Transcript Chapter 10 Commercial Damages Forensic and Investigative Accounting .

Forensic and Investigative Accounting
Chapter 10
Commercial Damages
.
Legal Framework of Damages
In order to win an award for damages, the
injured party must generally prove two
points:
– That the other party was liable for the
damage.
– That the injured party suffered damages
as the results of the actions or lack of
actions of the offending party.
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Legal Framework of Damages
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Proximate (direct) cause—The damages caused were a
direct result of the offending party’s actions or lack of
actions.
Reasonable certainty—That it is “reasonably certain”
that the injured party would have earned the claimed
amount of damages “but-for” the actions of the other
party.
– Courts tend not to create profits where none existed
before
Forseeability—That a prudent person could look into
the future and see that the actions of the offending
party would damage the other party to the litigation.
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Two Types of Harm
Tort—The occurrence of the harmful act
itself is wrongful.
 Breach of contract—A failure without
excuse or justification to fulfill one’s
obligations under a contract.
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Two Types of Damages
Restitution—When the harmful act unjustly
enriches the defendant at the expense of the
plaintiff.
 Reliance—When the harmful act is fraud
and the intent of damages is to restore the
plaintiff to the position as if no promises
had been made.
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Damages Calculation Approaches
The out-of-pocket loss refers to the difference
between the actual value received and the
actual value conveyed. The plaintiff can
recover nothing beyond his or her investment.
 Under the benefit-of-the-bargain theory (or
expectations remedy), the damages include not
only the money invested but also other
expenses such as increased costs, lost profits,
and decreased value of the investment.
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Damages Calculation Example
Debra (defendant) sells Paula (plaintiff) an asset
with an alleged value of $2 million for $1.8
million. However, the asset really had a market
value of only $1.6 million. The fraud damages can
be calculated in two ways:
– Out-of-pocket loss rule: $1.8 million - $1.6
million = $200,000.
– Benefit-of-the-bargain rule: $2 million - $1.6
million = $400,000.
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Lost Profits Methods
Before-and-after method—Take sales or
sales growth before the act and compare to
the comparable figures afterward.
 Yardstick (or benchmark) method—
Compare sales or sales growth of the
company to other companies or to other
industry averages.
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Lost Profits Methods
“But-for” method—The difference in the
estimated profits (but-for the actions of the
defendant) and the actual profits.
 Direct method—Any agreement may
indicate how to calculate.
 Combination method—May use a
combination of methods.
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Economic Framework for the
Lost Profits Estimation Process
Macroeconomic analysis.
 Industry analysis.
 Company-specific analysis.
 Financial analysis conclusion.
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Length of the Loss Period
Projecting lost revenues.
 Measuring profitability.
 Mitigation and offsetting profits.
 Time value of money considerations.
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Components of Damages
Lost profits
 Lost value
 Lost cash flows
 Lost revenue
 Extra costs
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Defendant’s Damages Estimate
The defendant’s expert report would include
his or her damages estimate along with
support for the numbers presented.
 In order to arrive at a “zero” damages
estimate, a defendant must demonstrate to
the court that the plaintiff suffered no
financial damages.
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Plaintiff’s Damages Estimate
Much of the support for the damages estimate
for the plaintiff comes from various accounting
records, but the use of those supporting data also
shows that damages estimates are both an art
and a science. The scientific part is primarily the
understanding and appropriate use of accounting
information. The art part of the process is in
knowing how the accounting information is used
in creating components of the damages estimate.
(continued on next slide)
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Plaintiff’s Damages Estimate
In addition, expert witnesses frequently use
many other kinds of information other than
traditional accounting records in arriving at
and defending damages calculations.
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Expert’s Journey Through the
Legal System
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Testimony early in case
– Pretrial summary judgments
– Decision to try the case
(continued on next slide)
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Expert’s Journey Through the
Legal System
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Defending the expert report
– Deposition testimony
– Trial testimony
– Questioning by client’s attorney
– Questioning by opposing attorney
– Preparation for trial testimony
– Rebuttal testimony
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Cost Behavior Defined
In its simplest form, cost behavior is
the way that cost(s) change with respect
to changes in the volume of activity.
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Developing a Theoretical Model for
Damages
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Sometimes it is necessary to develop a theoretical model
for damages
Frequently actual damage calculations are measured
against the theoretical model
The theoretical framework should be supported by
accounting foundations such as
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Incurred historical costs
The matching concept
Relevant costs
Conservatism
Differential or incremental costs
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