Explain the potential justification 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. use this comprehension. In a complaint dated $26$ July $2007,$ and after a four$$year investigation, the US Securities and Exchange Commission $($SEC$)$ accused Cardinal Health, the world's second largest distributor of pharmaceutical products, of violating generally accepted accounting principles $($GAAP$)$ by prematurely recognizing gains from a provisional settlement of a lawsuit filed against several vitamin manufacturers. Weeks earlier, the company agreed to pay $$600$ million to settle a lawsuit filed by shareholders who bought stock between $2000$ and $2004,$ accusing Cardinal of accounting irregularities and inflated earnings.$*$ The recovery from the vitamin companies should have been an unqualified positive for Cardinal Health. What happened?BackgroundThe story begins in $1999$ when Cardinal Health joined a class action to recover overcharges from vitamin manufacturers. The vitamin makers had just pled guilty to charges of price$$fixing from $1988$ to $1998.$ In March $2000,$ the defendants in that action reached a provisional settlement with the plaintiffs under which Cardinal could have received $$22$ million. But Cardinal opted out of the settlement, choosing instead to file its own claims in the hopes of getting a bigger payout.The accounting troubles started in October $2000$ when senior managers at Cardinal began to consider recording a portion of the expected proceeds from a future settlement as a litigation gain. The purpose was to close a gap in Cardinal's budgeted earnings for the second quarter of FY $2001,$ which ended $31$ December $2000.$ According to the SEC, in a November $2000$ e$$mail a senior executive at Cardinal Health explained why Cardinal should use the vitamin gain, rather than other earnings initiatives, to report the desired level of earnings: $$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 Q$3.$On $31$ December $2000,$ the last day of the second quarter of FY $2001,$ Cardinal recorded a $$10$ million contingent vitamin litigation gain as a reduction to cost of sales. In its complaint, the SEC alleged that Cardinal's classification of the gain as a reduction to cost of sales violated GAAP. It is worth noting that had the gain not been recognized, Cardinal would have missed analysts' average consensus EPS estimate for the quarter by $$\mathrm{.}02.$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 $2001.$ Moreover, PwC advised Cardinal that the $$10$ million recognized in the second quarter of FY $2001$ as a reduction to cost of sales should be reclassified $$below the line$$ as nonoperating income. Cardinal management ignored the auditor's advice, and the $$10$ 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 cover an expected shortfall in earnings. On $30$ September $2001,$ the last day of the first quarter of FY $2002,$ Cardinal recorded a $$12$ million gain, bringing the total gains from litigation to $$22$ million. As in the previous year, Cardinal classified the gain as a reduction to cost of sales, allowing the company to boost operating earnings. However, PwC disagreed 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 nonrecurring, and stemmed from claims against third parties that originated nearly $13$ years earlier.By May $2002,$ PwC had been replaced as Cardinal's auditor by Arthur Andersen.

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 Q$3."$ Include specific clarification of the phrase "not steal from Q$3."$

Explain specifically what Cardinal Health did to get into trouble with the SEC.

Justify the timing of the $$10$ million and $$12$ million gains, and explain how Cardinal Health's senior managers defend these decisions.

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 justified 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.