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Firms in the life sciences industry (i.e., pharmaceuticals, medical devices) are constantly facing lawsuits related to personal injury due to medical devices (continuous positive airway pressure - CPAP) (Cuniff & Cetera, 2023), prescription medications (opioids) (Hoffman, 2022), over the counter medications (Prilosec) (Mancini, 2023), and patent infringements (migraine drugs Emgality made by Eli Lilly and Ajovy made by Teva Pharmaceutical) (Brittain, 2023). These lawsuits take years to litigate and can end in billions of dollars being paid out over many years (Hoffman, 2022). According to Li (2023), Litigation Trends provided survey data from 2018 which showed that companies in the United States (all industries) incur costs for "legal disputes" averaging $1.2 million for every "$1 billion in revenue," and that settling lawsuits cost these companies just over $5 billion (p. 437). Merck & Co., Inc., in the notes to the financial statements, inform their users that they are "a defendant in product liability lawsuits in the U.S. involving Gardasil" (SEC, 2023b, p. 105), which is noted as one of their "key products" (SEC, 2023b, p. 27). Johnson & Johnson, in the notes to the financial statements, inform their users that they and some of their "subsidiaries are involved in numerous product liability claims and lawsuits involving multiple products" (SEC, 2023a, p. 84). Both of these firms also note that they are "self-insured" against liability claims. Merck "self-insures substantially all of its risk, as the availability of commercial insurance has become more restrictive" (SEC, 2023b, p. 37). While Johnson & Johnson "has self-insurance through a wholly-owned captive insurance company" (SEC, 2023a, p. 36). When would a firm be required to disclose in the notes to the financial statements and/or report the gain or loss associated with these events? And, what does the auditor have to consider when determining if the client has properly followed generally accepted accounting principles (GAAP)? The Financial Accounting Standards Board (FASB, n.d.) in Accounting Standards Codification (ASC) 450: Contingencies defines a contingency as "an existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an entity that will ultimately be resolved when one or more future events occur or fail to occur." According to 450-20-25-2, "a loss contingency shall be accrued by a charge to income if:" (1) "it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements," and (2) "the amount of loss can be reasonably estimated." If the preceding two conditions have not been met by the date of the financial statements, then "disclosure is preferable to accrual." Paragraph 450-30-25- 1 provides guidance on how to handle a contingency gain. It states that "a contingency that might result in a gain usually should not be reflected in the financial statements because to do so might be to recognize revenue before its realization."
As the auditor, it would be necessary to make inquiries to management, the board of directors (meeting minutes), and the firm's legal team ("letter of inquiry" from management) regarding contingencies. These inquires would concern possible future litigation to ensure that the firm is properly disclosing and/or reporting any potential losses. Finding out "the period in which the underlying cause for legal action occurred" is necessary as that will determine when to report and/or disclose the event. Also asking about the status of previously reported and/or disclosed contingencies will allow the auditor to determine if contingencies that had only been disclosed need to now be reported on the face of the financial statements, or if already reported contingencies need to be adjusted based on new information. When assessing these cases, the firm's past experiences with similar cases, as well as industry peer's experiences, may assist in determining probability and estimating losses (PCAOB, 2020, p. 277). References Brittain, B. (2023, September 26). US judge overturns Eli Lilly's $176.5 million loss in Teva patent case . Reuters. https://www.reuters.com/legal/us- judge-overturns-eli-lillys-1765-million-loss-teva-patent-case-2023-09-26/ Cuniff, M., & Cetera, M. (2023, January 10). CPAP lawsuit update October 2023 . Forbes Media LLC. https://www.forbes.com/advisor/legal/product- liability/cpap-lawsuit/ FASB. (n.d.). Accounting standards codification 450: Contingencies . Financial Accounting Standards Board. https://asc.fasb.org/450/showallinonepage Hoffman, J. (2022, February 25). Companies finalize $26 billion deal with states and cities to end opioid lawsuits . The New York Times. https://www.nytimes.com/2022/02/25/health/opioids-settlement-distributors- johnson.html Li, H. (2023). Litigation-disclosure modifications in the 10-k: Large-sample evidence. Journal of Accounting, Auditing & Finance, 38 (2), 437-452. https://doi.org/10.1177/0148558X211017838 Mancini, D. P. (2023, October 3). AstraZeneca settles heartburn drug lawsuits for $425mn . The Financial Times Ltd. https://www.ft.com/content/b430c9ca- 9c48-46ff-afd7-f63e8b501f0c PCAOB. (2020, December 15). Auditing standards of the Public Company Accounting Oversight Board . https://assets.pcaobus.org/pcaob- dev/docs/default- source/standards/auditing/documents/auditing_standards_audits_after_dece mber_15_2020.pdf?sfvrsn=5862544e_4 SEC. (2023a, February 16). Johnson & Johnson form 10-k for the fiscal year ended January 1, 2023 . United States Securities and Exchange Commission.
https://www.sec.gov/ix? doc=/Archives/edgar/data/200406/000020040623000016/jnj-20230101.htm SEC. (2023b, February 24). Merck & Co., Inc. form 10-k for the fiscal year ended December 31, 2022 . United States Securities and Exchange Commission. https://www.sec.gov/ix? doc=/Archives/edgar/data/310158/000162828023005061/mrk- 20221231.htm
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