured by production costs and gross receipts offers interesting insight into whether or not some of these films that have been the center of controversy would have been considered profitable products using costing methods appropriate to most other products.

In this study, first, the top grossing films of each major film studio are studied. According to Box Office Report (2004), these film studios and specific films are as follows: Disney and Miramax, The Lion King (1994); DreamWorks, Shrek (2001); Fox, Star Wars (1977); MGM/United Artist, Gone with the Wind (1939); Paramount, Titanic (1997); Sony, Spider-Man (2002); Universal, E.T. The Extra-Terrestrial (1982); Warner and New Line, The Two Towers (2002).

Another way of selecting successful films is to examine films that have won the Academy Award for Best Picture. Intuitively, there should be some connection between the cost of a film and its quality. The Academy Award or Oscar for Best Picture is a surrogate measure for quality. This award is considered by many in the film industry to be the highest award that can be given to a film. Although not a strictly quantitative factor, many film studios do measure success of films by Oscar nominations and wins. The Best Picture Oscar winners for the past ten years are Chicago (2002), A Beautiful Mind (2001), Gladiator (2000), American Beauty (1999), Shakespeare in Love (1998), Titanic (1997), The English Patient (1996), Braveheart (1995), and Forrest Gump (1994) (Academy Awards Database, 2004).

For each of the films in the two categories data is obtained on gross box office receipts consisting of the United States gross receipts plus the foreign gross receipts (ShowBIZ Data, 2004) and production budget (Internet Movie Database, 2004).

After compiling the gross box office data, relevant ratios are computed to show the relationship between the gross box office receipts and the film budget. The ratio is computed by dividing box office gross by the production budget. A ratio or less than one indicates the film did not gross enough to cover its cost. High ratios indicate that the film makes a significant amount of gross profit above the film's budget cost.

The data compiled for film studios' top films reveal several significant findings. Table 1 shows that Titanic produced by Paramount in 1997 is the top grossing film for all major film studios. This is true domestically and internationally. It also showcases the fact that Titanic cost more money than any of the other films. This seems to suggest a larger budget can ensure large box office sales. However examination of this very limited sample shows a significant variation in the relationship between the budget and the gross box office receipts. While Titanic's return ratio is high, there are others significantly higher. Star Wars, Gone with the Wind, and E.T. have ratios over 50 compared to Titanic's ratio of 9.17. Ironically, the films with the highest ratios also had the lowest budgets. They are all under $12,000,000 as compared to Titanic's $200,000,000 budget. The three films with low budgets may be attributed to the fact that these three films are the three oldest of the eight films analyzed. Although Star Wars (1977) and E.T. (1982) are modern films produced not so long ago that inflation alone would offer an adequate explanation for the discrepancy. The high ratios might have another feasible explanation; these films all have multiple releases. The box office figures for Star Wars, Gone with the Wind, and E.T. actually represent two theatrical runs versus Titanic's one. Star Wars is originally released in 1977 and re-released twenty years later in 1997. Gone with the Wind is re-released in 1989 for its fifty-year anniversary. E.T. was released again on its twentieth anniversary in 2002 (ShowBIZ Data, 2004). Without this additional information, the ratios seem unrealistic. A significant increase in profits occurs when film studios are able to capitalize on the success of a film through re-release. Inclusion of other films, which were either judged successful, but were not top grossing films or were not successful, would offer even more insight. For example the film Dinosaur from Disney, was budgeted the same amount as Titanic ($200,000,000), but returned only $354,600,000, or 1.77 times its cost.

The findings in Table 2 are similar to those found in Table 1. Table 2 analyzes data for Academy Award Best Picture Oscar winners. As shown in Table 2, the film with the largest budget was Titanic almost double the second ranked film, Gladiator, and slightly more than twice the budget of the third most expensive film Return of the King. These three most expensive films rang first, fourth, and third in level of gross receipts suggesting some correlation. The relationship is far from perfect though American Beauty's budget is significantly lower than Gladiator's budget, but according to Table 2, American Beauty's ratios are much greater than Gladiator's.

Based on Table 2, it appears films that win Academy Awards do well at the box office and have higher ratios of box office receipts to budgets. Regressing the cost against gross receipts reveals an Adjusted R Square of .64 with a positive intercept very close to zero and a positive slope of 6.55 indicating the cost of a film is a reasonably good predictor of its gross receipts.

To further analyze this relationship between profitability and success as determined by Academy Award wins, data is analyzed on the four most recent Oscar Best Picture winners compared to the other four films nominated for the award The gross receipts on these films is the gross over the first ten weeks after their release.

A regression analysis of these data indicate that the gross receipts immediately after release of the film may not be as well predicted by the cost of the film as is longer-term receipts. The Adjusted R Square for this model is much lower at .27. The intercept is very large at 33,623,216 and the slope is 0.231, which indicates a less defensible model. These findings offer three very significant insights into the film industry and the relationship between profitability and the success of films. First, a studio cannot guarantee box office success of a film by allocating a large budget to it. Although a substantial budget may lead to large profits as in the case of the 1997 film Titanic, the returns are far from assured and may actually be proportionally better on a less expensive film. Second, one way to increase profits is to re-release films. Studios should consider modeling the strategy used by Fox, MGM/UA, and Universal in their re-releases of Star Wars, Gone with the Wind, and Spider-Man respectively. Last, some film studios may view success beyond profits, in qualitative ways such as winning the Best Picture Academy Award.

Overall, the film industry's finances are unique, and success is hard to predict. However, regulators, auditors and those disputing payments on contracts do have some data to help assess the likelihood that the profit or loss claims of the studio are reasonable. The industry distinctiveness, in fact, initiated some accounting changes by regulatory authorities. These accounting regulatory changes and some specific legal conflicts showcased the creative accounting methods and practices sometimes used by film studios. Perhaps, now, after the issuance of Statement of Accounting Standards Number 139, the accounting and reporting will no longer be the most creative aspect of Hollywood.

REFERENCES:

Academy Awards Database. (2004). Retrieved February 24, 2004, http://www.oscars.org/awardsdatabase/.

AICPA issues new rules for film industry. (2000). Journal of Accountancy [online serial], 190, http://www.aicpa.org/pubs/jofa/aug2000/news3.htm.

Berton, L., & Harris, R. (1999). Reel-world accounting. CFO, 15, 34-40.

Box Office Report. (2004). Retrieved February 24, 2004, http://www.boxofficereport.com.

Buchwald v. Paramount Pictures Corporation, No C 706083, 1990 Cal. App. LEXIS 634, 13 U.S.P.Q.2D (BNA) 1497, January 31, 1990.

Cheatham, C., Cheatham, L. R., & Davis D. A. (1996). Hollywood profits: gone with the wind? CPA Journal, 66, 3242.

Davis, C. E. (1997). Accounting is like a box of chocolates: a lesson in cost behavior. Journal of Accounting Education, 15, 307-318.

Financial Accounting Standard Board. (2000). Statement of Financial Accounting Standards No. 139. Norfolk, Connecticut.

Goldberg, V. P. (1997). The net profits puzzle. Columbia Law Review.

Horngren, C. T., Datar, S. M. Foster, G. (1998). Cost Accounting A Managerial Emphasis, Pearson Prentice Hall, Upper Saddle River, NJ.

Internet Movie Database, Inc. (2004). Retrieved February 24, 2004 from http://www.imdb.com/.

Levine, M. H., Siegel, J. G. (2001). Accounting changes for the film industry. CPA Journal, 71, 32-38.

Pfeiffer, G., Capettini, R., Whittenburg, G. (1997). Forrest Gump--accountant: a study of accounting in the motion picture industry. Journal of Accounting Education, 15, 319-344.

ShowBIZ Data. (2004). Retrieved February 24, 2004 http://www.showbizdata.com/.

Martha Lair Sale, Sam Houston State University

Paula Diane Parker, University of South Alabama

Table 1: Box Office and Budget Information for Top Films in Dollars

 Gross/
Film U.S. Gross Foreign Gross Budget Budget

The Lion King 310,785,532 545,000,000 79,300,000 6.65
Shrek 267,652,016 155,808,898 60,000,000 7.06
Star Wars 460,195,523 319,100,000 11,000,000 70.84
Gone with the
 Wind 198,933,802 * N/A 3,900,000 61.01 *
Titanic 600,787,052 1,234,600,000 200,000,000 9.17
Spider-Man 403,706,375 380,900,000 139,000,000 5.64
E.T. 399,804,539 305,000,000 10,500,000 67.12
The Two
 Towers 340,478,898 577,400,000 139,000,000 6.60

* Foreign gross receipts for this film are not available and the ratio
is based on domestic gross only.

Note: Data from ShowBIZ Data and Internet Movie Database

Table 2: Box Office and Budget Information for Academy Award Best
Picture Winners

 Gross/
Film Worldwide Gross Budget Budget

Return of the King (2003) 778,174,794 94,000,000 8.28
Chicago (2002) 306,664,505 45,000,000 3.00
A Beautiful Mind (2001) 295,256,996 60,000,000 4.92
Gladiator (2000) 454,364,866 103,000,000 4.41
American Beauty (1999) 336,104,047 15,000,000 22.41
Shakespeare in Love (1998) 252,241,322 25,000,000 10.09
Titanic (1997) 1,835,387,052 200,000,000 9.18
The English Patient (1996) 230,351,430 27,000,000 8.54
Braveheart (1995) 202,604,871 72,000,000 2.81
Forrest Gump (1994) 629,699,757 55,000,000 11.45

Note: Data from ShowBIZ Data and Internet Movie Database

Table 3: Academy Award Winners for Best Film Compared to Contenders

 Film (Winner listed U.S 10-Week Budget/
Year first) Gross Budget Gross

2003 Lost in Translation 28,061,165 4,000,000 7.02
2003 Master and Commander 92,076,135 150,000,000 0.61
2003 Mystic River 52,989,083 30,000,000 1.77
2003 Return of the King 361,118,894 94,000,000 3.84
2003 Seabiscuit 118,251,555 86,000,000 1.38
2002 Chicago 114,442,185 45,000,000 2.54
2002 Gangs of New York 74,621,519 97,000,000 0.77
2002 The Hours 26,531,638 25,000,000 1.06
2002 The Two Towers 330,338,275 139,000,000 2.38
2002 The Pianist 16,779,231 35,000,000 0.48
2001 A Beautiful Mind 138,929,921 60,000,000 2.32
2001 Gosford Park 33,387,034 15,000,000 2.23
2001 In the Bedroom 16,985,037 1,700,000 9.99
2001 The Fellowship of the
 Ring 287,573,505 93,000,000 3.09
2001 Moulin Rouge! 54,029,521 52,500,000 1.03
2000 Chocolat 40,062,665 103,000,000 0.39
2000 Crouching Tiger, Hidden
 Dragon 73,202,832 N/A
2000 Erin Brockovich 121,529,105 15,000,000 8.10
2000 Gladiator 176,582,114 51,000,000 3.46
2000 Traffic 97,543,805 48,000,000 2.03

Note: Data from ShowBIZ Data and Internet Movie Database