October 2006 Newsletter

Objecting to the CPA Expert Witness

Customarily, opposing counsel checks the credentials of the CPA expert. The lack of proper licensing will likely be brought forward with regard to the admissibility or weight of the CPA’s testimony. In checking credentials, be mindful there exists in general a trend by individual states to restrict CPA practice within the state to those specifically licensed by that state. During August of this year, the Texas State Board of Public Accountancy issued a staff opinion that deserves recognition. The Board was asked whether a CPA licensed in Florida and testifying in Texas as an “accountant” who is “asserting an expertise in accounting or auditing” would violate the Rules of the Texas State Board of Public Accountancy, subjecting the Florida CPA potentially to disciplinary action by the Texas State Board.

The staff opinion letter on this issue requires out-of-state CPAs to prove substantial equivalence with the Texas licensing requirements and to notice the Texas State Board under 22 Tex. Admin. Code §§ 513.5 and 512.2. Colorado, Puerto Rico, Delaware, Vermont, Florida, the U. S. Virgin Islands and New Hampshire do not meet substantial equivalence with Texas and the other states according to the opinion and http://www.nasbatools.com/display_page?id=105.

Most importantly, the staff opinion states: “. . . a CPA licensed in Florida, who has not received authorization to practice in Texas from the Texas State Board of Public Accountancy, should not be allowed to testify as an expert witness in a Texas Legal proceeding concerning methods or practices in the valuation of corporate stock, nor rebut the expert witness testimony of CPA licensed in Texas.”

Conversely, we urge attorneys to confirm a Texas CPA testifying in another state has met that state’s temporary licensing requirements.

Please contact Jesse Daves regarding the staff opinion letter.

GAAP and Fair Value

FAS 157 is a new GAAP pronouncement defining “fair value” that offers assistance toward defining fair value according to GAAP.. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the principal (or most advantageous) market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. Therefore, the definition focuses on the price that would be received to sell the asset or paid to transfer the liability at the measurement date (an exit price), not the price that would be paid to acquire the asset or received to assume the liability at the measurement date (an entry price). Note the requirement to use the measurement date, not a date in the future; i.e. what is it worth today.

This Statement emphasizes that fair value is a market-based measurement, not an entity-specific measurement. This Statement clarifies that market participant assumptions also include assumptions about the effect of a restriction on the sale or use of an asset. A fair value measurement for a restricted asset should consider the effect of the restriction if market participants would consider the effect of the restriction in pricing the asset.

This Statement affirms the requirement of other FASB Statements that the fair value of a position in a financial instrument (including a block) that trades in an active market should be measured as the product of the quoted price for the individual instrument times the quantity held. The quoted price should not be adjusted because of the size of the position relative to trading volume (blockage factor).

The guidance in this Statement applies for derivatives and other financial instruments measured at fair value under Statement 133 at initial recognition and in all subsequent periods. Therefore, this Statement nullifies the guidance in footnote 3 of EITF Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.”

Cooking the Books – Common Recipes

At the recent AICPA National Conference on Fraud and Litigation Services a representative of the FBI presented on the financial fraud in smaller companies. Within your company or that of your clients, be mindful of the following schemes:

Parked Inventory Sales – Recording sales for goods shipped to a site (warehouse, parking lot) controlled by the seller to provide the appearance a valid sale occurred.

Swap Transactions – a scheme in which two conspiring companies exchange payments and services solely for the purpose of inflating revenues.

Channel Stuffing – overselling products to conspiring companies exchange payments and services solely for purpose of inflating revenues.

Side Deals – an arrangement in which the buyer of goods is given the right to cancel the sales contract, return products or received rebates in future periods. Although the sale is booked, the side deals are hidden from auditors.

Capitalizing Expenses – the improper reclassification of an expense to an asset. This scheme is typically conducted through a series of journal entries at the end of a fiscal period in order to inflate the financial statements.

Deferred Expenses – recording expenses applicable to the current fiscal period at some date in the future. Typically, this scheme continues to perpetuate itself in future periods.

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