Joe Epps 2013-03-06 00:14:51
“But For” Lost Income Damages – An Accounting Perspective Joe Epps is a CPA and CFE with over 30 years of experience in forensic accounting. His litigation support experience includes contract disputes, anti-trust, economic damages, fraud investigations, business valuation and intellectual property litigation. Joe is currently president of Epps Forensic Consulting and teaches a graduate course on forensic accounting at Arizona State University. For more information, please call (480) 595-0943 or visit www.eppsforensics.com. When a business is impacted by a “Triggering Event” such as a fire, storm, or breach of contract, for example, accountants are often asked to verify the amount of lost income sustained as a direct result of that event. One common method of calculating damages of this type is the “But For” method. The “But For” method requires the accountant to make a projection of the revenues, expenses, and resulting net profit that would likely have been earned during a specific period of time if the triggering event had not occurred; or “But For” the triggering event. The “But For” projections are then compared to the actual results achieved by the business during that same time period to identify the difference between the “But For” projections and the actual results; this difference represents the potential amount of lost income damages sustained due to the triggering event. It may seem that the comparison of the “But For” projections and the actual results is just a mathematical process, but that ignores the nuances associated with the analysis. When comparing the projected revenues, expenses and profits to the actual results, care must be taken to analyze whether those differences are only a result of the triggering event. There are many types of differences which are not related to the triggering event. For example, a new union contract increases wages during the post-event period. In this situation, wages may increase above historical trends and that increase would have nothing to do with the triggering event. Such an occurrence may only become apparent when analyzing the cause of the differences. In this case, the accountant might go back and change the projection to factor in the increase. The key point is that a proper analysis does not merely take the difference between projected and actual as being the lost income due to the triggering event, the accountant should analyze the differences in revenues and expenses to develop some basis for concluding that such differences are due only to the triggering event. The “But For” method of calculating lost income damages requires making projections. Those projections must be supported by documentation and data to render the projections probable, not speculative. This means that the accountant cannot guess, or speculate, when making the projections. One way to avoid speculation is to make use of the actual historical results of the business and build projections which reflect a combination of the business’s historical results and trends coupled with the expected impact of both internal and external current factors and circumstances (outside of the triggering event). Examples of internal factors which may impact the projections include the loss of a key employee, addition of a new product line, or a gain or loss of a significant client or contract just prior to the triggering event. These internal factors may result in either an increase or a decrease in the projections, relative to the historical trends. Example external factors potentially might include recent changes in general economic conditions, new sources of competition, or changes in critical technology. Note that in all of the examples cited above, one ingredient is that the identified factors arose either shortly prior to the triggering event or in the period after the triggering event during which the damages are being calculated. If a key customer was lost a full year prior to the triggering event, for example, the impact of that lost customer may be fully included in the historical trend. However, if the customer was lost only a month prior to the triggering event, the full impact has not been included in the historical trend. Projections may differ from the historical trends. The key to using projections that differ from historical trends is the presence of a solid foundation for the difference. Historical results of a company are recorded fact and so should be a primary, but certainly not the only, factor. However, almost any projection must include some amount of estimate and/or assumption. Even if the projection is fully based on the historical trends, there is an implicit assumption that the trends will extend into the future. Accepted accounting practices for lost income damages are that if projections are to differ from historical trends and the basis for such differences are not adequately supported, they should not be applied. The “But For” method for determining economic damages due to lost income is a generally accepted method. However, this method must be supported with adequate documentation and applied with care and thoughtful consideration of all the factors which should be included in creating the critical projections and in analyzing the results.
Published by Target Market Media . View All Articles.
This page can be found at http://digitaleditions.walsworthprintgroup.com/article/FORENSIC+ACCOUNTING/1337142/149408/article.html.