forensic and investigative accounting chapter 10 commercial damages © 2013 cch incorporated. all...

Forensic and Investigative AccountingForensic and Investigative Accounting

Chapter 10

Commercial Damages

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Chapter 10 Forensic and Investigative Accounting 2

Legal Framework of DamagesLegal Framework of Damages

In order to win an award for damages, the In order to win an award for damages, the injured party must generally prove two injured party must generally prove two points:points:

– That the other party was liable for the That the other party was liable for the damage.damage.

– That the injured party suffered damages That the injured party suffered damages as the results of the actions or lack of as the results of the actions or lack of actions of the offending party.actions of the offending party.


Legal Framework of DamagesLegal Framework of Damages Proximate (direct) causeProximate (direct) cause—The damages caused were a —The damages caused were a

direct result of the offending party’s actions or lack of direct result of the offending party’s actions or lack of actions.actions.

Reasonable certaintyReasonable certainty—That it is “reasonably certain” —That it is “reasonably certain” that the injured party would have earned the claimed that the injured party would have earned the claimed amount of damages “but-for” the actions of the other amount of damages “but-for” the actions of the other party.party.– Courts tend not to create profits where none existed Courts tend not to create profits where none existed

beforebefore ForseeabilityForseeability—That a prudent person could look into —That a prudent person could look into

the future and see that the actions of the offending the future and see that the actions of the offending party would damage the other party to the litigation.party would damage the other party to the litigation.


Two Types of HarmTwo Types of Harm

TortTort—The occurrence of the harmful act —The occurrence of the harmful act itself is wrongful.itself is wrongful.

Breach of contractBreach of contract—A failure without —A failure without excuse or justification to fulfill one’s excuse or justification to fulfill one’s obligations under a contract.obligations under a contract.


Two Types of DamagesTwo Types of Damages

RestitutionRestitution—When the harmful act unjustly —When the harmful act unjustly enriches the defendant at the expense of the enriches the defendant at the expense of the plaintiff.plaintiff.

RelianceReliance—When the harmful act is fraud —When the harmful act is fraud and the intent of damages is to restore the and the intent of damages is to restore the plaintiff to the position as if no promises plaintiff to the position as if no promises had been made.had been made.


Damages Calculation ApproachesDamages Calculation Approaches

The The out-of-pocket lossout-of-pocket loss refers to t refers to the difference he difference between the actual value received and the between the actual value received and the actual value conveyed. The plaintiff can actual value conveyed. The plaintiff can recover nothing beyond his or her investment.recover nothing beyond his or her investment.

Under the Under the benefit-of-the-bargain theory benefit-of-the-bargain theory (or(or expectations remedyexpectations remedy), the damages include not ), the damages include not only the money invested but also other only the money invested but also other expenses such as increased costs, lost profits, expenses such as increased costs, lost profits, and decreased value of the investment.and decreased value of the investment.


Damages Calculation ExampleDamages Calculation Example

Debra (defendant) sells Paula (plaintiff) an asset Debra (defendant) sells Paula (plaintiff) an asset with an alleged value of $2 million for $1.8 with an alleged value of $2 million for $1.8 million. However, the asset really had a market million. However, the asset really had a market value of only $1.6 million. The fraud damages can value of only $1.6 million. The fraud damages can be calculated in two ways:be calculated in two ways:– Out-of-pocket loss rule: $1.8 million - $1.6 Out-of-pocket loss rule: $1.8 million - $1.6

million = $200,000.million = $200,000.– Benefit-of-the-bargain rule: $2 million - $1.6 Benefit-of-the-bargain rule: $2 million - $1.6

million = $400,000.million = $400,000.


Lost Profits MethodsLost Profits Methods

Before-and-after methodBefore-and-after method—Take sales or —Take sales or sales growth before the act and compare to sales growth before the act and compare to the comparable figures afterward.the comparable figures afterward.

Yardstick (or benchmark) methodYardstick (or benchmark) method——Compare sales or sales growth of the Compare sales or sales growth of the company to other companies or to other company to other companies or to other industry averages.industry averages.


Lost Profits MethodsLost Profits Methods

““But-for” methodBut-for” method—The difference in the —The difference in the estimated profits (but-for the actions of the estimated profits (but-for the actions of the defendant) and the actual profits.defendant) and the actual profits.

Direct methodDirect method—Any agreement may —Any agreement may indicate how to calculate.indicate how to calculate.

Combination methodCombination method—May use a —May use a combination of methods.combination of methods.


Economic Framework for the Economic Framework for the Lost Profits Estimation ProcessLost Profits Estimation Process

Macroeconomic analysis.Macroeconomic analysis. Industry analysis.Industry analysis. Company-specific analysis.Company-specific analysis. Financial analysis conclusion.Financial analysis conclusion.


Length of the Loss PeriodLength of the Loss Period

Projecting lost revenues.Projecting lost revenues. Measuring profitability.Measuring profitability. Mitigation and offsetting profits.Mitigation and offsetting profits. Time value of money considerations.Time value of money considerations.


Components of DamagesComponents of Damages

Lost profitsLost profits Lost valueLost value Lost cash flowsLost cash flows Lost revenueLost revenue Extra costsExtra costs


Defendant’s Damages EstimateDefendant’s Damages Estimate

The defendant’s expert report would The defendant’s expert report would include his or her damages estimate along include his or her damages estimate along with support for the numbers presented.with support for the numbers presented.

In order to arrive at a “zero” damages In order to arrive at a “zero” damages estimate, a defendant must demonstrate to estimate, a defendant must demonstrate to the court that the plaintiff suffered no the court that the plaintiff suffered no financial damages.financial damages.


Plaintiff’s Damages EstimatePlaintiff’s Damages EstimateMuch of the support for the damages estimate for Much of the support for the damages estimate for the plaintiff comes from various accounting the plaintiff comes from various accounting records, but the use of those supporting data also records, but the use of those supporting data also shows that damages estimates are both an art and shows that damages estimates are both an art and a science. The scientific part is primarily the a science. The scientific part is primarily the understanding and appropriate use of accounting understanding and appropriate use of accounting information. The art part of the process is in information. The art part of the process is in knowing how the accounting information is used knowing how the accounting information is used in creating components of the damages estimate.in creating components of the damages estimate.

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Plaintiff’s Damages EstimatePlaintiff’s Damages Estimate

In addition, expert witnesses frequently use In addition, expert witnesses frequently use many other kinds of information other than many other kinds of information other than traditional accounting records in arriving at traditional accounting records in arriving at and defending damages calculations.and defending damages calculations.


Expert’s Journey Through the Expert’s Journey Through the Legal SystemLegal System

Testimony early in caseTestimony early in case– Pretrial summary judgmentsPretrial summary judgments– Decision to try the caseDecision to try the case

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Expert’s Journey Through the Expert’s Journey Through the Legal SystemLegal System

Defending the expert reportDefending the expert report– Deposition testimonyDeposition testimony– Trial testimonyTrial testimony– Questioning by client’s attorneyQuestioning by client’s attorney– Questioning by opposing attorneyQuestioning by opposing attorney– Preparation for trial testimonyPreparation for trial testimony– Rebuttal testimonyRebuttal testimony

The Art and Science of Computing The Art and Science of Computing and Defending Damage Estimatesand Defending Damage Estimates

In any given case there are differences of opinion In any given case there are differences of opinion about the issues at hand. Some find this surprising.about the issues at hand. Some find this surprising.– As a result your client will want/expect favorable As a result your client will want/expect favorable

treatment in damage estimatestreatment in damage estimates– The other side in the case will expect the sameThe other side in the case will expect the same– There are a lot of different reasons that experts arrive at There are a lot of different reasons that experts arrive at

significantly different damage estimatessignificantly different damage estimates» Adversarial biasAdversarial bias

Conscious bias: opinions for hire “hired guns”Conscious bias: opinions for hire “hired guns” Unconscious bias: wanting to help the side that is paying your billsUnconscious bias: wanting to help the side that is paying your bills Selection bias: the attorney has the ability to select from a wide Selection bias: the attorney has the ability to select from a wide

range of expert positions “picking an unrepresentative expert for range of expert positions “picking an unrepresentative expert for testimony” testimony”


The Art and Science of Computing The Art and Science of Computing and Defending Damage Estimatesand Defending Damage Estimates– Other reasons why experts arrive at significantly Other reasons why experts arrive at significantly

different damage estimatesdifferent damage estimates» Some experts can be boughtSome experts can be bought» Experts review and utilize different data/information in Experts review and utilize different data/information in

forming damage estimate opinionsforming damage estimate opinions» Different experts may devise different “theoretical Different experts may devise different “theoretical

frameworks” for their calculation of damagesframeworks” for their calculation of damages» Sometimes events/data/circumstances can be viewed Sometimes events/data/circumstances can be viewed

differently by equally competent and ethical differently by equally competent and ethical professionals professionals

» Attorneys and clients can persuade experts that certain Attorneys and clients can persuade experts that certain components of the case can/should be viewed in a certain components of the case can/should be viewed in a certain wayway

» OthersOthers


Ethical Challenges for an Expert Ethical Challenges for an Expert Witness Witness

Independence and objectivityIndependence and objectivity– You are the expert for the court not a pawn of You are the expert for the court not a pawn of

your client (Coping with lawyers)your client (Coping with lawyers) ConfidentialityConfidentiality

– You will possess and use much confidential You will possess and use much confidential informationinformation

Conflicts of interestConflicts of interest Contingency feesContingency fees

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An Expert Witness Should “Stay the An Expert Witness Should “Stay the Course” with Ethical IssuesCourse” with Ethical Issues

Sometimes a role of the expert is made clear at Sometimes a role of the expert is made clear at trialtrial– Federal Tax Court ExperienceFederal Tax Court Experience

Often the issue is not raised directly but there Often the issue is not raised directly but there are many possible consequences to not are many possible consequences to not addressing the issueaddressing the issue– Daubert challengeDaubert challenge– Professional reputationProfessional reputation– Deposition or cross examination questioning of Deposition or cross examination questioning of

previous testimonyprevious testimony– OtherOther

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Developing a Theoretical Developing a Theoretical Framework for DamagesFramework for Damages

Often it is desirable to develop a theoretical model for damagesOften it is desirable to develop a theoretical model for damages Examples:Examples:

– A model to address the issues presented by the “theory of A model to address the issues presented by the “theory of liquidated damages”liquidated damages”

– A model to address the issues presented for a “model for cost A model to address the issues presented for a “model for cost reconstructions” reconstructions”

– A model that describes and discusses the difference between A model that describes and discusses the difference between expensing and capitalizing repairs and maintenance expensing and capitalizing repairs and maintenance

Frequently actual damage calculations are measured against the Frequently actual damage calculations are measured against the theoretical modeltheoretical model

Also it is helpful to a jury to explain why the damages of the Also it is helpful to a jury to explain why the damages of the other side do not meet accounting measurement/reporting other side do not meet accounting measurement/reporting standardsstandards


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Commonly Used Cost/Managerial Commonly Used Cost/Managerial Accounting Concepts in CasesAccounting Concepts in Cases

Cost behaviorCost behavior– Fixed/variable/mixedFixed/variable/mixed– Strength of relationshipsStrength of relationships

Differential costs/incremental costsDifferential costs/incremental costs Relevant costsRelevant costs Matching conceptMatching concept Identifying the cost objectiveIdentifying the cost objective Direct costsDirect costs Allocated costAllocated cost The entity conceptThe entity concept


Cost Behavior DefinedCost Behavior Defined

In its simplest form, In its simplest form, cost behaviorcost behavior is the is the way that cost(s) change with respect to way that cost(s) change with respect to changes in the volume of activity.changes in the volume of activity.

Cost behavior is a very important Cost behavior is a very important concept in the computation of damages.concept in the computation of damages.

Chapter 11 discusses the process of Chapter 11 discusses the process of estimating cost behavior for a company estimating cost behavior for a company and defending it during litigation and defending it during litigation actionsactions

Cost Behavior CategoriesCost Behavior Categories

Fixed costs: Costs that are fundamentally Fixed costs: Costs that are fundamentally unaffected by changes in the colume of activityunaffected by changes in the colume of activity

Variable costs: Costs that change directly and Variable costs: Costs that change directly and proportionately with the volume of activity proportionately with the volume of activity

Mixed costs: Costs that contain both a fixed Mixed costs: Costs that contain both a fixed and a variable component.and a variable component.

Semi-variable costs: Costs that change with the Semi-variable costs: Costs that change with the volume of activity but not proportionatelyvolume of activity but not proportionately

Semi-fixed costs: Costs that increase ot Semi-fixed costs: Costs that increase ot decrease in a step functiondecrease in a step function


forensic and investigative accounting chapter 10 commercial damages © 2013 cch incorporated. all...

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fraud damages

commercial damages

intent of damages

injured party

lack of actions

harmful act

actual value

offending partys actions