March 2008 Newsletter
Sources of Electronic Stored Information: Voice Mail
When you think of electronic evidence for discovery or internal investigations, the focus tends to be on email for reconstruction of historical events. However there are other sources that offer a potential gold mine of evidence, such as digital voice mail systems. Today, many offices are using voice over internet protocol (VOIP) for their telephone systems. A VOIP system is nothing more than a computer based telephone operator and repository for voice mail messages. Like a computer, when a voice mail is deleted it isn’t really deleted. The file is merely hidden from the review menu and the space is marked as available for the next time the drive needs somewhere to write a file. How quickly that message will be overwritten depends on the size of the hard drive in your system and the volume of calls.
On a recent case for a busy mid-size office, we were able to recover voice mail messages dating back to 2003 when the system was installed, including the key messages that the client was looking for. If you are interested in using voicemail as part of your investigative efforts please call or email Paul Price at (713) 351-7150 or firstname.lastname@example.org for additional information.
Fiduciary Duty and the CPA
While not defining fiduciary duty, we note the Rules of Professional Conduct of the Texas State Board of Certified Public Accountants provides under Rule 501.90 Discreditable Acts, “A person shall not commit any act that reflects adversely on his fitness to engage in the practice of public accountancy. A discreditable act includes but is not limited to . . . fiscal dishonesty or breach of fiduciary responsibility of any type . . . voluntarily disclosing information communicated to the person by an employer, past or present, or through the person's employment in connection with accounting services rendered to the employer, except: by permission of the employer; pursuant to the Government Code, Chapter 554 (commonly referred to as the "Whistle Blowers Act"); pursuant to a subpoena or other compulsory process; in an investigation or proceeding by the board under the Public Accountancy Act; or in an ethical investigation conducted by a professional organization of certified public accountants.”
While not addressing CPA’s, there’s a helpful discussion of the fiduciary relationship in Navigant Consulting Inc. v. John Wilkinson; Sharon Taulman (5th Circuit No. 06-11071, 11/15/07). The opinion addresses employees leaving a firm and attempting to sell part of their employer’s business.
Liquidity and Marketability
Liquidity means the ability the turn an asset into cash while marketability means the ability to sell an asset. Financial Valuation and Litigation Expert (www.valuationproducts.com) contains a very informative article in its February/March 2008 issue describing the need to distinguish between these characteristics when valuing an asset. Among the points to consider when reading a valuation should be whether the distinction between marketability and liquidity has been made correctly because it affects the selection of discount; for example, a control interest in a private company is marketable but not liquid and a non-control interest in a private company is both not marketable and not liquid. The current thinking about marketability of control interests in private companies seems to be that the transaction costs of sale are the liquidity discount, with no marketability discount applying.
Discount rates for businesses appear at times understated in lost profit calculations, especially those prepared by economists addressing small businesses. Both finance and valuation textbooks explain the positive correlation of the discount rate to the uncertainty of returns such as cash flows. The uncertainty of achieving specific cash flows goes up as the size of the subject company gets smaller, everything else being equal. An extensive survey of current research on this subject has been prepared by Roger Grabowski of Duff & Phelps LLC (email@example.com).
Legal Liability/Accounting Liability
Accounts payable and other liability accounts form part of every general ledger. Accountants routinely determine the existence and amount of liabilities without reference to the legal concept of liability. In analyzing the legal concept of liability, the accounting concept of liability and the fact of recording an accounting liability may facilitate the analysis.
The accounting concept of liability may be found in Financial Accounting Concept Number 6, paragraphs 35 et seq.:
35. Liabilities are probable 21 future sacrifices of economic benefits arising from present obligations 22 of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
CON6, Footnote 21--Probable is used with its usual general meaning, rather than in a specific accounting or technical sense (such as that in Statement 5, par. 3), and refers to that which can reasonably be expected or believed on the basis of available evidence or logic but is neither certain nor proved (Webster's New World Dictionary, p. 1132). Its inclusion in the definition is intended to acknowledge that business and other economic activities occur in an environment characterized by uncertainty in which few outcomes are certain (pars. 44-48).
CON6, Footnote 22--Obligations in the definition is broader than legal obligations. It is used with its usual general meaning to refer to duties imposed legally or socially; to that which one is bound to do by contract, promise, moral responsibility, and so forth (Webster's New World Dictionary, p. 981). It includes equitable and constructive obligations as well as legal obligations (pars. 37-40).
More of the definition follows below:
Characteristics of Liabilities
36. A liability has three essential characteristics: (a) it embodies a present duty or responsibility to one or more other entities that entails settlement by probable future transfer or use of assets at a specified or determinable date, on occurrence of a specified event, or on demand, (b) the duty or responsibility obligates a particular entity, leaving it little or no discretion to avoid the future sacrifice, and (c) the transaction or other event obligating the entity has already happened. Liabilities commonly have other features that help identify them—for example, most liabilities require the obligated entity to pay cash to one or more identified other entities and are legally enforceable. However, those features are not essential characteristics of liabilities. Their absence, by itself, is not sufficient to preclude an item's qualifying as a liability. That is, liabilities may not require an entity to pay cash but to convey other assets, to provide or stand ready to provide services, or to use assets. And the identity of the recipient need not be known to the obligated entity before the time of settlement. Similarly, although most liabilities rest generally on a foundation of legal rights and duties, existence of a legally enforceable claim is not a prerequisite for an obligation to qualify as a liability if for other reasons the entity has the duty or responsibility to pay cash, to transfer other assets, or to provide services to another entity.
37. Most liabilities stem from human inventions—such as financial instruments, contracts, and laws—that facilitate the functioning of a highly developed economy and are commonly embodied in legal obligations and rights (or the equivalent) with no existence apart from them. Liabilities facilitate the functioning of a highly developed economy primarily by permitting delay—delay in payment, delay in delivery, and so on.
38. Entities routinely incur most liabilities to acquire the funds, goods, and services they need to operate and just as routinely settle the liabilities they incur. For example, borrowing cash obligates an entity to repay the amount borrowed, usually with interest; acquiring assets on credit obligates an entity to pay for them, perhaps with interest to compensate for the delay in payment; using employees' knowledge, skills, time, and efforts obligates an enterprise to pay for their use, often including fringe benefits; selling products with a warranty or guarantee obligates an entity to pay cash or to repair or replace those that prove defective; and accepting a cash deposit or prepayment obligates an entity to provide goods or services or to refund the cash. In short, most liabilities are incurred in exchange transactions to obtain needed resources or their use, and most liabilities incurred in exchange transactions are contractual in nature—based on written or oral agreements to pay cash or to provide goods or services to specified or determinable entities on demand, at specified or determinable dates, or on occurrence of specified events.
40. Similarly, although most liabilities stem from legally enforceable obligations, some liabilities rest on equitable or constructive obligations, including some that arise in exchange transactions. Liabilities stemming from equitable or constructive obligations are commonly paid in the same way as legally binding contracts, but they lack the legal sanction that characterizes most liabilities and may be binding primarily because of social or moral sanctions or custom. An equitable obligation stems from ethical or moral constraints rather than from rules of common or statute law, that is, from a duty to another entity to do that which an ordinary conscience and sense of justice would deem fair, just, and right—to do what one ought to do rather than what one is legally required to do. For example, a business enterprise may have an equitable obligation to complete and deliver a product to a customer that has no other source of supply even though its failure to deliver would legally require only return of the customer's deposit. A constructive obligation is created, inferred, or construed from the facts in a particular situation rather than contracted by agreement with another entity or imposed by government. For example, an entity may create a constructive obligation to employees for vacation pay or year-end bonuses by paying them every year even though it is not contractually bound to do so and has not announced a policy to do so. The line between equitable or constructive obligations and obligations that are enforceable in courts of law is not always clear, and the line between equitable or constructive obligations and no obligations may often be even more troublesome because to determine whether an entity is actually bound by an obligation to a third party in the absence of legal enforceability is often extremely difficult. Thus, the concepts of equitable and constructive obligations must be applied with great care. To interpret equitable and constructive obligations too narrowly will tend to exclude significant actual obligations of an entity, while to interpret them too broadly will effectively nullify the definition by including items that lack an essential characteristic of liabilities.
Transactions and Events That Change Liabilities
41. Liabilities of an entity are changed both by its transactions and activities and by events that happen to it. The preceding paragraphs note most major sources of changes in liabilities.
An entity's liabilities are also sometimes affected by price changes, interest rate changes, or other events and circumstances that may be partly or wholly beyond the control of an entity and its management.
42. Once incurred, a liability continues as a liability of the entity until the entity settles it, or another event or circumstance discharges it or removes the entity's responsibility to settle it.
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