1. Chapter 15 Consulting, Litigation Support and Expert Witnesses: Damages, Valuations and Other Engagements

2. Engagement Issues and Professional Responsibility Consider the implications CPAs need to ensure they have or can obtain necessary skills, training, and experience Engagement letter – Nature and extent of professional services to be provided – Outline degree of responsibility assumed No opinion about guilt or innocence

3. Types of Consulting and Litigation Support Activities Assessing the risk of fraud and illegal acts’ Evaluating the adequacy of internal control systems Substantive testing of transactions during an attest or general consulting engagement Designing and implementing internal control policies and procedures Proactive fraud auditing when fraud is not suspected Preparing company codes of business ethics and conduct Consulting about employee bonding Developing corporate compliance programs

4. Tools and Techniques – General Discussion AICPA Practice Aid 07-1 1.Public Domain Reviews and Background Investigations 2.Interviews of Knowledgeable Persons 3.Confidential Sources of Information and Evidence 4.Laboratory Analysis of Physical and Electronic Evidence 5.Physical and Electronic Surveillance 6.Undercover Operations 7.Analysis of Financial Transactions

5. Commercial Damages Estimating damages on a case-by-case basis Understanding and appropriate use of proper accounting methods Understanding how accounting information is used to create the required components of the damages estimate Accurate, timely, and professional advice will help attorney formulate effective strategies

6. Legal Framework for Damages To pursue legal damages, injured part must prove 2 points – Liability: That the other party was liable for all or part of the damages claimed – Damages: That the injured party suffered damages as the results of the actions or lack of actions of offending party – (A contract does not need to be in place) To prove damages were sustained, injured party must prove 3 additional elements – Accused party was the direct or proximate cause of the damages – Amount must be calculable to a reasonable degree of certainty – Accused parties should have been reasonably able to foresee that damages were likely to accrue

7. Types of Commercial Damages Compensatory Restitution (actual loss) – Lost wages – Incremental or incidental expenses – Lost profits – Lost Value Reliance Punitive Special

8. The Loss Period One of the first steps to measuring commercial damages is to determine the loss period For breach of contract, it is generally the remaining term of contract – If the contract term is very long, courts may be reluctant to enforce it because of issues of uncertainty – The damages may extend beyond the contract term because the parties have a history of extending or renewing prior contracts

9. Economic Framework for Damages Amount of loss may be affected by the economy or conditions of the industry Give consideration to the appropriate economic conditions as a starting point Next level of consideration is the industry Performance of entity compared to competitors Gather financial statement data, breakdowns, non-financial data, and tax returns Consider historical performance Assessment of cash flows

10. Quantifying Lost Revenues and Increased Expenses Decisions that need to be made – Base amount of revenues or expenses – Choose revenue or expense growth rates – Are historical rates of growth applicable to the damage period? Methods used to develop estimates of lost sales and incremental expenses – The Before and After Method – The Benchmark (“Yardstick”) Method – Cash Flow Method

11. Determining Lost Profits Consider impact on “bottom-line” net income Incremental costs subtracted from incremental revenues Damaged party must mitigate its damages AICPA practice Aid No. 7 “Litigation Services” – Losses characterized as lost profits, lost value, lost cash flows, net revenue and incremental costs

12. Determining Incremental Costs Incurred as a result of plaintiff’s action or inaction that would otherwise not be incurred Infrastructure requirements in order for the plaintiff to have the capacity necessary Cost Behavior – Fixed – Variable Relevant range Allocated costs Accounting estimates

13. Determining Incremental Costs Methods for determining cost behavior – Account analysis – High-low method – movement of variable costs – Graphics – Statistical (regression, survey and sampling) – Engineering

14. Valuations Value business, business ownership interest, security, or intangible asset Valuation method most often used: Fair Market Value

15. Overall Engagement Considerations Assessment of economic and industry conditions Ability to identify, gather and analyze relevant data Simplified versus complex valuation methods – Limitations – Assumptions Understand nature of client’s expectations and planned use for valuation services outcomes

16. Type of Valuation Engagements Two types of engagements – Valuation Data and information are continually gathered, updated, incorporated and analyzed Use most appropriate methods and approaches – Calculation Outline assets, valuation methods and other aspects of the engagement Service provider agrees in advance Professional proceeds to apply agreed-upon procedures

17. Measures of Value Book value – Balance sheet value Liquidation value – Cash likely received by owner under pressure to sell item quickly Fair Market value – most often used – Willing buyer and seller come to terms under normal market conditions

18. Determining Market, Fair Market and Fair Value Two considerations that determine market and fair market value of an asset – Future income stream – Difference between future income stream and alternative investment options Three methods used to determine fair market values – Discounted earnings and cash flows – Market comparables valuation – Asset and liability market valuation

19. Forecasting Income and Cash Flows Consider data in the following areas – Nature of the business – General economic and industry outlook – Book value of equity – Earnings capacity of the company – Dividend paying capacity – Goodwill and other intangible assets – Previous sales of company securities – Market prices of comparable companies – Number, type and age of organizational facilities – Classes of debt or equity and their associated rights – Industry markets and conditions – Business risks

20. The Valuation Report Accredited Senior Appraiser’s (ASA’s) Principles of Appraisal Practice – Description of the property – Objectives of the appraisal work – Statement of contingent and limiting conditions – Description and explanation of appraisal method – Statement of appraiser’s disinterestedness – Appraiser’s responsibility to communicate each analysis, opinion and conclusion – Mandatory recertification statement – Signatures and inclusion of dissenting opinions

21. The Valuation Report Uniform Standards of the Professional Appraisal Practice (USPAP) – Identify and describe business enterprise, assets or equity – State purpose and intended use of appraisal – Define the value to be estimated – Set forth the effective date of the appraisal and report – Describe the extent of the appraisal process employed – All assumptions and limiting conditions that affect analyses opinions and conclusions – The information considered, appraisal procedures followed and reasoning that supports the analyses, opinions and conclusions – Any additional information that may be appropriate to show compliance – Rationale for the valuation methods and procedures used – A certification in accordance with Standards Rule 10-3

22. Personal Injury, Wrongful Death and Survival Actions Three types of damages that may ensue – Losses to the individual – Losses to survivors – Losses to the estates of decedents More technical than analytical Guidelines are relatively straight forward do to their common nature Inflation is a major challenge

23. Losses: Personal Injury Injured person survived and subsequently lost income Experts estimate reduced earnings and other forms of support as a result of the injury May incur future costs or earnings capacity may be reduced as part of a permanent injury Injured person may suffer 5 types of losses – Loss of earnings – Loss of employment benefits – Losses associated with ability to perform “non-market services” – Medical costs – Life care costs

24. Losses: Wrongful Death and Survival Cases Death of a person where another party may be held accountable can result in two types of cases – Wrongful death Primary right of recovery resides with survivors – Survival actions Estate of deceased has primary right of recovery “What if” No need for medical or life-care costs

25. Analysis of Earnings Losses Investigation of five areas – Determining the basis for earnings losses – Analysis of employment history and related past earnings – Projection of probable career paths – Determining the proper earnings for each projected career path – Consideration of other factors on earnings losses Three methods for projecting earnings – Case-by-case method – Below-market discount method – Total offset method