Read Case Study 13-1 "Accounting for Contingent Assets: The Case of Cardinal Health (attached).

In a 250-500 word executive summary to the Cardinal Health CEO, address the following.

1. Explain the justification that could be given for deducting the expected litigation gain from cost of goods sold and explain why Cardinal Health chose this alternative rather than reporting it as a nonoperating item.
2. Explain what the senior Cardinal Health executive meant when he said, "We do not need much to get over the hump, although the preference would be the vitamin case so that we do not steal from Q3." Include specific clarification of the phrase "not steal from Q3."
3. Explain specifically what Cardinal Health did to get into trouble with the SEC.
4. Justify the timing of the $10 million and $12 million gains, and explain how Cardinal Health's senior managers defend these decisions.
5. Cardinal Health received more than $22 million from the litigation settlement. Discuss whether the actions of Cardinal Health senior managers were so wrong that they justify the actions of the SEC. Classify Cardinal Health's behavior on a scale from 1-10, with 1 being "relatively harmless" and 10 being "downright fraudulent." Justify your rating.

13-1 Accounting for Contingent Assets: The Case of Cardinal Health In a complaint dated 26 July 2007, and after a four-year investigation, the US Securities and Exchange Comunission (SEC) accused Cardinal Ilealth, the world's second largest distributor of pharmaceutical products, of violating generally accepted accounting principles (GAAI) by prcmtiaturcly recognizing gains from a provisional settlement of a lawsuit filed against Several vitamin manufacturers Wecks carlier, the company agreed to pay S600 rullion to settle a lawsuit filed by sharcholders who bought stock between 2000 and 2001, accusing Cardinal of accounting irregulantics and inflated carrings The recovery from the vitamin companies should have been an unqualified positive for Cardinal Health. What happened Rackground The story begins in 1999 when Cardinal Health joined a class action to recover wercharges from vitamin manufacturers The vitamin mukars hul just pled guilty to charges al pricefixing from 1988 to 1998. In March 2000, the defendants in thal action reached a provisional settlement with the plaintis under which Cardinal could have received S22 million. But Cardinal opted out of the settlement, choosing instead to tile its www.claims in the hopes of yelling a bigger you The accounting troubles started in October 2000 witen SETTI managers al Cardinal legati lo consider recording a Exit of the expected proceeds from a lulure sellement as a litigation gain. The purpose was to close a gap in Cardinal's bulgelel caring for the second quarter of FY 2001, which ended 31 December 2000. According to the SEC, in a November 2000 e-mail a senior executive at Cardinal Health explained why Cardinal should use the vilatruite guin, mulher that her earnings initiatives, to report the desired level of earnings: "We co not need much lagel awer the hurrip, although the preference would be the villaTITI CON that we do to steal from Q3." On 31 December 2000, the last day of the second quarter of FY 2001, Curcinul recorded $10 trillion acriliigetil vilattii litigation gain as a reduction to cost of sales. In its complaint, the SEC alleged that Cardinal's classification of the gain as a reduction lo cost of salas violated GAAP. It is worth tholing that had the gain not been recognized, Cardinal would have missed analysts' Hverage CUTISTISUS EPS estitute for the quarter by S.02. By May 2002, PwC had been replaced as Cardinal's auditor by Arthur Andersen Andersen was responsible for auditing Cardinal's financial statements for the whole of FY 2002, ended 30 June 2002, and thus, it reviewed Cardinal's classification of the $12 million vitanun gain. The Andersen clos agreeil with PwCthul. Curlinal hud Trisolusi liel the gain. After Cardinal's persistent refusal to reclassify the gains, At letseri advised the criany thai il clisagreecl bul would real the $12 million as a "passed achjustmenlund include the issue in its Summary of Auclit Differences. In spring 2002 Curcimal Health ranched a $35.3 million settlement with several vitamin manufacturers. The $13.3 nullion not yet recognized was recorded as a gain in the final quarter of FY 2002. Bul while management thoughiils accounting policies had been vindicated by the settlement, the issue woulcilge away On 2 April 2003. u rticle in the "Heard the Street column in The Full Street Journal sharply criticized Cardinal Health for is handling of the litigation guits. Ilsa CARDINAL rule of accounting the article begins, pun intended. "Don't count your chickens before they hatch. Yet new disclosures in Cardinal Ilealth Inc.'s latest annual report suggests that is whaal the drug wholesaler has come to just once, bullwice." Nevertheless, Remchleutliud lo defend its accounting practices, partly on the grounds that the amounts later received from the vilarTI CUTTIMes exocodex theatrout of the contingent gains recognized in T'Y 2001 and I'Y 2002. Moreover, after the initial settlement, Cardinal Health recived at kliional 592.8 nullion in vitamin related litigation settlements, bringing the total proceeds to wer $128 Tullion The Outcome Cardinal management finally succumbed to reality in the following year, and in the Form 10-K annual report) tiled with the SEC for FY 2004, Carctinal restated its financial results to reverse both gains, restating operating income from the two affected quarters. But the damage had already been done. The article in The Wall Street Journal triggered the SEC investigation alluded to earlier. Alroad range of issues, going far beyond the treatment of the litigation gains, were brought under the agency's scrutiny, culminating in the SEC complaint. Two weeks atter the complaint was filed, Cardinal Health settled with the SEC, agreeing to pay a $35 nullion fine. Later in FY 2001, Cardinal considered recording a similar gain, but its auditor at the time, PricewaterhouseCoopers (hereafter PwC), was opposed to the idea. Accordingly, no litigation gains were recorded in the third or fourth quarters of FY 2001. Morewer, PwC advised Cardinal that the SIO million recognized in the second quarter of FY 2001 as a reduction to cost of sales should be reclassified below the line" as nonoperating income. Cardinal management ignored the auditor's advice, and the SIO million gain was not reclassified The urge to report an additional gain resurfaced during the first quarter of FY 2002, and for the same reason as in the prior year: to coer an expected shortfall in earnings On 30 September 2001, the last day of the first quarter of FY 2002, Cardinal recorded a $12 million gain, bringing the total gains from litigation to S22 million. As in the previous year, Carclinal classified the gain as a recluction to cost of sales, allowing the company to boost operating earnings. However, PwCclisagreed with Cardinal's classification. The auditor advised Cardinal that the amount should have been recorded as nonoperating income on the grounds that the estimated vitamin recovery arose from litigation was nonrecuuring, and stenumed from claims against third parties that originated nearly 13 years earlier. Required a. What justification could be given for declicting the expected litigation gain from cost of goods sold? Why did Cardinal Health choose this alleative instead of reporting it as a nonoperating item? h. What did the senior Carclinal executive mean when he said, "We do not need much to get over the hump. although the preference would be the vitamin case so that we do not steal from Q3"? And more specifically, what is meant by the phrase, not steal from Q3"? c. What specifically did Cardinal Health do wrong that got it into trouble with the SEC? d. What might Cardinal Health's senior managers say in their own defense? How might they justify the timing of the $10 million and the $12 million gains? e. Cardinal Health ended up receiving a lot more than $22 million from the litigation settlement. Were their actions SO wrong as to justify the actions of the SEC? On a scale ofl to 10, with being relatively harmless" and 10 being downright fraudulent," where would you classify Cardinal's behavior, and why? 13-1 Accounting for Contingent Assets: The Case of Cardinal Health In a complaint dated 26 July 2007, and after a four-year investigation, the US Securities and Exchange Comunission (SEC) accused Cardinal Ilealth, the world's second largest distributor of pharmaceutical products, of violating generally accepted accounting principles (GAAI) by prcmtiaturcly recognizing gains from a provisional settlement of a lawsuit filed against Several vitamin manufacturers Wecks carlier, the company agreed to pay S600 rullion to settle a lawsuit filed by sharcholders who bought stock between 2000 and 2001, accusing Cardinal of accounting irregulantics and inflated carrings The recovery from the vitamin companies should have been an unqualified positive for Cardinal Health. What happened Rackground The story begins in 1999 when Cardinal Health joined a class action to recover wercharges from vitamin manufacturers The vitamin mukars hul just pled guilty to charges al pricefixing from 1988 to 1998. In March 2000, the defendants in thal action reached a provisional settlement with the plaintis under which Cardinal could have received S22 million. But Cardinal opted out of the settlement, choosing instead to tile its www.claims in the hopes of yelling a bigger you The accounting troubles started in October 2000 witen SETTI managers al Cardinal legati lo consider recording a Exit of the expected proceeds from a lulure sellement as a litigation gain. The purpose was to close a gap in Cardinal's bulgelel caring for the second quarter of FY 2001, which ended 31 December 2000. According to the SEC, in a November 2000 e-mail a senior executive at Cardinal Health explained why Cardinal should use the vilatruite guin, mulher that her earnings initiatives, to report the desired level of earnings: "We co not need much lagel awer the hurrip, although the preference would be the villaTITI CON that we do to steal from Q3." On 31 December 2000, the last day of the second quarter of FY 2001, Curcinul recorded $10 trillion acriliigetil vilattii litigation gain as a reduction to cost of sales. In its complaint, the SEC alleged that Cardinal's classification of the gain as a reduction lo cost of salas violated GAAP. It is worth tholing that had the gain not been recognized, Cardinal would have missed analysts' Hverage CUTISTISUS EPS estitute for the quarter by S.02. By May 2002, PwC had been replaced as Cardinal's auditor by Arthur Andersen Andersen was responsible for auditing Cardinal's financial statements for the whole of FY 2002, ended 30 June 2002, and thus, it reviewed Cardinal's classification of the $12 million vitanun gain. The Andersen clos agreeil with PwCthul. Curlinal hud Trisolusi liel the gain. After Cardinal's persistent refusal to reclassify the gains, At letseri advised the criany thai il clisagreecl bul would real the $12 million as a "passed achjustmenlund include the issue in its Summary of Auclit Differences. In spring 2002 Curcimal Health ranched a $35.3 million settlement with several vitamin manufacturers. The $13.3 nullion not yet recognized was recorded as a gain in the final quarter of FY 2002. Bul while management thoughiils accounting policies had been vindicated by the settlement, the issue woulcilge away On 2 April 2003. u rticle in the "Heard the Street column in The Full Street Journal sharply criticized Cardinal Health for is handling of the litigation guits. Ilsa CARDINAL rule of accounting the article begins, pun intended. "Don't count your chickens before they hatch. Yet new disclosures in Cardinal Ilealth Inc.'s latest annual report suggests that is whaal the drug wholesaler has come to just once, bullwice." Nevertheless, Remchleutliud lo defend its accounting practices, partly on the grounds that the amounts later received from the vilarTI CUTTIMes exocodex theatrout of the contingent gains recognized in T'Y 2001 and I'Y 2002. Moreover, after the initial settlement, Cardinal Health recived at kliional 592.8 nullion in vitamin related litigation settlements, bringing the total proceeds to wer $128 Tullion The Outcome Cardinal management finally succumbed to reality in the following year, and in the Form 10-K annual report) tiled with the SEC for FY 2004, Carctinal restated its financial results to reverse both gains, restating operating income from the two affected quarters. But the damage had already been done. The article in The Wall Street Journal triggered the SEC investigation alluded to earlier. Alroad range of issues, going far beyond the treatment of the litigation gains, were brought under the agency's scrutiny, culminating in the SEC complaint. Two weeks atter the complaint was filed, Cardinal Health settled with the SEC, agreeing to pay a $35 nullion fine. Later in FY 2001, Cardinal considered recording a similar gain, but its auditor at the time, PricewaterhouseCoopers (hereafter PwC), was opposed to the idea. Accordingly, no litigation gains were recorded in the third or fourth quarters of FY 2001. Morewer, PwC advised Cardinal that the SIO million recognized in the second quarter of FY 2001 as a reduction to cost of sales should be reclassified below the line" as nonoperating income. Cardinal management ignored the auditor's advice, and the SIO million gain was not reclassified The urge to report an additional gain resurfaced during the first quarter of FY 2002, and for the same reason as in the prior year: to coer an expected shortfall in earnings On 30 September 2001, the last day of the first quarter of FY 2002, Cardinal recorded a $12 million gain, bringing the total gains from litigation to S22 million. As in the previous year, Carclinal classified the gain as a recluction to cost of sales, allowing the company to boost operating earnings. However, PwCclisagreed with Cardinal's classification. The auditor advised Cardinal that the amount should have been recorded as nonoperating income on the grounds that the estimated vitamin recovery arose from litigation was nonrecuuring, and stenumed from claims against third parties that originated nearly 13 years earlier. Required a. What justification could be given for declicting the expected litigation gain from cost of goods sold? Why did Cardinal Health choose this alleative instead of reporting it as a nonoperating item? h. What did the senior Carclinal executive mean when he said, "We do not need much to get over the hump. although the preference would be the vitamin case so that we do not steal from Q3"? And more specifically, what is meant by the phrase, not steal from Q3"? c. What specifically did Cardinal Health do wrong that got it into trouble with the SEC? d. What might Cardinal Health's senior managers say in their own defense? How might they justify the timing of the $10 million and the $12 million gains? e. Cardinal Health ended up receiving a lot more than $22 million from the litigation settlement. Were their actions SO wrong as to justify the actions of the SEC? On a scale ofl to 10, with being relatively harmless" and 10 being downright fraudulent," where would you classify Cardinal's behavior, and why