PIXAR ANIMATION STUDIOS1
Pixar Animation Studios is a computer animation studio with the capabilities to create animated
feature films. Pixar's objective is to combine proprietary technology and world-class creative
talent to develop computer-animated feature films with memorable characters and heartwarming
stories that appeal to audiences of all ages. In partnership with Walt Disney Pictures, Pixar
created and produced Toy Story (1995), A Bug's Life (1998), Toy Story 2 (1999), Monsters, Inc.
(2001), Finding Nemo (2003) and The Incredibles (2004).

Successful animated feature films have become some of Hollywood's top money makers. A
single animated feature film has the ability to generate billions of dollars worth of consumer
spending. Production studios derive revenues from marketing campaigns surrounding the
theatrical release of the animated film, which, in turn, drive demand for home videos, television,
toys, and other film-related merchandise.                  Figure 1 – Movie Revenues*
Films continue to generate revenues for
their production studios across all of
these platforms, known as "windows of
exhibition," for years after their theatrical
release. Figure 1 presents the average
distribution of movie exhibition revenues
from the various major categories
(“Television includes revenues from pay-
per-view, premium cable and network *Includes domestic and international revenue sources.
TV). A movie remains exclusively in the Source: "Filmspace: Behind the Scenes," ABN Amro, Sept.
cinema circuit for anywhere from two to 12, 2000
four months after initial release and the
production studio generally receives 50-55 percent of the box office revenues with the remainder
going to the cinema owners. To illustrate the pattern of box office revenues, Figure 2 presents
US gross ticket sales for the Pixar animated film Monsters, Inc. Pixar released Monsters, Inc. to
the cinemas during the first week of November 2001, where it ran for forty-one weeks until the
                                                          end of September 2002. Monsters, Inc.
  Figure 2 – Monsters, Inc. US Gross Ticket Sales         achieved 50% of its US gross ticket sales
                                                          by its third week of release, achieving the
                                                          remaining ticket sales over the next
                                                          thirty-eight weeks of its theatrical

                                                             Pixar capitalizes its film production costs
                                                             as incurred. Once it releases a film, Pixar
                                                             amortizes capitalized film production
                                                             costs in the proportion that the revenue
                                                             during the period bears to the estimated
                                                             revenue to be received from all sources.
                                                             The amount of amortization depends on
Source: Third Millennium Entertainment,                      how much future revenue Pixar expects
                                                             to receive from the film. Pixar makes
 Prepared by Prof. Clifton Brown, Department of Accountancy, University of Illinois at Urbana-Champaign. All
rights reserved, 2006.
                                                                                  Pixar Animation Studios 2

estimates and judgments of future gross revenues to be received for each film based on historical
results and management’s knowledge of the industry. Management periodically reviews its
estimates of anticipated total gross revenues, which it may revise if necessary.

The company received a proposal for a license on Pixar movie characters from an agent who
represents manufacturers of children’s products. The proposal asks for an exclusive right for the
manufacturer to use specific Pixar movie characters in its manufacture and sale of children’s
lunch boxes. The proposed license agreement includes the following terms:
    1. The license agreement will have a three-year term;
    2. Pixar will receive a royalty, payable at the end of each year, equal to 1% of the manu-
       facturing company’s annual sales of the Pixar character lunch boxes2;
    3. The minimum royalty due to Pixar is $30,000 per year, payable at the beginning of each
       year, and credited against the annual end-of-year royalty if the end-of-year royalty is
       greater than $30,000;
    4. Pixar will provide the necessary camera-ready artwork to the manufacturing company,
       which will remain the property of Pixar. The manufacturing company will return the
       artwork at the termination of the agreement and cease all use of the Pixar characters.


A. What should Pixar’s revenue recognition policies be for this license agreement? Describe a
   number of possible policies and explain the issues that you considered in proposing the
   recognition policy you consider most appropriate.
B. Discuss the theoretical support for the method that Pixar uses to amortize its capitalized film
   production costs. How should this license agreement affect Pixar’s amortization of those
   capitalized production costs associated with the movie that includes the characters in the
   license agreement?

 The manufacturing company estimates that its sales from lunch boxes with Pixar characters will be as follows:
$10,000,000 for the first year, $5,000,000 for the second year, and $2,500,000 for the third year of the agreement.

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