QUESTION 1

Read the article below and answer the questions that follow.

Drugs Code Set to Get Tougher
By: Emma Connors

The pharmaceutical industry faces a nervous wait as the competition regulator deliberates over proposed changes to the rules that govern the promotion of prescription drugs. The last review of the industry code of conduct resulted in major changes when the Australian Competition & Consumer Commission ruled innovative drug companies would have to publicly disclose the details of hospitality given to health professionals at educational events.

Companies found to have broken the rules at these events or in other promotions can be fined up to $200,000. Those fines are set to increase when the latest edition of the code takes effect in future. The draft code increases the maximum penalty for a breach of the code from $200,000 to $250,000 – a long way short of the maximum $1.1 million fine called for by the consumer organization Choice.

Choice argues the fines are not large enough to deter companies from irresponsible promotion because of the substantial revenue increases that can be gained if such promotion delivers the company even a small increase in market share. Medicines Australia, however, believes the other sanctions – including corrective letters to doctors and corrective advertising – that are imposed on companies that break the rules are often a better deterrent than fines.

Source: Excerpts from The Australian Financial Review, 4 August 2009, p.5, www.afr.com

a) Positive Accounting Theory models the political processes involving the relationship between the firm and other parties interested in the firm. How does the article demonstrate political processes? In your answer, explain what, if anything, firms in the pharmaceutical industry can do to manage political costs. (4 marks)

b) What is the potential impact of the increased fines on the content of the accounting reports of firms in the pharmaceutical industry, particularly in relation to accounting information?
(4 marks)

c) What do you expect will be the impact of the increased fines in the (i) earnings and (ii)
management compensation contracts, of firms in the pharmaceuticals industry?
(4 marks)

The review of the rules and regulation that govern the operations of the industry, such as the method promotion of prescription drugs through educational events
The proposals of industry observers

The input from consumer organizations that are focused on protecting the end users of the prescription drugs

b) According to the article, the maximum fines for companies that brake the

rules is expected to increase from $200,000 to $250,000, however the

consumer organization calls for a maximum fine of $1.1 million

Based on the expected increase in fines of $50,000, the potential impact

of the fines on small firms will be much larger than impact of the fines on

the large companies in the pharmaceutical industry who can afford such

fines thereby making it more affordable the large firms to introduce more

new prescription drugs that increases revenue and market share

Therefore, the impact of the increases fines on the content of the

accounting reports of firms is that the increased fines will pressurize firms

to alter their accounting information through the use of reduced

accounting details and generalized expenditure geared towards avoiding

fines that may come due to the required marketing which increase sales of

prescription drugs

c) (i) The proposed increase in fines from $200,000 to $250,000 will

further reduce the earnings of defaulting firms.

However, the increased revenue and market share that comes from

promoting prescription drugs to professionals at educational events can be

easily made to offset the fine costs by increasing the price of the drugs

Therefore, the fines which are a quarter of the amount called for by

consumer organizations will have little impact on the earnings of the firms

in the pharmaceutical industry

(ii) The increase in fines indicates the level of effectiveness of the previous

fines was less than expected.

The impact of the further increase in fines which indicates increase scrutiny