1、CASE 1-1Analysis of Contingent Obligation: Bristol-Myers SquibbINTRODUCTIONIn 1992, Bristol-Myers Squibb BMY, a major U.S. based drug company, reported substantiallitigation against the company by recipients of breast implants manufactured and sold by a sub-sidiary of the company. In 1993, BMY made
2、a provision for losses expected from such litiga-tion.1In succeeding years, as the litigation proceeded, the company added to that provision forloss. Eight years later, as of December 31, 2000, while many of these claims had been settled,the amount of BMYs ultimate cash outflows remained uncertain.
3、This case illustrates the diffi-culty in assessing the impact of such litigation on reported income and financial position.W641As an offset to the loss provisions for the company also provided estimates for amounts recoverable from insurance.EXHIBIT 1C1-1. BRISTOL-MYERS SQUIBBBreast Implant Litigati
4、on FootnotesNote 17: ContingenciesThe company is a defendant in a substantial number of actions filed in various U.S. federal and statecourts and in certain Canadian provincial courts by recipients of two types of breast implants, formerlymanufactured and sold by a subsidiary of the company, allegin
5、g damages for personal injuries of vari-ous types. Certain of these cases are class actions, some of which seek to allege claims on behalf of allbreast implant recipients. All federal court actions have been consolidated for pre-trial proceedings infederal District Court in Birmingham, Alabama. In t
6、he case of Pamela Jean Johnson v. Medical Engi-neering Corporation, tried in state Court in Harris County, Texas, a jury on December 23, 1992awarded plaintiff compensatory and punitive damages totaling $25 million. Absent settlement, thecompanys subsidiary will appeal this verdict.Source: Bristol-My
7、ers Squibb Annual Report, December 31, 1992Note 17 LitigationBreast ImplantThe Company, together with its subsidiary, Medical Engineering Corporation (MEC), and certain othercompanies, has been named as a defendant in a number of claims and lawsuits alleging damages for per-sonal injuries of various
8、 types resulting from polyurethane-covered breast implants and smooth-walledbreast implants formerly manufactured by MEC or a related company. Of the more than 90,000 claimsor potential claims against the Company in direct lawsuits or through registration in the nationwideclass action settlement app
9、roved by the Federal District Court in Birmingham, Alabama (the “RevisedSettlement”), most have been dealt with through the Revised Settlement, other settlements, or trial.In the fourth quarter of 1993, the Company recorded a charge of $500 million before taxes ($310million after taxes) in respect o
10、f breast implant cases. The charge consisted of $1.5 billion for potentialliabilities and expenses, offset by $1.0 billion of expected insurance proceeds. In the fourth quarters of1994 and 1995, the Company recorded additional special charges of $750 million before taxes ($488million after taxes) an
11、d $950 million before taxes ($590 million after taxes), respectively, related tobreast implant product liability claims. In the fourth quarter of 1998, the Company recorded an addi-tional special charge to earnings in the amount of $800 million before taxes and increased its insurancereceivable in t
12、he amount of $100 million, resulting in a net charge to earnings of $433 million aftertaxes in respect to breast implant product liability claims At December 31, 2000, $186 million wasincluded in current liabilities for breast implant product liability claims.Source: Bristol-Myers Squibb Annual Repo
13、rt, December 31, 2000CASE OBJECTIVES:1. Discuss the value to financial analysts of the initial disclosures in BMYs 1992 financialstatement footnotes.2. Examine the impact on BMYs financial statements and ratios of the 1993 loss provisionand additional loss provisions in following years.3. Consider t
14、he impact on BMYs financial statements and ratios of alternative financial re-porting (timing and measurement) of the loss.Exhibit 1C1-1 contains excerpts from the Annual Reports of Bristol-Myers Squibb for the years1992 and 2000. These extracts provide a review of the firms disclosures on breast im
15、plant liti-gation. Exhibit 1C1-2 contains data, extracted from annual reports for the years 1993 through2000, regarding the income statement and balance sheet consequences of the accounting forthis litigation.Required:1. The firm did not record a liability for the breast implant litigation for the y
16、ear ended De-cember 31, 1992. Discuss the usefulness of the footnote disclosure in 1992.2. The firm recorded a special charge and related liability in the fourth quarters of 1993,1994, 1995, and 1998. The 1993 charge was offset by $1.0 billion of expected insur-ance proceeds; the 1998 charge was off
17、set by $100 million of expected insurance recov-ery. The firm engaged in litigation with some of its insurers regarding the extent ofinsurance coverage for these losses. Describe the impact of this offset on the incomestatement and the balance sheet.3. Estimate the actual cash inflows and outflows r
18、elated to this litigation for the years 1993through 2000, using the income statement and balance sheet information provided.4. Restate reported earnings for the years 1993 through 2000 assuming that Bristol-Myershad recorded an expense for each year equal to the (net of insurance recovery) cash out-
19、flow for that year. Use a marginal tax rate of 35% for each year.CASE OBJECTIVES W65EXHIBIT 1C1-2. BRISTOL-MYERS SQUIBBSelected Financial Statement DataYears Ended December 31 ($ in millions)Income Statement 1992 1993 1994 1995 1996 1997 1998 1999 2000Breast Implant LitigationSpecial charge: gross $
20、1,500 $ 750 $ 950 $ 800(Expected insurance recovery) (1,000) $1,5 $1,5 $1(100)Net charge (pretax) $ 500 $ 750 $ 950 $ 700Net charge (after-tax) 310 488 590 433Net earnings* $1,378 $1,696 $1,542 $1,517 $2,484 $2,744 $2,750 $3,789 $4,096*Continuing operations, using restated data from 2000 annual repo
21、rtBalance SheetNon-Current Assets:Insurance recoverable $1,000 $ 968 $ 959 $ 853 $ 619 $ 523 $ 468 $ 262Product Liability:Current portion 100 635 700 800 865 877 287 186Non-current portion $1,370 $1,201 $1,645 $1,031 $1,171 $1,244 $3,167 $1,1Total $1,470 $1,836 $2,345 $1,831 $1,036 $1,121 $ 354 $ 18
22、6Source: Bristol-Myers Squibb Annual Reports, 19922000W66 CASE 1-1 ANALYSIS OF CONTINGENT OBLIGATION: BRISTOL-MYERS SQUIBB5. Discuss the effect of the restatement in part 4 on the level and trend of BMY earningsover the 1992 to 2000 time period.6. Discuss the effect of the restatement in part 4 on B
23、ristol-Myers reported return on equity(ROE) for the years 1993 through 2000. Hint: consider the effect of the restatement onstockholders equity as well as income.7. Based on information available at December 31, 2000, describe how to compute thecharge that Bristol-Myers should have recorded in Decem
24、ber 31, 1992. Describe the im-pact of that charge on BMY earnings and ROE in 1992 and subsequent years.8. Based on your answers to parts 1 through 7, discuss the advantages and disadvantages tothe company of recording expense equal to(i) The actual cash flows estimated in part 3(ii) The charge descr
25、ibed in part 7rather than the special charges actually recorded.CASE 2-1Revenue and Expense RecognitionOrthodontic Centers of AmericaCASE OBJECTIVESThe objective of this case is to evaluate the revenue and expense recognition methods used bythe company.INTRODUCTIONThe following information was extra
26、cted from the 1999 and 2000 annual reports of OrthodonticCenters of America OCA.The company provides practice management services to orthodontic practices in theUnited States. OCA acquires and develops orthodontic centers and manages the business opera-tions and marketing aspects of affiliated ortho
27、dontic practices. At December 31, 2000, therewere 592 orthodontic centers, of which the company developed 306 and acquired 361 (75were consolidated into another center).The affiliated orthodontists control the orthodontic practices, determine which personnel,including orthodontic assistants, to hire
28、 or terminate, and set their own standards of practice inorder to promote quality orthodontic care.A typical patient receives an initial consultation and preliminary procedures (teeth impres-sions, x-rays, and the placing of spacers between the teeth for braces) in advance of the next ap-pointment.
29、The patient signs a contract for treatment in the event the orthodontist recommendsorthodontic treatment. Generally, braces are applied two weeks later and subsequent adjust-ments to the braces are made every four to eight weeks.The contract specifies the terms and the length of the treatment as wel
30、l as the total fees. Theaverage contract length is 26 months. No initial down payment is required; the patient makesequal monthly payments followed by a final payment on completion of the treatment.OCA provides the following services to its affiliates:1. Staffing2. Supplies and inventory3. Computer
31、and management information services4. Scheduling, billing, and accounting servicesAn unrelated financial institution finances operating losses and capital improvements for newlydeveloped orthodontic centers; OCA guarantees the related debt.1999 REVENUE RECOGNITIONThe Company earns its revenue from l
32、ong-term service or consulting agreements with affiliated or-thodontists. Through December 31, 1999 OCA recognized monthly fees equal to approximately: 24% of the aggregate amount of all new patient contracts entered into during that partic-ular month, plus The balance of contract amounts allocated
33、equally over the remaining term of the contract.Gross amounts are reduced by the portion of contract amounts expected to be retained bythe orthodontist.OCA recognizes operating expenses as incurred.Required:1. OCA believes that at least 24% of its services relate to the first month of the patientcon
34、tracts. Given the services provide by OCA and the terms of the service and consult-ing agreements: Evaluate the revenue recognition method used by OCA. Propose and justify a more appropriate revenue recognition method.W67W68 CASE 2-1 REVENUE AND EXPENSE RECOGNITIONORTHODONTIC CENTERS OF AMERICA2. Es
35、timate OCAs average contract balance for new patients in 1999, using the operatingdata in Exhibit 2C-1.3. Estimate the first year revenue that OCA recognizes from a new patient contract, as-suming that OCAs share of the contract amount is $3,000, the contract length is 26months, and the contract is
36、signed on(i) January 1 of the first year(ii) July 1 of the first year(iii) December 1 of the first year4. Estimate the second year revenue that OCA recognizes from a new patient contract,under the same assumptions as Question 3, for each of the three signing dates.5. Explain why, using your answers
37、to Questions 3 and 4, OCA must expand its opera-tions rapidly to maintain revenue growth.2000 Revenue RecognitionEffective January 1, 2000, OCA changed its revenue recognition method citing SEC Staff Ac-counting Bulletin No. 101 (see page 45 of text). OCA now recognizes net revenue using astraight-l
38、ine allocation of patient contract revenue over the duration of the patient contract (typi-cally 26 months). The company reported thatThe cumulative effect of this accounting change, calculated as of January 1, 2000, was $50.6 mil-lion, net of income tax benefit of $30.6 million. The effect of this
39、accounting change in 2000 was toreduce revenue by $26.3 million. In 2000, the Company recognized revenue of $57.3 million thatwas included in the cumulative effect adjustment.1The company also reported the pro forma effect of the accounting change on net income, as-suming it had been in effect in pr
40、ior years. Results for those years were not, however, restated.Exhibit 2C-1 contains operating and income statement data for OCA for the years 1997through 2000. The exhibit also shows reported balance sheet data for 1998 through 2000,and restated data for 1999 (see Question 15). Use the exhibit to a
41、nswer the questions thatfollow.Required:6. Redo Questions 3 and 4, using the revenue recognition method that OCA adopted in2000.7. Compare the first and second year revenue recognized under the 2000 and 1999 meth-ods. Note: use an average of the three signing assumptions.8. The accounting change had
42、 two effects on year 2000 revenue: Revenue recognized from new patients was reduced. Revenue from patients signed in prior years, included in the cumulative effect adjust-ment, was recognized in 2000.(i) From the companys disclosure of the effect of the accounting change, computeeach of these effect
43、s.(ii) Use your answer to Question 7 to estimate the second of these effects.9. Compute OCAs 2000 revenue and net income assuming that it had not changed itsrevenue recognition policy.10. Explain why OCAs revenue recognition policy has a disproportionate effect on netincome.11. Discuss the effect of
44、 the accounting change on your answer to Question 5.12. Compute the annual percent changes in each of the following statistics for 1997 to2000, and discuss their trend and their implications for future revenue growth: Number of orthodontic centers Total case starts Number of patients under treatment
45、13. Describe the effect of the accounting change on OCAs receivables.1Source: footnote 2 to 2000 financial statements.14. Compute each of the following statistics for 1997 to 2000. Discuss their trend, their im-pact on reported income, and their implications for future revenue and income growth.Disc
46、uss the effect of the accounting change on the 2000 statistics.(i) Revenue, expense, and operating profit per patient under contract(ii) Revenue, expense, and operating profit per center15. In 2000, OCA restated its 1999 balance sheet to aggregate billed and unbilled patient re-ceivables (as service
47、 fee receivables). It also reduced that amount by patient prepayments,1999 REVENUE RECOGNITION W69EXHIBIT 2C-1. ORTHODONTIC CENTERS OF AMERICAReported Operating and Financial DataYears Ended December 31Operating Data 1997 1998 1999 2000Number of orthodontic centers 360 469 537 592Total case starts 7
48、0,611 95,377 126,307 160,639Number of patients under treatment 130,000 195,000 267,965 343,373New patient contract balances ($ millions) $ 369.1 $ 494.1Income Statement Years Ended December 31(Amounts in $ Thousands, Except Per Share Data) 1997 1998 1999 2000Net revenue $117,326 $171,298 $226,290 $2
49、68,836Operating expense $(81,368) (117,012) (149,366) (188,834)Operating profit $ 35,958 $ 54,286 $ 76,924 $80,002Net interest income (expense) $331,143 $444,280 $1 (2,204) $8 (3,731)Pretax income $ 37,101 $ 54,566 $ 74,720 $ 76,271Income tax expense $ (14,469) $ (20,753) $ (28,206) $ (28,549)Net income* $ 22,632 $ 33,813 $ 46,514 $ 47,722*Before cumulative effect of accounting changesDiluted earnings per share $ 0.50 $ 0.70 $ 0.96 $ 0.96Provision for bad debt expense $ 1,851 $ 2,295 $ 2,079 $ 373Pro Forma for 2000 Accounting ChangeNet income $ 12,013 $ 22,
