forensic and investigative accounting chapter 11 litigation support in special situations © 2013...

Forensic and Investigative AccountingForensic and Investigative Accounting

Chapter 11

Litigation Support in

Special Situations

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Chapter 11 Forensic and Investigative Accounting 2

Antitrust LawsAntitrust Laws

Antitrust laws are an outgrowth of the early Antitrust laws are an outgrowth of the early years of the Industrial Age in the United years of the Industrial Age in the United States when a small number of powerful States when a small number of powerful businessmen used any tactic at their disposal businessmen used any tactic at their disposal to force competitors out of business. Because to force competitors out of business. Because such business practices were not in the best such business practices were not in the best interest of the country, federal legislation was interest of the country, federal legislation was passed that prohibits the formation and passed that prohibits the formation and continuation of monopolies except when in continuation of monopolies except when in the best interest of the public.the best interest of the public.


Role of Accountants in Role of Accountants in Antitrust LitigationAntitrust Litigation

Accountants may be called upon to Accountants may be called upon to determine whether there is liability under determine whether there is liability under the antitrust laws. The primary issue that the antitrust laws. The primary issue that forensic accountants address is whether the forensic accountants address is whether the defendant has engaged in predatory pricing.defendant has engaged in predatory pricing.

After liability is proved in an antitrust case, After liability is proved in an antitrust case, then the forensic accountant will be asked then the forensic accountant will be asked to estimate damages.to estimate damages.


Predatory PricingPredatory Pricing

Predatory pricing is the act of pricing a Predatory pricing is the act of pricing a product so low that the only logical product so low that the only logical explanation is that the pricing is designed to explanation is that the pricing is designed to drive competitors out of business.drive competitors out of business.

The operational definition is whether a The operational definition is whether a company prices its products or services company prices its products or services below “average variable cost” and, if so, below “average variable cost” and, if so, predatory pricing is present.predatory pricing is present.


Cost Behavior DefinedCost Behavior Defined

In its simplest form, In its simplest form, cost behaviorcost behavior is is the way that cost(s) change with the way that cost(s) change with respect to changes in the volume of respect to changes in the volume of activity.activity.


Common Types of Cost BehaviorCommon Types of Cost Behavior

Fixed costsFixed costs Variable costsVariable costs Mixed costsMixed costs Semivariable costsSemivariable costs Semifixed costsSemifixed costs


Cost Behavior AssumptionsCost Behavior Assumptions

Basis of cost behavior estimatesBasis of cost behavior estimates– Relevant range assumptionRelevant range assumption– Time assumptionTime assumption

Ways of estimating cost behaviorWays of estimating cost behavior– Account analysis methodAccount analysis method– High-low methodHigh-low method– Regression analysisRegression analysis– Engineering or work-measurement Engineering or work-measurement

methodmethod

Reasons Why Managers Want to Know Reasons Why Managers Want to Know About Cost BehaviorAbout Cost Behavior PatternsPatterns

To use in many different types of cost-volume-profit To use in many different types of cost-volume-profit (CVP) analyses.(CVP) analyses.

For use in flexible (dynamic) budgeting activities.For use in flexible (dynamic) budgeting activities. For use in standard costing, in particular, MOH variance For use in standard costing, in particular, MOH variance

analysis.analysis. For use in determining Manufacturing Overhead (MOH) For use in determining Manufacturing Overhead (MOH)

application rates.application rates. For use in litigating or defending a wide variety of cost-For use in litigating or defending a wide variety of cost-

related legal issues:related legal issues:– Federal antitrust cases - predatory pricing.Federal antitrust cases - predatory pricing.– Alleged contractual violations.Alleged contractual violations.– Measurements of damages for lost sales/profits/etc.Measurements of damages for lost sales/profits/etc.

8IES-Tomkins College

Common Types Of Cost Behavior Common Types Of Cost Behavior

FIXED COSTSFIXED COSTS: : Costs that fundamentally are Costs that fundamentally are notnot driven by changes in volume. driven by changes in volume.

Y = Total CostY = Total Cost Y = Y = aa, where , where aa is the amount of fixed cost is the amount of fixed cost Common examples of fixed costs - Depreciation, Common examples of fixed costs - Depreciation,

Property taxes, Supervisor salariesProperty taxes, Supervisor salaries


Common Types Of Cost BehaviorCommon Types Of Cost Behavior

VARIABLE COSTSVARIABLE COSTS: : Costs that change directly Costs that change directly and proportionately with the volume of activity.and proportionately with the volume of activity.

Y = bX, where Y = bX, where bb is the slope of the line (the is the slope of the line (the increase in cost relating to the increase in volume) increase in cost relating to the increase in volume) and and XX is the measure of the volume of activity. is the measure of the volume of activity.

Common examples of variable costs - Direct Common examples of variable costs - Direct materials, Direct Labor, Sales Commissionsmaterials, Direct Labor, Sales Commissions



MIXED COSTS: MIXED COSTS: Costs that contain Costs that contain bothboth a a fixed and a variable component.fixed and a variable component.

Y = a + bX, Where Y = a + bX, Where aa equals the fixed equals the fixed component and component and bX bX is the variable is the variable component.component.

Common examples of mixed costs - Some Common examples of mixed costs - Some lease agreements, some utility costs, many lease agreements, some utility costs, many overhead costs.overhead costs.



SEMI-VARIABLE COSTS: SEMI-VARIABLE COSTS: Costs that change Costs that change but not proportionately with the volume of but not proportionately with the volume of activity.activity.

Learning curve costsLearning curve costs - are costs that increase at a - are costs that increase at a decreasing rate with the volume of activity.decreasing rate with the volume of activity.

When graphed, learning curve costs slope upward When graphed, learning curve costs slope upward and to the right but not in a straight line; Instead and to the right but not in a straight line; Instead they curve downward.they curve downward.



SEMI-FIXED COSTS: SEMI-FIXED COSTS: Costs that Costs that increase in steps or jumps. increase in steps or jumps.

Also called set function costsAlso called set function costs Some argue that all fixed costs are step Some argue that all fixed costs are step

function costs over the long runfunction costs over the long run


Cost Behavior AssumptionsCost Behavior Assumptions

Relevant RangeRelevant Range: : Cost behavior estimates are Cost behavior estimates are usually based on historical cost observations and usually based on historical cost observations and analyses. If cost behavior characteristics are analyses. If cost behavior characteristics are projected outside of the observed range of projected outside of the observed range of activities, the projections may not be accurate.activities, the projections may not be accurate.

Time assumptionTime assumption: : As time passes, the business As time passes, the business environment changes, and cost behavior may environment changes, and cost behavior may change as well.change as well.


Cost Behavior Estimation MethodsCost Behavior Estimation Methods

Most organizations have very little cost information that is Most organizations have very little cost information that is captured and reported by type of cost behavior pattern. In captured and reported by type of cost behavior pattern. In order to determine cost behavior characteristics, order to determine cost behavior characteristics, accountants must use a variety of methods to estimate cost accountants must use a variety of methods to estimate cost behavior patterns.behavior patterns.– EXPERIENCE: EXPERIENCE: Often a working knowledge of a firm’s Often a working knowledge of a firm’s

accounting system will provide some knowledge of the nature of accounting system will provide some knowledge of the nature of cost behavior in the firm’s accounting system.cost behavior in the firm’s accounting system.

– Merely trying to separate all current cost accounts into fixed and Merely trying to separate all current cost accounts into fixed and variable costs is usually not a very accurate method of estimating variable costs is usually not a very accurate method of estimating cost behavior.cost behavior.



PLOTTING COST DATA: PLOTTING COST DATA: “ “A picture is worth A picture is worth a 1,000 words”, is an old saying that has some a 1,000 words”, is an old saying that has some merit in describing cost behavior patterns.merit in describing cost behavior patterns.– It is really easy now to take accounting cost data and It is really easy now to take accounting cost data and

use many different software packages to plot data. use many different software packages to plot data. – The resulting graphs can provide a good idea of the The resulting graphs can provide a good idea of the

general nature of the cost volume relationships, general nature of the cost volume relationships, although precise descriptive cost models are not although precise descriptive cost models are not provided.provided.



HIGH-LOW METHOD:HIGH-LOW METHOD: The highest and lowest costs are identified along The highest and lowest costs are identified along

with their related volume levels. These are used to with their related volume levels. These are used to estimate fixed and variable costs:estimate fixed and variable costs:

Example:Example: Variable cost = Variable cost = $300,000 - $280,000 $300,000 - $280,000

100,000 un. - 90,000 un.100,000 un. - 90,000 un. = = $20,000$20,000 = $2.00 / unit = $2.00 / unit

10,000 un.10,000 un.



HIGH-LOW METHOD (cont.)HIGH-LOW METHOD (cont.)Fixed cost = $300,000 - (100,000 units x Fixed cost = $300,000 - (100,000 units x

$2.00 unit)$2.00 unit)

= $100,000= $100,000

Total cost = $100,000 + $2.00 XTotal cost = $100,000 + $2.00 X



REGRESSION/CORRELATION ANALYSISREGRESSION/CORRELATION ANALYSIS– An analytical tool for measuring the degree of An analytical tool for measuring the degree of

association between two or more variablesassociation between two or more variables..

It is a two-step process:It is a two-step process:– Regression measures the Regression measures the naturenature of the association of the association

between the variables.between the variables.

– Correlation measures the Correlation measures the strength strength of the association of the association between the variables.between the variables.


Regression/Correlation AnalysisRegression/Correlation Analysis

TYPES OF REGRESSIONTYPES OF REGRESSION:: Simple Linear Regression or Bi-Variate Simple Linear Regression or Bi-Variate

RegressionRegression– Two variables:Two variables:

» A dependent variable which is usually cost in our A dependent variable which is usually cost in our analyses.analyses.

» An independent variable or predictor variable which An independent variable or predictor variable which is usually the measure of the volume of activity in is usually the measure of the volume of activity in our analyses.our analyses.



A positive (+) value for A positive (+) value for bb indicates that the dependent and indicates that the dependent and the independent variables are positively correlated the independent variables are positively correlated (moving in the same direction). A negative (-) (moving in the same direction). A negative (-) bb value value indicates that the dependent and the independent variables indicates that the dependent and the independent variables are moving in opposite directions. (Example, and increase are moving in opposite directions. (Example, and increase in interest rates is related to a decrease in construction in interest rates is related to a decrease in construction costs.)costs.)

The The a a value indicates point where the regression line value indicates point where the regression line crosses the “Y” axis. What does a negative? positive? crosses the “Y” axis. What does a negative? positive? value for value for a a indicate?indicate?



The coefficient of determination measures the amount of The coefficient of determination measures the amount of explained variance (i.e. Of the total variance of the explained variance (i.e. Of the total variance of the dependent variable about its mean (average) value, the dependent variable about its mean (average) value, the amount of that variance that can be explained by changes amount of that variance that can be explained by changes in the volume of activity is measured by the coefficient of in the volume of activity is measured by the coefficient of determination.) For example, a coefficient of determination.) For example, a coefficient of determination of .84 or 84% means that 84% of the determination of .84 or 84% means that 84% of the dependent variable’s total variance can be explained by dependent variable’s total variance can be explained by changes in the volume of activity.changes in the volume of activity.

Association vs. Causation - Regression/correlation analysis Association vs. Causation - Regression/correlation analysis shows the degree of association between variables, but it shows the degree of association between variables, but it does not prove causation. does not prove causation.



Standard Error of the Estimate: Standard Error of the Estimate: Indicates the variability of the data used in Indicates the variability of the data used in the regression calculations. The greater the the regression calculations. The greater the variability of the data, the less precision that variability of the data, the less precision that results from estimates made from the results from estimates made from the regression data. regression data. – Point estimates are made and confidence Point estimates are made and confidence

intervals are used to achieve desired levels of intervals are used to achieve desired levels of precision.precision.

– tt-tables and -tables and zz tables: Used to provide desired tables: Used to provide desired precision levels.precision levels.


Using Regression Analysis for Using Regression Analysis for Damages in GeneralDamages in General

Virtually all cases in which liability is found Virtually all cases in which liability is found has a damages phase to the case.has a damages phase to the case.

Most scenarios require an analysis of what Most scenarios require an analysis of what would have happened absent the act that would have happened absent the act that caused the liability.caused the liability.– Regression analysis gives an expert a foundation Regression analysis gives an expert a foundation

from which to develop and support costs behavior from which to develop and support costs behavior assertions.assertions.

– There is a solid analysis approach which describes There is a solid analysis approach which describes the nature of the analysis so the expert can present the nature of the analysis so the expert can present his/her findings clearly to the jury/judge in order to his/her findings clearly to the jury/judge in order to gain support of the expert’s opinions. gain support of the expert’s opinions.



USING REGRESSION/CORRELATION USING REGRESSION/CORRELATION ANALYSISANALYSIS

MULTIPLE REGRESSIONMULTIPLE REGRESSION– More than one independent variable.More than one independent variable.– Most medical research uses multiple regression.Most medical research uses multiple regression.– Still one “a” value and “r” value.Still one “a” value and “r” value.



Reasons for the UnexpectedReasons for the Unexpected

Some of the accounting reasons that regressions may yield unexpected or perplexing results include:– When and how allocations are made.– The nature of transfer prices in an organization.– Entity concept: what part of the business is

involved in the case?– Accounting policies can make a big difference

in cost behavior analysis.Forensic accountants must be adequately informed about the nature and operation of the accounting system for each and every business that they are evaluating.


Federal False Claims ActFederal False Claims Act

The Federal False Claims Act was passed to The Federal False Claims Act was passed to protect the government from the unscrupulous protect the government from the unscrupulous acts of a few government contractors that acts of a few government contractors that intentionally or carelessly overcharge the intentionally or carelessly overcharge the government for goods or services.government for goods or services.


Federal False Claims Act LitigationFederal False Claims Act Litigation

Fraud allegations from audits or other sourcesFraud allegations from audits or other sources Fraud allegations from Whistleblower (relator) Qui tam Fraud allegations from Whistleblower (relator) Qui tam

suitssuits» Filed on behalf of the US GovernmentFiled on behalf of the US Government

Filed under seal along with a disclosure statement documenting the Filed under seal along with a disclosure statement documenting the alleged fraud(s)alleged fraud(s)

» The US Department of Justice (USJD) evaluates the claims and The US Department of Justice (USJD) evaluates the claims and decides whether to intervene in the casedecides whether to intervene in the case

» Once the USJD makes its decision, the case is unsealed and the Once the USJD makes its decision, the case is unsealed and the relator and the alleged issues in the case becomes known to the relator and the alleged issues in the case becomes known to the public and the defendant public and the defendant

– Reasons for bringing actionReasons for bringing action» Financial gainsFinancial gains» The right thing to doThe right thing to do» OtherOther


The Special Nature of Fraud in a The Special Nature of Fraud in a FFCA CaseFFCA Case

Under the Federal False Claims Act, a person acts Under the Federal False Claims Act, a person acts knowinglyknowingly with respect to information if the person has:with respect to information if the person has:

– Actual knowledge of information.Actual knowledge of information.– Acts in deliberate ignorance of the truth or falsity of the Acts in deliberate ignorance of the truth or falsity of the

information.information.– Acts in reckless disregard of the truth or falsity of the Acts in reckless disregard of the truth or falsity of the

information.information.In criminal fraud case the standard for conviction is In criminal fraud case the standard for conviction is “beyond a reasonable doubt”, but in a FFCA case the “beyond a reasonable doubt”, but in a FFCA case the standard is “preponderance of the evidence”standard is “preponderance of the evidence”

– The latter is a much lower hurdle to cross when trying to prove The latter is a much lower hurdle to cross when trying to prove fraud under the FFCAfraud under the FFCA


Accountants may act as an expert witness Accountants may act as an expert witness for the defense, the government, or a for the defense, the government, or a whistleblower litigating the qui tam parts of whistleblower litigating the qui tam parts of the case.the case.

The dynamics of FFCA cases can be quite The dynamics of FFCA cases can be quite different than typical cases.different than typical cases.

Accountants have a unique role to play in Accountants have a unique role to play in FFCA cases.FFCA cases.

Accountant’s Role in Federal False Accountant’s Role in Federal False Claims Act LitigationClaims Act Litigation



Typical questions that accountants help courts to answer Typical questions that accountants help courts to answer are:are:

– What costs should be included in the contract?What costs should be included in the contract?– How should costs be measured under the contract?How should costs be measured under the contract?– What is the correct timing of the costs and/or What is the correct timing of the costs and/or

revenues under the contract?revenues under the contract?– What accounting concepts, rules, etc., apply under What accounting concepts, rules, etc., apply under

this contract?this contract?– What is the magnitude of the damages that occurred What is the magnitude of the damages that occurred

because of the fraud that took place?because of the fraud that took place?



Under the Federal False Claims Act, a person Under the Federal False Claims Act, a person acts acts knowinglyknowingly with respect to information if the with respect to information if the person has:person has:

– Actual knowledge of information.Actual knowledge of information.

– Acts in deliberate ignorance of the truth or Acts in deliberate ignorance of the truth or falsity of the information.falsity of the information.

– Acts in reckless disregard of the truth or Acts in reckless disregard of the truth or falsity of the information.falsity of the information.

FFCA Case OutcomesFFCA Case Outcomes

““Fraud” as defined by the FFCA typically result in Fraud” as defined by the FFCA typically result in damages being tripled anddamages being tripled and– May result in the defendant no longer being able to contract May result in the defendant no longer being able to contract

with the Federal Governmentwith the Federal Government– Triple damages result because it is thought that if the court Triple damages result because it is thought that if the court

found some fraud damages there might well be other FFCA found some fraud damages there might well be other FFCA damages that were not uncovered and the triple damages are damages that were not uncovered and the triple damages are viewed as a deterrent to othersviewed as a deterrent to others

Simple contract damages are assessed if there was an Simple contract damages are assessed if there was an error in government billings but it did not rise to fraud as error in government billings but it did not rise to fraud as defined by the FFCAdefined by the FFCA

The impact on rewards to the WhistleblowerThe impact on rewards to the Whistleblower– Whistleblowers typically are rewarded for case issues in Whistleblowers typically are rewarded for case issues in

which the court find fraud under the FFCA guidelineswhich the court find fraud under the FFCA guidelines

Intellectual PropertyIntellectual Property

Intellectual property includes copyrights, patents, Intellectual property includes copyrights, patents, trademarks, trade secrets, business processes and trademarks, trade secrets, business processes and other intangible rights that are conveyed to owners other intangible rights that are conveyed to owners via laws and regulations.via laws and regulations.

Most intellectual rights are conveyed for a specified Most intellectual rights are conveyed for a specified period of time:period of time:– Patents are twenty yearsPatents are twenty years– Copyrights on property created after January 1, 1978 Copyrights on property created after January 1, 1978

are for the creators life plus 70 years. Companies hold are for the creators life plus 70 years. Companies hold copyrights for 95 to 120 years.copyrights for 95 to 120 years.

– Other intellectual property such as trademarks may Other intellectual property such as trademarks may have an indefinite lifehave an indefinite life


Enforcing Intellectual Property Enforcing Intellectual Property RightsRights

Because of the varying nature and related differing Because of the varying nature and related differing laws and regulations associated with intellectual laws and regulations associated with intellectual property, when intellectual property laws are property, when intellectual property laws are breeched the determination of damages can be breeched the determination of damages can be complexcomplex– Unlike tangible assets, intellectual property may be Unlike tangible assets, intellectual property may be

taken and used without the owner even knowing about taken and used without the owner even knowing about it for some timeit for some time

– Like damages in tangible property cases, intellectual Like damages in tangible property cases, intellectual property damages may include lost sales and lost property damages may include lost sales and lost profitsprofits

– In addition, there may be other damages such as loss of In addition, there may be other damages such as loss of reputation, lost company value and lost customersreputation, lost company value and lost customers


Assessing Damages in Copyright Assessing Damages in Copyright Infringement CasesInfringement Cases

In the United States, original works are instantly In the United States, original works are instantly copyrighted without the author doing anything except copyrighted without the author doing anything except putting the work into tangible form. putting the work into tangible form. – In a copyright infringement case, however, the author is on In a copyright infringement case, however, the author is on

much firmer ground if the copyright is “registered” with the much firmer ground if the copyright is “registered” with the U.S. GovernmentU.S. Government

– The owners of registered pacopyrights can seek “statutory The owners of registered pacopyrights can seek “statutory damages” which are set by lawdamages” which are set by law

– Statutory damages range for hundreds of dollars to Statutory damages range for hundreds of dollars to thousands of dollars per infringement regardless of the actual thousands of dollars per infringement regardless of the actual damages suffered in the casedamages suffered in the case

– If the copyright is not registered or statutory damages do not If the copyright is not registered or statutory damages do not apply, actual damages must be computed in much the same apply, actual damages must be computed in much the same fashion as other damage calculations in contract casesfashion as other damage calculations in contract cases


Common Issues in Proving or Common Issues in Proving or Defending Patent Infringement Defending Patent Infringement The Georgia-Pacific FactorsThe Georgia-Pacific Factors

– These are 15 different factors that the court These are 15 different factors that the court considered in measuring damages in the Georgia-considered in measuring damages in the Georgia-Pacific patent infringement casePacific patent infringement case

– These rules have been widely adopted in many These rules have been widely adopted in many other similar patent infringement cases by courtsother similar patent infringement cases by courts

The 25 percent rule– This rule was used by the courts to assess damages

in patent infringement cases, but federal courts are no longer using this rule in cases


Common Issues in Proving or Common Issues in Proving or Defending Patent InfringementDefending Patent Infringement Cost of next best alternative refers to the Cost of next best alternative refers to the

application of opportunity cost to measure application of opportunity cost to measure damages in a patent infringement casedamages in a patent infringement case– This approach has a simple and logical basis, but This approach has a simple and logical basis, but

sometimes it is very difficult to identify and cost sometimes it is very difficult to identify and cost the next best alternativethe next best alternative

Running Royalty vs. Upfront Payments refers Running Royalty vs. Upfront Payments refers to the need to evaluate the total royalty to the need to evaluate the total royalty package in assessing damagespackage in assessing damages– If there are significant upfront royalty payments, If there are significant upfront royalty payments,

those amounts should be allocated over the life of those amounts should be allocated over the life of the patent agreementthe patent agreement


Common Issues in Proving or Common Issues in Proving or Defending Patent InfringementDefending Patent Infringement Cost of Designing AroundCost of Designing Around

– It is perfectly legal to design around a patent It is perfectly legal to design around a patent (that is to “invent a different item that is (that is to “invent a different item that is designed to replace the item covered by the designed to replace the item covered by the patent)patent)

– In doing so, the new inventor must be carful not In doing so, the new inventor must be carful not to infringe on any part of the patent or other to infringe on any part of the patent or other intellectual property item covered by the patentintellectual property item covered by the patent


Common Issues in Proving or Common Issues in Proving or Defending Patent InfringementDefending Patent Infringement Anti-Trust IssuesAnti-Trust Issues

– Patent laws and other intellectual property laws and Patent laws and other intellectual property laws and regulations are designed to provide a limited “monopoly” to regulations are designed to provide a limited “monopoly” to those holding the rights to patents, copyrights, trademarks, those holding the rights to patents, copyrights, trademarks, etc.etc.

– However, the government has strong anti-trust laws that are However, the government has strong anti-trust laws that are designed to encourage fair competitiondesigned to encourage fair competition

– Many Patent Infringement cases have anti-trust issues in Many Patent Infringement cases have anti-trust issues in which plaintiffs contend that the intellectual property rights which plaintiffs contend that the intellectual property rights holders have exceeded the protection offered under the law holders have exceeded the protection offered under the law and are in fact engaged in anti-trust activityand are in fact engaged in anti-trust activity

– Courts attempt to identify the fine line between these two Courts attempt to identify the fine line between these two positions and rule in a way that protects both components of positions and rule in a way that protects both components of the lawthe law


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