Homework Lance
ANALYSING LIABILITIES
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Solution
The justification that could be given is that the litigation gain is considered to be a fringe benefit of the vitamin sales. The fact that the gain stems from Vitamin sales and remuneration for these vitamin sales represents an allocation of costs to future periods, which is properly deductible from cost of goods sold, (Young et al., 2018). The choice of deducting the litigation gain from cost of goods sold is consistent with past practice, which recognises gains attributable to litigation as an operating expense; normal accounting principles require operating income to be allocated first to reduce Cost of Goods Sold.
“We do not need much” means we do not need a big gain to overcome the initial loss in Q2. “the preference would be the vitamin case so that we do not steal from Q3” refers to the fact that Cardinal Management does not want to report a substantial loss in Q3 and therefore has a tendency to take any gains unfairly or prematurely. “not steal from Q3” means that Cardinal Management is not going to report losses in Q3 which it anticipates so as not to be accused of reverting back to the prior year year-end results after having reported a few months of healthy profits.
Cardinal Health did two things wrong;
- They misclassified the $12 million vitamin recovery as an operating gain when it should have been recognized as a non-operating gain.
- They misstated net income in their annual report for fiscal year 2001 and 2002. If a company has to report these two gains, it must recognize them in the year when they occur. Cardinal Health did not do this. The $10 million vitamin recovery was recognized in the first quarter of Fiscal Year 2000, while the $12 million vitamin recovery was recognized in the first quarter of Fiscal Year 2002, when it should have been recognized in the fourth quarter of fiscal year 2001.
First the $10 million of vitamin settlement income should not be recognized in 2000 and should be recognized as a gain in 2001 to avoid stealing from Q3. Then the $12 million vitamin settlement income should be recognized in fiscal 2001 and not 2002. As mentioned above, the $12 million is a lot more than initially thought, which means the misstatement of net income is bigger. Cardinal Health’s actions were seriously wrong that deserve to be punished by SEC, (Venturelli et al., 2018). The case is a 10.
References
Venturelli, A., Caputo, F., Leopizzi, R. and Pizzi, S., 2018. The state of art of corporate social disclosure before the introduction of non-financial reporting directive: A cross country analysis. Social responsibility journal.
Young, S.D., Cohen, J. and Bens, D.A., 2018. Corporate Financial Reporting and Analysis: A Global Perspective. John Wiley & Sons.
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