Assignment - Regarding the Accounting Consequences of the Tylenol Incident
I could have chosen another article(s) we have examined for this assignment. I chose this article because the information it contains is the most complete for our purposes.
A quick review of some facts: October 1, 1982: Five deaths were reported that were tied directly to consumption of cyanide-laced Tylenol capsules. The authors discovered 4-day (-2, +1) cumulative abnormal return for Johnson & Johnson over this window of -11.92% which they translated into approximately a $1.02 billion market loss.
From Day (+2) through Day (+25) Johnson & Johnson's stock lost an additional 17% and their competitors and other pharmaceutical companies' stocks lost, on average, 11.15%.
Assumptions: Suppose we attribute the $1.02 billion market loss suffered by Johnson & Johnson during the four-day window (-2, +1) to the following estimates made by the market over this four-day window: (1) Future lost sales, and (2) Future costs due to class-action lawsuits. Further, assume that Johnson & Johnson prepares their year-end financial statements as of December 31, and that their lawyers believe that $750 million could potentially be lost to class-action claimants.
Question One: When should the $750 million dollar loss be reported by Johnson & Johnson, December 31, 1982, or the year(s) in which actual payment(s) is made to the claimants (explain your answer including any assumptions YOU make)?
Question Two: Assume Johnson & Johnson pays the $750 million to claimants in 1983 and reports this as an expense in 1983, where on a multiple-step income statement should this loss be reported (explain your answer)?
Question Three: Assume Johnson & Johnson pays the $750 million to claimants in 1983, however, they report this as an expense in 1982. Where on a multiple-step income statement should this loss be reported in 1982? Would there be any other financial statement effects in 1982 (e.g. balance sheet)? What had to be true in order for Johnson & Johnson to report this loss before any actual payments were made in 1983? (Explain all answers)
Question Four: Assume Johnson & Johnson pays $250 million to settle all claims with claimants in 1983, however, they reported an expense of $750 million in 1982. What do you think would happen to their financial statements in 1983? What do you think would happen to their stock price following payment of the $250 million? (Explain all answers)
Question Five: The authors attribute the stock market losses that all of the pharmaceutical firms suffered from Day (+2) through Day (+25) to legislation calling for additional packaging safeguards. Where on the multiple-step income statement would one expect to see these costs reported? When might these costs appear?