Question

Martin Pharmaceutical Co. is currently involved in two lawsuits. One is a class-action suit in which consumers claim that one of Martin's best selling drugs caused severe health problems. It is reasonably possible that Martin will lose the suit and have to pay $20 million in damages. Martin is suing another company for false advertising and false claims against Martin. It is probable that Martin will win the suit and be awarded $5 million in damages. What amount should Martin report on its financial statements as a result of these two lawsuits

Answer 1

Martin Pharmaceutical Co. should disclose the possible $20 million loss in the financial statement notes and refrain from recognizing the probable $5 million gain until it is realized, following accounting principles of liability recognition and conservatism.

Step-by-step explanation:

Martin Pharmaceutical Co. is dealing with two lawsuits, with different contingencies affecting their financial reporting. According to accounting principles, a company should record a liability in its financial statements if the loss is deemed probable and the amount can be reasonably estimated. In the case of the class-action lawsuit, where it's reasonably possible that Martin could lose and be required to pay $20 million, the potential loss should be disclosed in the notes of the financial statements but not necessarily recorded as an expense. On the other hand, regarding the lawsuit Martin is pursuing, since Martin will probably win and be awarded $5 million, this gain is not recognized until it is realized or realizable, due to the conservatism principle in accounting that prevents the anticipation of revenue.

In summary, Martin should only report the potential loss in their financial statement notes, without recognizing the potential gain from their other lawsuit before the outcome is realized.

Answer 2

$20 million

Step-by-step explanation:

Martin Pharmaceutical Co. is currently involved in two lawsuits. One is a class-action suit in which consumers claim that one of Martin's best selling drugs caused severe health problems.

1, It is reasonably possible that Martin will lose the suit and have to pay $20 million in damages.

2. Martin is suing another company for false advertising and false claims against Martin. It is probable that Martin will win the suit and be awarded $5 million in damages.

Therefore the amount that Martin should report on its financial statements as a result of these two lawsuits will be $20 million because:

For scenario 1, there has to be a PROVISION made in the balance sheet because the outcome of the legal case is MORE LIKELY THAN NOT.

For scenario 2, there is no need to make a provision because the outcome is PROBABLE. hence, only a DISCLOSURE is required as a foot note to the financial statements