Avoid These Accounting Expert Problems

The following hypothetical example illustrates the practical need to avoid violations of accounting standards.

By Jeff Compton and Laura Giese
September 08, 2014
Originally published in Texas Lawyer.

The Texas State Board of Public Accountancy rules provide standards to be followed by certified public accountants testifying as expert witnesses. These rules are also published by the American Institute of Certified Public Accountants as the Statement on Standards for Consulting Services No. 1, applicable to litigation services generally, and the Statement on Standards for Valuation Services No. 1, applicable to valuation services specifically.

The following hypothetical scenario illustrates the practical need to avoid violating these standards.

Having been called as the last witness for the plaintiff, Bob was sworn in. He proceeded to tell the jury his qualifications as an independent CPA who did some bookkeeping work for Acme and to explain his opinion regarding the lost profits of his client. Bob described how the sales manager of Acme had left, taking key customers with him. Bob explained he had been asked by Acme’s president, based upon his prior accounting services for Acme, to calculate the lost profits from the misappropriation of trade secrets by the former sales manager. Bob said he calculated the lost profits of Acme as its expected sales to the lost customers less the expected cost to purchase the goods Acme sold to those customers. Bob presented his lost profit figure and testified it was reasonably certain and in accordance with the relevant professional standards.

Bob had also been asked to calculate the lost value of Acme which he did by multiplying its lost profits by a factor of five. According to Bob, he and the president of Acme decided this was the appropriate approach.

The defendant’s cross examination began with asking Bob about his experience calculating lost profits arising from trade secret claims. Bob candidly explained he had not done so before. Defense counsel then handed Bob a copy of the Statement on Standards for Consulting Services No. 1 and the rules of the Texas State Board of Public Accountancy and asked if there was a competence requirement and what it meant. Bob confirmed there was such a requirement and agreed it meant mastering the techniques needed for the calculation and that such proficiency was usually acquired through relevant experience and training.

Defense counsel followed up by exploring Bob’s understanding of mitigation and whether a new sales manager had been hired, which had mitigated the losses by bringing new customers. Bob conceded he did not know about the new sales manager and had not thought to consider mitigation. Bob had to admit mitigation should have been considered. Questioning about competence continued with challenges to the method Bob used to discount the lost profits to a present value contrasted with the method consistently used in three texts Bob acknowledged as authoritative in the area of discounted cash flows.

Moving on, the defense counsel asked Bob what due professional care meant to him. Bob wasn’t sure, so counsel referred him again to the standard along with the rules, and Bob agreed it meant being careful in his calculations. Upon further questioning, Bob acknowledged no one had checked his calculations, neither in his office nor at the client office. Bob seemed genuinely surprised to learn the second largest lost customer had not actually been lost to the former sales manager but had gone out of business the same month the sales manager left. Bob’s surprise increased visibly when he was shown the deposition of the Acme president acknowledging this fact.

The next line of questioning had to do with the costs of the lost sales and sufficient relevant data. Bob had obtained these cost figures over the phone from the new sales manager. Defense counsel showed Bob invoices from the vendors for the goods which were significantly more costly than the figures obtained over the phone. Going again to the standard and rules at the request of counsel, Bob read: “A person shall obtain and maintain appropriate documentation to afford a reasonable basis for conclusions.” Bob agreed he did not have the documents he needed.

With regard to the lost profits, the final questions involved planning and supervising the work Bob did. Bob agreed there were things he would do differently next time, acknowledging this to be a requirement of the standards and rules.

To begin the questioning about the lost value of Acme, defense counsel referred Bob back to the competence requirement, asking Bob to show lost profits and lost value were not duplicative; Bob said he did not know how to do so. Discussion then turned to the Statement on Standards for Valuation Services No. 1 and its adoption under the Texas State Board Rules. Bob was given time to read the standard which he used, quietly reading, until interrupted by a question regarding his compliance with the standard. Bob said it looked like there were many specific requirements among the 79 numbered paragraphs he could not say he had followed or should have followed in arriving at a calculated lost value for Acme.

At the conclusion of the trial, the plaintiff’s counsel and the president of Acme reviewed how their decision to employ Bob had been motivated by his loyalty to Acme and his billing rate which was well below that of accountants experienced in the areas of litigation consulting and valuation. In hindsight, they wished knowledge of relevant professional standards had played the key role in their decision.