Commercial litigation often necessitates the use of a financial expert to value a business interest, calculate economic damages or investigate fraud allegations. In these situations, the quality of the numeric data that's available to the financial expert can affect both the amount of investigation that the expert must put into the engagement and the reliability of his or her opinions.
Varying Levels of Assurance
The quality of financial information can span a wide range — from a company that generates only tax returns to a business with audited financial statements that conform to U.S. Generally Accepted Accounting Principles (GAAP). Larger companies tend to have audited financial statements because it's required by investors or lenders. In turn, companies with audited financial statements usually have strong internal controls and formalized accounting systems. For litigation matters, this means that the financial expert will be able to access information that's unavailable — or not as readily available — for a company without audited financial statements.
At the other end of the financial reporting spectrum is a company that uses only tax returns for its financial recordkeeping. In such situations, it's important for the attorney and financial expert to develop a plan to assess what additional information the expert will need to perform his or her analyses and develop reliable conclusions.
The client should also be made aware of the situation. A lack of quality information can impact both sides of the case. If a company is unable to produce reliable records, it could impair your financial expert's ability to render reliable conclusions.
Remedying Data Deficiencies
Sometimes the opposing side has lax financial reporting. When this happens, the attorney and expert should document any deficiencies in the financial data and any attempts to reduce those deficiencies, including information requests, interrogatories and depositions. If the deficiencies can't be fully remedied, then the expert needs to document in his or her workpaper files what was done to arrive at the opinions — and why the expert believes the conclusions have been obtained with reasonable certainty.
Financial experts can help prepare information requests and interrogatories. They can also be valuable assets in depositions. Always keep the client apprised of the situation regarding the lack of quality of information, what's being done about it and the potential risks to the case because of the situation.
Identifying Deficiencies Early
The quality of financial reporting is a subject that attorneys and financial experts should discuss early on in litigation support engagements. It can impact not only on the level of investigation and the reliability of an expert's conclusions, but financial reporting quality can also affect the cost of the work to be done by the financial expert. So, the attorney should be fully aware of these issues before the financial expert commences work on the engagement.
GAAP Is Optional for Private Companies
In 2013, the American Institute of Certified Public Accountants (AICPA) introduced its Financial Reporting Framework for Small and Medium Sized Businesses. This special purpose reporting framework provides an option for small and mid-sized privately held businesses to prepare financial statements for both internal and external purposes that don't comply with U.S. Generally Accepted Accounting Principles. However, the AICPA contends that statements under the new framework do provide the following characteristics:
1. Objectivity. The framework is free from bias.
2. Measurability. It permits reasonably consistent measurements.
3. Completeness. It's sufficiently complete so that relevant factors that would alter a conclusion about the financial statements aren't omitted.
4. Relevance. It's relevant to financial statement users.
The advent of this framework highlights the varying quality of the financial reporting practices of private businesses that may be involved in litigation.
LOUIS J. CERCONE, JR., CPA, CFE, CFF, ABV, ASA, CVA
Lou is the Managing Director of Brisbane Consulting Group in charge of business valuations, forensic accounting, and litigation support services. He has extensive valuation experience and has served as a financial consultant and expert to attorneys in the economic aspects of matrimonial dissolution. He has been engaged in several forensic accounting cases and has served the judiciary as a court appointed expert and receiver for financially troubled companies. He has testified as an expert witness in State Supreme Court and Federal Court. Lou has also been engaged in the quantification of lost income in determining business interruption claims for insurance adjusters.