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Unformatted text preview: Forensic and Investigative Accounting Chapter 10 Commercial Damages 2007 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com 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. (continued on next slide)
Chapter 10 Forensic and Investigative Accounting 2 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. 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 3 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 4 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 5 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 6 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 7 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. (continued on next slide) Chapter 10 Forensic and Investigative Accounting 8 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 9 Standard Formula for Damages
Earnings Actual Damages before trial, earnings + Prejudgment = before had the before trial interest harmful event trial not occurred Projected Projected Damages earnings after earnings Discounting = after trial, had the after trial trial harmful event not occurred
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
Three outcomes of business damages: Closed Open Infinite Projecting lost revenues. Measuring profitability. Mitigation and offsetting profits. Time value of money considerations. Chapter 10 Forensic and Investigative Accounting 12 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
Forensic and Investigative Accounting 18 Chapter 10 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. Chapter 10 Forensic and Investigative Accounting 19 Common Types of Cost Behavior
Fixed costs Variable costs Mixed costs Semivariable costs Semifixed costs Chapter 10 Forensic and Investigative Accounting 20 Cost Behavior Assumptions
Basis of cost behavior estimates Relevant range assumption Time assumption Ways of estimating cost behavior Account analysis method High-low method Regression analysis Engineering or work-measurement method Chapter 10 Forensic and Investigative Accounting 21 Discounting After-trial Damages
There are two major approaches to discount amounts to present values. One approach is to project a plaintiff's hoped-for income stream by modifying losses to a realistic expectation by factoring in future losses to a present value at a riskreduced relatively low discount rate. (continued on next slide)
Chapter 10 Forensic and Investigative Accounting 22 Discounting After-trial Damages Another approach is to project the hopedfor-but-lost amounts and then apply a higher discount rate that already includes risk or uncertainty in order to determine the present value. Chapter 10 Forensic and Investigative Accounting 23 ...
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