1. Forensic and Investigative Accounting
Chapter 10
Commercial Damages
© 2013 CCH Incorporated. All Rights Reserved.
4025 W. Peterson Ave.
Chicago, IL
CCHGroup.com

2. 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.
Chapter 10
Forensic and Investigative Accounting

3. Legal Framework of Damages
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.
Chapter 10
Forensic and Investigative Accounting

4. Forensic and Investigative Accounting
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.
Chapter 10
Forensic and Investigative Accounting

5. Forensic and Investigative Accounting
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.
Chapter 10
Forensic and Investigative Accounting

6. 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.
Chapter 10
Forensic and Investigative Accounting

7. 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.
Chapter 10
Forensic and Investigative Accounting

8. Forensic and Investigative Accounting
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.
Chapter 10
Forensic and Investigative Accounting

9. Forensic and Investigative Accounting
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.
Chapter 10
Forensic and Investigative Accounting

10. Economic Framework for the Lost Profits Estimation Process
Macroeconomic analysis.
Industry analysis.
Company-specific analysis.
Financial analysis conclusion.
Chapter 10
Forensic and Investigative Accounting

11. Length of the Loss Period
Projecting lost revenues.
Measuring profitability.
Mitigation and offsetting profits.
Time value of money considerations.
Chapter 10
Forensic and Investigative Accounting

12. Forensic and Investigative Accounting
Components of Damages
Lost profits
Lost value
Lost cash flows
Lost revenue
Extra costs
Chapter 10
Forensic and Investigative Accounting

13. 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.
Chapter 10
Forensic and Investigative Accounting

14. 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)
Chapter 10
Forensic and Investigative Accounting

15. 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.
Chapter 10
Forensic and Investigative Accounting

16. Expert’s Journey Through the Legal System
Testimony early in case
Pretrial summary judgments
Decision to try the case
(continued on next slide)
Chapter 10
Forensic and Investigative Accounting

17. Expert’s Journey Through the Legal System
Defending the expert report
Deposition testimony
Trial testimony
Questioning by client’s attorney
Questioning by opposing attorney
Preparation for trial testimony
Rebuttal testimony
Chapter 10
Forensic and Investigative Accounting

18. The Art and Science of Computing and Defending Damage Estimates
In any given case there are differences of opinion about the issues at hand. Some find this surprising.
As a result your client will want/expect favorable treatment in damage estimates
The other side in the case will expect the same
There are a lot of different reasons that experts arrive at significantly different damage estimates
Adversarial bias
Conscious bias: opinions for hire “hired guns”
Unconscious bias: wanting to help the side that is paying your bills
Selection bias: the attorney has the ability to select from a wide range of expert positions “picking an unrepresentative expert for testimony”
Chapter 10
Forensic and Investigative Accounting

19. The Art and Science of Computing and Defending Damage Estimates
Other reasons why experts arrive at significantly different damage estimates
Some experts can be bought
Experts review and utilize different data/information in forming damage estimate opinions
Different experts may devise different “theoretical frameworks” for their calculation of damages
Sometimes events/data/circumstances can be viewed differently by equally competent and ethical professionals
Attorneys and clients can persuade experts that certain components of the case can/should be viewed in a certain way
Others
Chapter 10
Forensic and Investigative Accounting

20. Ethical Challenges for an Expert Witness
Independence and objectivity
You are the expert for the court not a pawn of your client (Coping with lawyers)
Confidentiality
You will possess and use much confidential information
Conflicts of interest
Contingency fees

21. An Expert Witness Should “Stay the Course” with Ethical Issues
Sometimes a role of the expert is made clear at trial
Federal Tax Court Experience
Often the issue is not raised directly but there are many possible consequences to not addressing the issue
Daubert challenge
Professional reputation
Deposition or cross examination questioning of previous testimony
Other

22. Developing a Theoretical Framework for Damages
Often it is desirable to develop a theoretical model for damages
Examples:
A model to address the issues presented by the “theory of liquidated damages”
A model to address the issues presented for a “model for cost reconstructions”
A model that describes and discusses the difference between expensing and capitalizing repairs and maintenance
Frequently actual damage calculations are measured against the theoretical model
Also it is helpful to a jury to explain why the damages of the other side do not meet accounting measurement/reporting standards
Chapter 10
Forensic and Investigative Accounting

23. Commonly Used Cost/Managerial Accounting Concepts in Cases
Cost behavior
Fixed/variable/mixed
Strength of relationships
Differential costs/incremental costs
Relevant costs
Matching concept
Identifying the cost objective
Direct costs
Allocated cost
The entity concept

24. Forensic and Investigative Accounting
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.
Cost behavior is a very important concept in the computation of damages.
Chapter 11 discusses the process of estimating cost behavior for a company and defending it during litigation actions
Chapter 10
Forensic and Investigative Accounting

25. Cost Behavior Categories
Fixed costs: Costs that are fundamentally unaffected by changes in the colume of activity
Variable costs: Costs that change directly and proportionately with the volume of activity
Mixed costs: Costs that contain both a fixed and a variable component.
Semi-variable costs: Costs that change with the volume of activity but not proportionately
Semi-fixed costs: Costs that increase ot decrease in a step function
Chapter 10
Forensic and Investigative Accounting