A case of contract violation involving MV-Link and PACE
Material Facts of the Situation
A significant motion picture maker and distributor in the US is MV-Link production.
With roughly 475 theaters, the PACE theater company has a good geographic distribution throughout the United States.
In 2006, MV-Link Production released five movies. Kombat Rex had a chance to be well received by consumers. KR II through KR V were the other four movies.
-MV-Links and PACE entered into a six-month agreement for PACE to screen the movies solely in its network of theaters.
-PACE received payment for the initial contract fee of $ 5000000 as specified in the contract. The other payments were fully made at the end of the contract.
-PACE writes to MV-Link demanding a refund of all the money they paid. This is after they found out an advertisement for the five films on a Canadian daily before the end of the contract
-PACE’s argument is that MV-Link breached the contract making it null and void.
Specific Questions Arising From the Case
1. Was the contract between MV-Link breached? Show that the advertising by a competitor in Toronto went against the spirit of the MV-Link/PACE agreement.
2. Did PACE follow the agreement signed accordingly?
3. Did PACE suffer any monetary loss as a result of the alleged breach of contract by MV-Link Production?
4. What revenue did the five films rake? Assuming that the contract was valid, show the revenues obtained from the showing of the five movies
5. Did PACE follow the cash flow schedule in remittance of revenues to MV-Link production?
Determination of Breach of Contract Case
The contract between MV-Link and PACE has clearly indicated that PACE was given exclusive rights to display the five films by MV-Link. The first statement of the agreement "PACE is granted the right, license, and permission to show the five films listed herein during the contract period." Therefore its clarity is of great help in solving this dispute. The contract, however, has an exclusivity clause that takes away the ambiguity in the first statement of the contract (Augustine 23).
To determine whether MV-Link breached the contract, we shall establish and ascertain the following;
-The existence of an agreement between MV-Link and PACE. Determine whether the two parties involved in the contract agrees to its existence. The agreement should be backed up by valid signatures of the parties involved.
-Evidently, the contract between these parties was breached. The terms that are outlined in the contract becomes binding once the participants sign the document. This means that all the clauses in the contract should be followed to the letter. Any action that is contrary to the terms of the agreement is considered a breach of the contract.
-Whether PACE followed the contract to the letter. In this case, MV-Link allegedly breached the contract. It is important to note that it is a condition that PACE must stick to the terms of the contract for the case to be balanced.
-Whether PACE suffered financial losses. For these allegations to hold any water, PACE must have run into a loss of monetary gains. The loss must be directly linked to the breaching of the contract by MV-Link Productions. (Jonathan, 2015)
From the contract documents given, it is clear that MV-Link allowed PACE 6 months exclusive right, license and permission to show Kombat Rex for a maximum of 42 times per theatre and a minimum of 18 times for the four films (KR 1-KR IV). The contract has also elucidated the terms of payment as $ 5000000. $2500000 was to be paid once the contract was signed and the remaining part on September 1, 2006. PACE was to submit $ 500 for each film showing in each location (Jonathan 36).
PACE followed the contract and made all the payments within the set deadlines. They even sent MV-Link an audited report of the number of shows they have done on the films. They submitted the required payment $ 5 462 500 on January 20, 2007. On the other hand, MV-Link allowed another theatre in Toronto, Canada to run an advertisement of the very films they gave exclusive rights to PACE. Regardless of the contract, the theatre in Canada intended to show the films without any communication from MV-Link to PACE. This a clear case of breaching of contract on the part of MV-Link. (Augustine, 1997)
This violation of the contract must have ripped PACE off their monetary benefits. This is because there is no clear evidence to the effect that the agreement (contract) was breached at that time. It is a fact that this very case was identified due to the due diligence of PACE. We cannot, therefore, rule out the possibility of loss to PACE (Dirk 42).
The above premises clearly reveal a breach of contract by MV-Links. The contract that was breached was signed and terms therein agreed upon by the two parties. The contract was, therefore, binding and the terms should have been followed to the letter by two terms. From the argument above PACE followed the deal's terms while MV-Link breached the exclusivity Clause (Augustine 54).
Expected Minimum Revenue under the Contract
To get the minimum revenues that are likely to come from this contract, it is paramount that we re-visit some crucial terms of the contract as below;
-PACE is a large theatre with chains of theatres, a total of which is approximately 475 all across the United Sates. They entered into a contract with an established film distributor, MV-link productions.
-MV-Link Productions gave PACE an exclusive right to show the films in their 475 theatres in the United States
-PACE is to pay $ 5000000 and after that $ 500 for each film shown in different locations
- The minimum times of showing the Kombat Rex is 42 per theatre while the accompanying four films (KR II-KR V) should show a minimum of 18 times each per theatre.
Going by the above terms, the minimum revenue for MV-Links will be as shown below;
Film
Minimum No. of times shown
No of theatres/locations shown
Total No. of shows
Charge per show
Total revenue
Kombat Rex
42
475
19950
$500
$9975000
KR II
18
475
8550
$500
$4275000
KR III
18
475
8550
$500
$4275000
KR IV
18
475
8550
$500
$4275000
KR V
18
475
8550
$500
$4275000
Total
$27075000
The above analysis shows the minimum revenue that is realizable. However, according to the management accounting concept 5, the figure $ 27075000 is a show of assurance and acceptable revenue before realization. Many factors can fall in place raising or lowering the target revenues. The revenues are not recognized until they are realized while the revenues only become valid after they are earned. This section only shows the revenue that MV-Links expected from PACE (Dirk 59).
The General Revenue Recognition Criteria under Generally Accepted Accounting Principles (GAAP)
GAAP refers to a certain set of principles in accounting including procedures and standards that every company must follow as they compile financial statements. Besides, it combines authoritative standards while reporting and recording accounting information. GAAP ensures minimum levels of consistency in the financial statements of the organization. These principles gives investors the ability to analyze useful information in a company. Additionally, it (GAAP) covers revenue recognition, outstanding share measurements and item classification of balance sheets. GAAP has established various conditions that must be met by any business entity before they can recognize the revenue resulting from a sale transaction. If these conditions are not met, the revenue recognition is deferred until all the conditions are met. This means that revenue does not automatically translate into earnings. These laws put in place for public entities. However, for prudence purposes, private businesses has the responsibility of binding with the law.
In our case, the revenue MV-Link expects from PACE is not recognizable until the general revenue recognition criteria are followed to the letter.
GAAP outlines the rules as shown below:
-Collection probability. If a client is dealing with a doubtful account, they should not recognize revenue until they can be in a position to make a sensible estimate of the allowance of such an account. It advises that it is prudent to defer revenue if the payment of the sale is in doubt.
-Complete delivery. For revenue to be recognized, the ownership must be transferred from the sale to the buyer or the service must have been provided to the user. The customer must receive and accept the sale or the service.
- Conversion into a sale. GAAP states that revenue is only recognized when the goods are services are converted into cash or claims of money. This means that the revenues can only be considered an earning after the product is sold out and turned into cash or claims of the same. If this does not happen, revenue recognition is deferred until the criteria are met.
-When the price can be determined. The buyer does not have the right to terminate the contract and receive back the payment for any amounts paid. If the price that is to be paid is dependent on a future event, it is prudent to defer the payment. Recognise the sale only after the event or more certainty on the transaction.
-Revenue is only recognised and earned if the good is delivered or the service delivered. If this has not happened, then the revenue recognition should be deferred. (Dirk)
GAAP clarifies the following majorly-used terms in contracts and revenues;
-Recognition- This is the process involving updating financial statements to include a given sale/transaction
-Realization. This refers to the process of converting items/services into cash
-Revenues. This refers to settlement of liabilities and inflows of asset into the business resulting from the business activities and transactions
-Gains. This refers to increase in the net assets of any given business.
In summary, the general revenue recognition revolves around the fact that revenue can only be recognized when realized. In the case of MV-Link and PACE, MV-Link had realized the revenues that had already been paid by PACE as per the agreement (Jonathan 58).
Application of GAAP Criteria for revenue recognition to account for revenues under this contract
The GAAP criteria are instrumental in determining the revenue recognized or earned by any given business. In the case of MV-Link and PACE revenue recognition according to GAAP is as follows;
The revenues are represented in $ millions in the vertical axis.
MV-Link had a contract with PACE that involved PACE submitting $ 5000000 and later a charge of $500 per show. According to GAAP criteria of revenue recognition, the estimated revenue for MV-Link was $ 32075000. This would come from $ 5000000 initial payment and the consequent payments of $500 per film shown. The contract signed between MV-Link and PACE required that Kombat Rex shows a minimum of 42 times per theatre. This would translate to a minimum revenue of;
42(times) x 475(No of theatres) x $ 500= $9975000
The four accompanying films were required to show a minimum of 18 times per theatre. This would result in a minimum revenue of;
4x$ 500x475x18=$ 17100000
The total realizable revenue was, therefore, $ 32075000. If all factors remained constant, there was a potential of realizing this amount of money. However, going by the report summary, the amount earned by MV-Link was significantly lower as shown below;
Kombat Rex showed 8550 while the four accompanying films showed a total of 2,375.
8550x 500= $ 4275000
2,375x500=$ 1187500
The total amount earned by MV-Link is, therefore, $ 10462500
d. Using the logic you developed in part c, calculate the revenue that MV-Link Productions should report for the set of five films for the year ended 12/31/2006.
MV-Link Productions offered five films to PACE on contract. PACE was supposed to show the films in all of its chains around the United States.
The contract and the terms of payment are as described in (c) above.
For the year ended December 31, 2006, the revenue of the MV-Link was a total of the initial settlement of the contract which included;
-$ 2,500,000 paid by PACE on the signing of the contract
-$ 2,500,000 paid on September 1, 2006.
The charges of the showing the shows in different locations were sent later in January 2007
Cash flow schedule for PACE to MV-Link
A cash flow plan avails a complete overview of how the business operates, the investments and the financing of the operations of any given company. The contractors and business people should always endeavor to prepare a cash flow statement elucidating the use of cash in various transactions carried out by the business since any given project was started. (Dirk 65)
A cash flow schedule is a useful tool for making vital financial decisions and detecting problems with cash flow in the firm or in running a given project. The cash flow schedule shows a detailed report on the money received and paid for the firm or a project. (Augustine 45). The cash flow schedule for the money received from PACE from the contract is as shown below;
Milestone of the project
Cash inflow ($)
First payment after the signing of the contract
2500000
Payment on 1st September 2006
2500000
Payment of the shows in different locations
Kombat Rex
4275000
RX II to V
1187500
Total
10462500
The cash flow of the PACE as per the contract is majorly from the charges of showing the shows. Additionally, PACE paid a total of five million dollars to MV-Link production as the set off the cost of the contract (Dirk 67).
Comparison of Cash Flows and Revenues
From my calculations above, there are no variations of the cash flows and the revenues
References
Augustine, Norman R. Augustine's Laws. Virginia: American Institute of Aeronautics and Astranautics, 1997.
Dirk, Mabing. Statement of Cash Flows. Grin Verlag, 2005.
Jonathan, Morgan. Great Debate in Contract Law. Macmillan Publishers, 2015.
