Kombar rex: adventure film producers.

Bell, Janice ; Williams, Melanie Stallings

CASE DESCRIPTION

The primary subject matter of this case concerns the interpretation of contracts and the calculation of revenue. Secondary issues examined include distinguishing cash flow vs. GAAP (Generally Accepted Accounting Principles) income, understanding the timing of revenue recognition and understanding how to budget revenue. The case has a difficulty level of three (appropriate for junior level). The case is designed to be taught in 1-1.5 class hours and is expected to require 3-5 hours of outside preparation by students.

CASE SYNOPSIS

In this case study, students must examine a film distribution agreement to determine its validity, scope and consequences. Adventure Film Producers entered a movie distribution agreement with a large movie theatre chain, Mammoth Theatres, Inc. One of Adventure's "hit" movies was bundled with four "filler" films, each requiring a certain number of screenings. Consideration for the contract was based partly on lump sum payments and partly on the number of screenings. In exchange, the distributor was given exclusive screening rights. After the distributor discovered that the films were being shown in Canada (where Mammoth had no theaters) they alleged that Adventure breached the agreement and demanded a return of all monies paid. Students must examine whether Adventure breached the exclusivity provision of the contract by allowing showings in Canada and must then perform the financial analyses to determine revenues. In order to analyze revenue, students must prepare a budget of expected minimum revenues, apply established revenue recognition criteria, and calculate the reportable revenue using GAAP principles. Students then prepare a schedule showing cash flow and distinguish that number from revenue.

CORE CONCEPTS

Accounting concepts: Financial Concept 5, cash flow vs. GAAP income, Financial Concept 8, understanding the timing of revenue recognition, and Managerial Concept 5, understanding how to budget revenue.

Business Law concepts: Business Law Concept 1: offer and acceptance of contracts; enforcement of contracts: interpreting the parties' intent.

CASE

Adventure Film Producers (Adventure) is a producer and distributor of motion picture films. It specializes in action adventure films popular with males, mostly in the teen and young adult market. While it has only been in business for 7 years, it has produced several moneymaking hits as well as many more minor "B" films that are shown on cable networks and through video rental stores.

Adventure has recently completed the production of five new films. This set of five films contains one film ("Kombat Rex") that marketing research indicates will be a top box office hit. The other four (KR II, KR III, KR IV, KR V) are "filler" films that will be bundled with the hit and licensed to theatres for exhibition. To receive access to the hit, theatres must agree to show all films a minimum number of times.

In July 2003, Adventure entered into an exclusive contract with Mammoth Theatres, Inc. (Mammoth), a large theatre chain with approximately 475 theatres across the United States. This contract provided in part as follows:

 Agreement: Mammoth is granted the right, license, and permission to
 display the five films listed herein during the contract period. In
 consideration of this contract, Adventure will receive:
 $5,000,000, payable $2,500,000 upon contract signature and
 $2,500,000 on September 1, 2003. $500 for each film showing in each
 location.

 Contract period: The contract period shall be the six months
 commencing on September 1, 2003.

 Limitation on screenings: Mammoth agrees to show Kombat Rex no more
 than 42 times per theater and the four accompanying films (KR II, KR
 III, KR IV and KR V) no fewer than 18 times each per theater.

 Exclusivity: Mammoth shall have exclusive screening rights during
 the contract period. Adventure acknowledges that an integral
 inducement in consideration of the contract is Mammoth's interest
 in being the sole source, without competition from other theaters in
 the market, during the contract period.

At the signing of the contract, Mammoth paid $2,500,000 of the $5,000,000.

Mammoth sent checks to Adventure for $2,500,000 on September 1,2003, and $5,462,500 on January 20, 2004, along with an audited statement detailing the number of showings as of December 31, 2003. The following is a summary of that information:

In March 2004, Adventures received a demand notice from Mammoth that all monies previously paid were to be returned or they would file a lawsuit. In their letter, they enclosed a newspaper clipping from a movie theatre in Toronto, Canada that was advertising the set of five films for showing the second week of February, 2004.

Required:

In your analysis of this case, include the following:

1. Did Adventure breach the contract? Specifically discuss whether the showing by a competitor movie chain in Toronto constituted a violation of the Adventure/Mammoth agreement.

2. Assuming the contract is valid, prepare the following financial analyses:

a. Prepare a budget of expected minimum revenues under the contract. Show the sources of revenues from the set of five films and the fee.

b. What are the general revenue recognition criteria established under Generally Accepted Accounting Principles (GAAP?

c. How would you apply the GAAP criteria for revenue recognition to account for the revenues under this contract? Explain your logic for both realizable and earned.

d. Using the logic you developed in part c, calculate the revenue that Adventure Films should report for the set of five films for the year ended 12/31/2003,

e. For the year ended 12/31/2003, prepare a schedule that shows the cash flows received from Mammoth from the contract.

f. Why do cash flows and revenues recognized differ, if they differ under your calculations?

Note: To the extent that you may recognize any antitrust issues (which we would not expect) please ignore them for purposes of this analysis.

Janice Bell, California State University, Northridge

Melanie Stallings Williams, California State University, Northridge

 Film Number of Showings Amount Due

Kombat Rex 8,550 $4,275,000
KR II-V 2,375 1,187,500
 10,925 $5,462,500