16
Remediation and Litigation Advisory Services

Supporting the criminal and civil litigation process is one aspect of remediation. This chapter examines that process, as well as the other two principal elements of remediation: recovery of money and other assets and restructuring the internal control environment. The modules along with the learning objectives for this chapter include the following:

  • Module 1 provides an overview of the remediation process and has one overarching objective—to describe the specific elements of remediation: asset recovery, litigation support, and reviewing the internal control structure and weaknesses that may have led to the issue under examination.
  • Module 2 dives deeper into recovering cash losses and other assets. The goal of Module 2 is for readers to be able to articulate the essentials of asset recovery along with many of the tools and techniques used in the process.
  • Module 3 examines the litigation process—civil and criminal—with an extensive review of oral and written communications. Supplemental to the chapter materials are four sample reports: fraud and financial crimes, commercial damages/lost profits, a valuation engagement, and a personal injury examination. The learning outcomes for Module 3 include the ability to identify major techniques associated with communications during civil and criminal examinations.
  • Module 4 considers the need to complete root cause analyses with the goal of preventing or deterring future, similar issues. The objective of module 4 is for the reader to examine the internal control environment in place at the time the issue arose and offer modifications and improvements to prevent or deter similar events in the future.

Module 1: Introduction to Remediation

The fraud examiner or forensic accountant has finished the examination. The investigator knows who did what to whom, when, where, how, and possibly why, and they have documented their findings; so their work is now done, correct? Not quite. What about a civil litigation case, a breach of contract, valuation dispute, or loss of employment income? The analyses are done, the assertions tested, the amounts estimated—all grounded in the evidence? Is the work done? Again, not quite. The fraud and forensic accounting professional still has a few remaining obligations in the remediation process. Remediation is characterized as the steps necessary to “clean up the mess” after a fraud, financial crime, or civil dispute has been discovered and examined, and the examination results have been prepared.

First, and perhaps most important to the litigants or victims, the forensic accountant plays an integral role in the recovery of money and assets.

Second, the fraud examiner or forensic accountant should support the client through the litigation process. This may include writing a report, preparing to testify, attending hearings and depositions, and completing other work on an as-needed basis.

Third, the forensic accountant or antifraud professional should return to the “scene of the crime” to determine how the offense was committed and how to prevent or deter its recurrence. Even in the case of civil dispute, what compliance breakdowns occurred? Are they a one-off issue or did systemic issues cause the dispute, and could similar disputes be possible in the future? If the issue was employee theft: Was there a breakdown of internal controls? How did the perpetrator misappropriate the assets? How were the acts concealed? If it was a civil litigation matter (such as discrimination, wrongful firing, personal injury, breach of contract, or tortuous interference), how did it occur? Where was the procedural or operational breakdown? How do we ensure that it does not occur in the future?

Finally, if the issue was financial statement fraud: Where was the deficiency in corporate governance?

Was management override involved? Collusion? A simple control deficiency in design or operation? How was the fraud hidden from the audit committee, auditors, and board of directors?

The examination process from initial red flags through deposition and courtroom testimony provides an excellent foundation for developing a knowledge repository for sharing lessons learned.

Module 2: Recovery of Money and Other Assets

Some fraud victims undertake a thorough investigation from initial symptoms through litigation based on principle, whereas others consider the cost–benefit aspect of the fraud examination. In other words, assuming that the examiner identified the perpetrator(s) and has evidence of the act, concealment, and conversion, is there likely to be any money in it for those injured? More simply stated, can the victim recover any money or other assets from the perpetrator? Why should the victim spend significant funds litigating a civil dispute, if a successful verdict is likely to result in no recovery of funds for the victim(s)? In fact, the possibility of loss recovery might be the only aspect of a fraud examination that is attractive to the victim.

Certainly, the examination process requires significant resources and is both taxing and time consuming. Antifraud and forensic accounting professionals would like their work product to be a resource that the client can use to obtain the largest recovery allowed by the evidence and the law. Of course, if the work was done to support a civil action, then recovery was the primary motive from inception. The plaintiff always has at least some focus on amounts to be recovered as a result of the perpetrator’s action.

If the evidentiary support is significantly in favor of the prosecution (plaintiff), then the claimant approaches the recovery stage in a position of relative power. Certainly, upon winning a civil action, the plaintiff is in the strongest position to collect. But even pretrial, civil attorneys for both the plaintiff and defense are constantly weighing the evidence and the relative positions of the parties to determine the optimal negotiating and potential courtroom strategy. Keep in mind that a favorable verdict for the plaintiff in a civil case is only a necessary first step in the recovery process; it requires additional action to collect amounts awarded.

The types of monetary remuneration that may be available to victims and plaintiffs include the following:

  • Money stolen
  • Other assets stolen
  • Value lost Interest
  • Fines and penalties
  • Punitive damages

Normally, some of the issues to consider when attempting to recover assets include the following:

  1. Amounts stolen and amounts that may be recovered
  2. The prospect of winning the case
  3. The value of the assets held by the defendant and whether they are sufficient
  4. The legal costs involved in pursuing the financial claim and subsequent collection

In addition, a multidisciplinary approach should be considered. For example, the fraud examiner or forensic accountant may need to obtain the assistance of individuals with international banking experience to trace money around the world, a private investigator to conduct surveillance, or an expert with knowledge of offshore banking techniques used to launder money and hide assets. Finally, claimants (victims and plaintiffs) should be proactive rather than reactive when it comes to the recovery of money and other assets.

Identification of Money and Assets for Recovery

The first step to successfully recover money and other assets is to identify them during the examination process. To prove fraud, the investigator needs to provide evidence that the perpetrator was involved in the act (money or other assets are missing), the concealment (there was an attempt to hide the act and possibly the assets), and the conversion (benefits accrued to the perpetrator). Inherently, the examination process requires that the fraud examiner or forensic accountant is able to show that the perpetrator was the recipient of assets and what, if anything, the perpetrator did with those assets.

As noted in prior chapters, this requires access and evaluation of banking, public, business, and personal records—financial and nonfinancial. The identification of money, assets, and other items of value obtained directly or indirectly as a result of fraud is one of the important goals of the examination. Such evidence not only facilitates the legal process but also helps to ensure the maximum recoverable amounts for the victim or plaintiff. One aspect of a civil action is that the jury will often be required by the presiding judge to consider the defendant’s ability to pay. If the defendant loses the civil issue in question, will they be able to pay the full amount of the award of damages or some lesser amount?

Generally, in order to be in a position to recover money from a civil suit, the injured party must prove two points:

  1. Liability: the defendant was responsible for all or part of the damages claimed.
  2. Losses or damages: the claimant suffered damages as a result of the actions or inactions of the offending party.

The types of losses available for recovery include (a) compensatory damages and restitution of losses such as value, cash, and other assets; (b) economic losses (e.g., wages, incremental expenses, or profits); (c) reliance, intended to restore the claimants back to where they would have been but for the actions of the defendant; and (d) punitive damages, to punish the defendant.

In a civil framework, the plaintiff must demonstrate three attributes:

  1. That the defendant was the proximate cause of any damages, meaning that the plaintiff caused or contributed to the lost amounts as a direct result of the conduct at issue
  2. Reasonable certainty as to the amounts (damages) claimed
  3. That the defendant could reasonably foresee that his or her actions, or lack thereof, were likely to result in damages to the plaintiff

“Following” versus “Tracing” the Money

“Following the money” and “tracing the money” are slightly different activities and may have legal ramifications on amounts available for recovery. Following the money assumes an ability to directly track funds from the victim to the alleged perpetrator and involves specificity, whereby the investigator can track the exact assets in question from the plaintiff or victim to the defendant. When an investigator can follow the money with specificity, the ability of a victim or plaintiff to lay claim to the ill-gotten gains may determine the likelihood of asset recovery. Cash or other assets can only be followed if those assets remain in their original, identifiable form as they flow from place to place or person to person. Following provides for no exchanges or substitutions. Note that some cryptocurrencies, Bitcoin, for example, permit following the money with specificity due to their underlying technology—blockchain.

In many cases, defendants will convert their ill-gotten gains into another type of asset. The whole purpose behind money laundering is to take money derived from some illegal activity and “clean” it to make it appear to have come from a legitimate source. Once illegal money has been combined with money from legitimate sources, typically, one can no longer follow the money; rather, the money can be traced.

In contrast to following the money, tracing the money is a process of identifying both its present location and its current form of value relevant to the claim brought by the plaintiff or victim. In such cases, the legal issues can become challenging. For example, what if illegal money has been combined in a bank account with the legitimate salary dollars of a spouse? To further complicate the matter, let’s assume that the couple has children, and one of the items paid out of the bank account is the mortgage on their primary home where the children reside. Notwithstanding the legal issues involved, tracing is the process of determining what has happened to the money or property, who handled it, and where it is now. This helps to justify a claim against the property in its current form.

In theory, complex financial crimes, fraud, organized crime, drug trafficking, money laundering, and terrorism financing can be prosecuted by following the money. But to prevent investigators from following the money, perpetrators attempt to disguise its sources to make it difficult to connect them with their ill-gotten gains. Such efforts also act to limit the ability of investigators to lay claim to money that otherwise appears to be derived from legitimate sources.

A complicating factor is that “money” is no longer cash and coin; it can be anything of value that can be traded, transferred, or sold, such as cash, coin, certificates of deposit, stocks, bonds, money orders, cashier’s checks, cybercurrencies, airline tickets, gift certificates, gift cards, prepaid credit and debit cards, diamonds, jewels, minerals, mineral rights, or deeds. Often times, money, such as Second Life’s Linden dollars, is nothing more than a digital series of 0s and 1s, electronic off and on switches that another person or entity is willing to accept as value.

Once illegal money has been combined with money from legitimate sources, one can no longer follow the money; the money must be traced. Even mixing money in a bank account creates the need to subsequently trace the money. Modern laws have addressed this issue to a certain extent by allowing claims to be made in situations in which illegal gains can only be traced. This requires additional work on the part of the investigator to identify the sources of assets that have been commingled and to make various assumptions to demonstrate how the conversion process was completed.

Other issues related to tracing involve what happens to the incremental value of assets for those assets that have increased in worth. For example, what if the perpetrator purchased a vacation home and the value increased by 20% annually? Generally, the courts have held that the perpetrator was acting to make an investment on behalf of the victim or plaintiff and any increases accrue to the victim or plaintiff; however, that may not always be the case in every jurisdiction. This “investment” approach means that, although rare, it may be possible for a plaintiff or victim to recover more than what was originally lost.

Legal Methods for Recovery of Assets

Depending on the jurisdiction, plaintiffs and victims have a number of possible legal mechanisms available to recover assets either through the civil or criminal justice system.

Freezing Orders

Freezing orders, restraining orders, and judicial injunctions are used early in a legal action to secure funds so that they do not disappear prior to obtaining a favorable verdict or negotiated settlement. Assuming that the victim or plaintiff can establish the current whereabouts of their money, a freezing order can be very effective, not only in protecting assets but also in bringing the defendant to the negotiating table. Freezing orders, restraining orders, and judicial injunctions can protect the assets from dissipation while legal proceedings move forward.

To obtain a freezing order, the plaintiffs or victims will need to demonstrate that they have a reasonably strong case, they have suffered significant damage or financial harm, there is a possibility that the assets will disappear if not protected by the courts, and any damage done to the defendant will be less than damages already suffered by the plaintiff or victim. Obtaining freezing orders can be risky because the courts may rule in favor of the defendants, thereby increasing their negotiating position and harming the negotiating power of the opposing side. On the other hand, a freezing order, once obtained, places pressure on the defendant to come to the negotiating table.

Plaintiffs and victims should attempt to get freezing orders in place at the earliest possible time to avoid losing track of assets or having them sold or disappear. Preferably, these orders are obtained ex parte so that they can surprise the defendant and prevent assets from disappearing before resolution of the case. The freezing order does not give the claimant the right to confiscate cash, assets, or property; it simply prevents the defendant from taking action to impair the value of those assets prior to resolving the issue via the judicial process. Freezing orders typically have time limits, so the claimant should attempt to get the longest period possible. The claimant should also try to get the order to cover as wide an array of property and other assets as possible. In some cases, specialists, such as accountants or other experts, may be needed to manage income-generating property pending the outcome of a civil or criminal trial.

Insurance and Bonds

Companies, as part of their fraud protection activities, will often purchase insurance and bonds to cover losses caused by dishonest employees, vendors, or customers. Such loss-prevention efforts usually come in the form of fidelity bonds or may be purchased with some property insurance policies as special riders. As with any insurance policy, this protection is subject to limits and exclusions.

To recover money from the policies, the claimant normally has to provide sworn proof of a loss claim within specified timeframes. These claims require supporting evidence and a statement of the loss. The insurance company does not normally participate in the investigation but will reserve the right to satisfy itself as to the facts and circumstances, as well as the amount of the loss. Some policies will pay for the cost of an investigation, but those costs may be specifically excluded by the insurance policy.

Once the insurance company pays a claim, it normally, as a matter of the contract, obtains the rights against the defendants. This aspect can provide heartburn to the victim or plaintiff. Consider the example in which a company was defrauded in a significant manner by a large customer of the insured. If the insurance company pays off the claimant and it obtains the rights against the customer that positions the victim company as an adversary of their customer. Thus, in some cases, even if insurance is in place, companies may not want to jeopardize their relationship with important stakeholders, even when possible damage amounts are significant.

Judgments

A judgment is a formal and final decision made by a court of law. Once a civil or criminal trial is complete and damages are awarded, this can be taken to a separate court for the purposes of entering a judgment for the amounts owed. Because a judgment is a final order entered by the court, it leaves no further action available to the losing party, absent an appeal. Armed with a judgment, the plaintiff or victim is now in a more secure position to demand payments from the defendant. Further, the judgment will be entered on the defendant’s credit report, diminishing, or possibly eliminating, the ability to obtain credit until the judgment is satisfied. Judgments may cover not only amounts lost but also interest and legal costs, depending on the jurisdiction.

Confiscation Orders, Compensation Orders, Forfeiture, and Seizure of Assets

When a defendant does not pay amounts owed to victims and plaintiffs as outlined in a judgment, the claimant may return to court to obtain various types of orders for the seizure and sale of specific property, usually at auction. In some jurisdictions, these court orders are referred to as confiscation orders, and in others they are called compensation orders or forfeiture orders. One of the primary differences is that forfeiture orders typically apply to specific assets, whereas confiscation and compensation orders refer to amounts that may be covered by available assets. Assuming that the value of assets included in a forfeiture order is sufficient to make a claimant whole, forfeiture is preferable in the sense that it effectively gives the claimant the right, and possibly title, to specific assets.

With a court order in hand, the sheriff or other officer of the court may enter the defendant’s business, home, or property and take possession of goods and other assets. If those goods are later sold at auction “on the courthouse steps,” the proceeds are paid to the victim or plaintiff. As noted above, assets that may be available for recovery need to be identified during the investigative stage and the claimant should proceed to court with a list of assets, estimated value, and their probable location. Normally, court orders are going to be limited in amount to the total assets held by the defendant or the amounts owed to the victim or plaintiff, whichever is lower.

Third-Party Debt Orders

A third-party debt order is similar to a garnishment and requires that the defendant’s debtors pay the claimant (the victim or plaintiff) instead of remitting money to the defendant. For example, assume that the defendant has accounts receivable from five customers that arose from the sale of goods and services and that the amounts to be received will perfectly cover the judgment amount. The court may order those third-party debtors to pay amounts owed to the defendant directly to the claimants. This has the effect of satisfying the third parties’ obligations to the defendant and the defendant’s obligation to the claimant all at the same time. It’s as though the third-party debtors made the payment to the defendant and the defendant turned around and immediately paid the victim or plaintiff.

Recovery against Third-Party Defendants

In some cases, accountants, lawyers, executives, managers, directors, audit committee members, and officers may be held accountable for the actions of the companies they represent. The threshold for such legal actions is normally negligence or gross negligence, although Sarbanes–Oxley has had the effect of making these parties more accountable in public companies for the quality of their work and the handling of their responsibilities. Direct claims can also be made against third parties who benefited from the fraud or financial crime even if the evidence isn’t strong enough to demonstrate that they knowingly participated.

Module 3: Support for Criminal and Civil Court Actions

The second major area of the remediation process involves supporting the plaintiff or prosecuting attorney through the legal process. This typically involves numerous consultations, periodic communication of findings and investigative issues, writing reports, attendance at opposing party depositions, being deposed, testifying in various hearings, being present during settlement negotiations, and testifying in court. In various types of fraud examination and forensic accounting engagements, the professional will do some, and possibly all, of these activities at the direction of the attorneys and/or other officers of the court. The antifraud professional or forensic accountant may be hired as a consultant or an expert witness or may be a court-appointed expert or master.

No matter what the engagement, the professional should remember that he or she is not an advocate for any side. In fact, at all times, the professional should remain independent and objective. All facts and evidence are to be objectively evaluated using critical thinking skills, analytical reasoning, and brainstorming. The antifraud professional is in search of an alternative explanation, an alternative hypothesis, and all the ways that one might characterize or mischaracterize the evidence, information, facts, and data to tell another side of the story.

The commitment to professionalism is the hallmark of the fraud examiner and forensic accountant. Although consultants are not expected to testify, it is common for the attorney to convert consultants into expert witnesses depending on the examination outcomes and the strategic direction of the case. More importantly, most prosecutors and attorneys work a case with an eye toward pretrial settlements: guilty or nolo contendere pleas, monetary settlements, and so forth. As such, they expect the forensic accountant and fraud examiner to provide them with all the information so that they can work toward a pretrial resolution after assessing the likely outcomes with an objective view.

In addition to financial crimes, a forensic accountant may serve as an expert in a number of civil litigation matters: damage claims, personal injury, wrongful death, predatory pricing, antitrust, breach of contract, divorce, bankruptcy, torts and tortuous interference, valuations, and financial reconstruction.

The Character and Flavor of Being an Expert Witness

Les Heitger is the BKD Distinguished Professor of Forensic Accounting at Missouri State University. Prior to that, he was a professor in the Kelley School of Business at Indiana University. Dr. Heitger has served as an expert witness and as a litigation consultant in many cases in state courts, federal courts, federal tax court, and in mediations and arbitrations. He has coauthored numerous textbooks including one in the area of Forensic and Investigative Accounting. He is the immediate past president of the Forensic Accounting Section of the American Accounting Association. In the following passage, Dr. Heitger offers some pearls of wisdom based on his more than 30 years as a forensic accountant.

From Dr. Heitger…

Although the field of accounting, in general, does not seem to garner endless streams of comments about how interesting and exciting it is, just the opposite is true of forensic accounting. Just the term forensic accounting seems to elicit thoughts of detective work, finding fraud and those who commit it, court cases, and other non-traditional accounting activities. And much of that image is very true. Seasoned veterans of the world of forensic accounting often talk about how no two cases in their career were ever alike. In forensic accounting, routine is the exception, not the rule. This suggests that forensic accountants possess knowledge, skills sets, and characteristics that are essential to succeed.

For those who have never served as an expert witness or those who have only a passing knowledge of accounting/financial information, it is hard to understand the need or purpose of accounting expert witnesses. Such people may think, “The numbers don’t lie” or something similar. The implication being, “why is there controversy about the financial data? It is, what it is.

Perhaps numbers don’t lie, but people do. Often financial information is slanted, carefully selected, or just plain wrong when those numbers are used for evaluating some situation that is in question. The trier-of-fact (Judge and / or Jury) seldom has much, if any, knowledge of accounting, financial information, or non-financial data that interacts with financial performance and condition, relevant to the resolution of the conflict. Because virtually all conflicts that are litigated are primarily about the financial consequences of the events that gave rise to the litigation, it is crucial that the judge and / or jury understand, as best they can, what those issues are. Often that is not possible without the guidance of an accounting, forensic accounting, or anti-fraud expert witnesses.

Successful forensic accountants must possess some important traits. For starters they must be very good with numbers. There is no such thing as a great forensic accountant who does not have a solid accounting foundation, in general. Good forensic accountants are also:

  • tenacious
  • look at all of the possibilities
  • are able to see through illogical or unusual financial information
  • are able to stay focused while operating in an adversarial environment
  • thrive on doing problem-solving detective work.

Additionally, they understand that they must be able to present their opinion to a typically unsophisticated audience, but do so in an understandable and persuasive manner that is consistent with the facts, circumstances and evidence.

One of my first big cases was a federal antitrust case in which my client was a defendant. One of my major goals was to convince the court that my client had not engaged in “predatory pricing’” (selling products below their average variable costs). I prepared sophisticated cost behavior analyses using regression-correlation analysis and other techniques, and gave my direct testimony to a mock jury in preparation for the actual trial. After I proudly finished my practice testimony, the very wise attorney with whom I was working took me aside and said, “That was really great, you convinced me! Now what you need to do is say what you just said, only in terms of buying a loaf of bread and a gallon of milk.” The message was clear, “I am sure you are correct, but nobody—the judge or the jury—is going to understand you.” This exchange brought home a clear message—that it is not good enough to be correct, you also have to be understandable and persuasive.

But good forensic accountants do more than just present and interpret accounting, financial, and numerical data for the court. Frequently attorneys and clients need to understand the nature and character of the financial information that has been presented as proof of liability and damage amounts in a lawsuit. As an example, I was hired by attorneys for the defendant in a case that had been pending for several years. I was asked to serve as an expert to examine the alleged damages in the case. The plaintiff alleged that the defendant hired some of the plaintiff’s professional staff away from the plaintiff, and that this had caused the plaintiff organization significant economic harm. In an effort to support its allegations, and to measure the damages suffered, the plaintiff hired a business valuation firm to compute the alleged lost value of the plaintiff organization due to the actions of the defendant.

After reviewing the report of the plaintiff’s expert and doing a lot of additional analysis of the plaintiff’s financial data, it appeared to me that there was no liability by the defendant in this case, and that many of the assumptions made by the plaintiff’s expert had no basis in fact. In my expert report and during my deposition testimony, I carefully identified that (1) the time periods used in the business valuations were arbitrary and had no relationship to the alleged acts in the case, (2) the two methods of valuation used by the plaintiff’s expert were illogical, and had no basic in economic reality, (3) there were numerous other more logical, business-related explanations for why the plaintiff’s value had declined, and (4) various trend analyses of the plaintiff’s financial information showed that the entity had questionable management policies and actions before and after the time periods covered by the allegations in the case.

The case was settled when the plaintiff agreed to seek no damages at all. The defendant in the case was very pleased, because prior to the time when it hired an expert, the defendant was considering settling with the plaintiff for a significant amount of money.

In general, accountants are in the business of developing, reporting, and disseminating information. Perhaps more than any other business discipline, accountants are called upon to communicate accounting, financial, and numerical information to countless others with whom they interact.

The challenges of effective communication are even greater for forensic accountants. First the information that must be communicated is often less structured and more complex than is true for more traditional accounting communications (e.g., balance sheet and income statements). Further, forensic accountants often are communicating accounting information to individuals who have little or no knowledge of accounting or financial issues. Sometimes this requires forensic accountants to be more creative and careful in explaining the information. More importantly, at least some forensic accounting communications occur in an adversarial environment. Therefore, forensic accountants need to excel at communicating in challenging environments.

Hopefully, these tidbits of information from my experience will contribute positively to your career as a forensic accountant and anti-fraud professional.

Fact Witness versus Expert Witness

Most foundation testimony in a case is provided by fact or lay witnesses. These individuals testify to various facts that they put in perspective by talking about events, activities, and state of mind at the time the issues in question arose. Generally, fact witnesses must testify to firsthand facts and knowledge. They are not permitted to offer opinions unless those views are based on specialized knowledge required as part of their normal responsibilities. For example, mine supervisors with twenty years of experience can provide opinions on mining conditions because they make those same assessments as part of their jobs. Further, the lay opinion rule allows a fact witness to offer “everyday” opinions under three conditions1:

  1. The opinion must be based on the witness’s personal perceptions (as opposed to hearsay).
  2. The opinion must be helpful to the trier-of-fact.
  3. The opinion must be the product of reasoning processes familiar to the average person in everyday life.

In contrast to a fact or lay witness, an expert witness is one who, by virtue of education, profession, publication, or experience, is believed to have special knowledge of his or her subject beyond that of the average person, sufficient that others may officially (and legally) rely upon the opinion.

Generally, the role of the fraud examiner or forensic accountant when working with attorneys and other persons related to legal matters is to do the following:

  • Educate counsel.
  • Reconstruct cash flows and performance from records.
  • Guide additional investigation and discovery.
  • Make connections, draw conclusions, and offer observations.
  • Determine whether evidence supports theories of case.
  • Provide objective evaluations of the information, data, and evidence.
  • Draft reports and exhibits.
  • Offer deposition and trial testimony.

An expert’s opinion is subject to two types of challenges:

  1. With the Daubert Rule, the basis of foundation for the opinion may not be based on “junk science.” Just because a person qualifies as an expert, that person cannot offer any opinion unless that opinion is reasonably grounded in scientific fact.
  2. The Frye Rule makes an opinion admissible only if that opinion has general acceptance in the scientific community.

In either case, the expert must provide the basis for his or her opinions as well as the facts, data, and other information relied upon. Not surprisingly, determining the amount of losses is both an art and a science. The science aspect requires the fraud examiner and forensic accountant to understand and use methods appropriate for their field such as generally accepted accounting principles and proper examination tools and techniques. The artistic aspect is understanding the judgment inherent in accounting, accounting estimates, the ability to connect the dots, the need to use creative thinking, and the proper consideration of alternative theories of the case, to name a few.

Assuming that legal counsel initiated the examination, the professional should complete the following steps:

  1. Obtain a written engagement letter with the terms and conditions of the engagement clearly spelled out. The antifraud professional or forensic accountant should ensure that the terms are clear and ethical. For example, the engagement letter should not state what the professional is expected to find as a result of his or her examination nor the topics on which the expert is expected to testify. Such language may suggest bias, may limit the examination, and may provide grounds for opposing counsel to attack the professional’s objectivity, integrity, and credibility.
  2. Conduct an initial consultation to obtain an overview of the issues in question, determine the required areas in which expertise is required, and acquire initial direction and other information, facts, and data.
  3. Complete the required investigative work. This requires fraud examiners and forensic accounting professionals to apply their judgment, develop insights, interpret the facts and data, draw conclusions, provide advice and counsel to the lawyers, and solicit additional data as needed. Typically, periodic consultations with the attorneys and others will be necessary to develop a complete picture of the issues in question, discuss preliminary findings and interpretations, and determine the next steps.
  4. Wrap up the examination, draw conclusions, and write the report.
  5. Prepare for depositions, hearings, and courtroom testimony and appear in court as needed.

Naturally, the investigative process involves the evaluation and interpretation of information, facts, and data. Nonetheless, much of what attorneys rely on from experts is determining what data are needed and what appears to be missing. In some cases, it’s not so much what you see, but what you don’t see, that needs to be identified. That requires the antifraud professional and forensic accountant to constantly apply their critical thinking skills, analytical reasoning, and brainstorming techniques to challenge their interpretations and preliminary conclusions. Once the expert has identified the needed data, the prosecutor or civil attorney can pursue obtaining those data through the legal system.

One of the continuing challenges faced by antifraud and forensic accounting professionals is “staying in their sandbox”—their area of expertise. As long as the professional remains within his or her field of expertise and develops conclusions grounded in the financial and nonfinancial evidence relevant to the issue at hand and within their domain, he or she has a safe haven. Determining what you can say as an expert is a challenge. For example, where are the boundaries of your expertise? When does accounting cross too far into finance, economics, marketing, management, and other business disciplines? Generally, when you have identified that you are relying on facts or another’s expertise, you need to acknowledge that reliance. You need to evaluate the importance of that evidence and be cognizant that the evidence needs to withstand the scrutiny of cross-examination. One technique is for the fraud examiner or forensic accountant to continually evaluate what happens to his or her own opinions and conclusions if or when a piece of evidence is eliminated for any reason.

Further, fraud and forensic accounting professionals should not get into a position in which they are defending the opinions and conclusions of others. Such defense is beyond their expertise. At the same time, the fraud examiner is likely to be working in an industry or business with which they do not have complete familiarity. Although professionals need to develop comfort with their knowledge base in order to understand the attributes of a successful business model, fraud examiners or forensic accountants need to expect some level of discomfort with not being experts in all subject areas; their opinions, to some extent, usually rely on facts and opinions of others where their own understanding is limited. In those situations, tread lightly with opinions or risk being criticized for drawing conclusions and expressing opinions beyond your area of expertise.

Supporting the Investigation

The fraud examiner or forensic accountant needs to recognize that although what they do during an examination may be second nature to them, others will not have the same knowledge or comfort level. For example, most law enforcement officers do not have training in following the money through checking accounts, books, and records. Many attorneys will miss basic accounting issues. This is not to suggest that the attorneys are not capable; in contrast, it is a result of their own training and specialization being directed toward other areas. That is why they rely on the expertise of the forensic accounting and fraud examination professional.

Thus, even though the forensic accountant and fraud examiner may work easily through books and records and recognize issues quickly, attorneys and nonfinancial investigative individuals may need a specialist to take the time to educate them, explain the issues, and show them the books, records, and other evidence. Optimally, the forensic accounting professional will explain the technical issues in such a manner that those orchestrating the broader legal activities can understand the underlying concepts and make strategic decisions regarding how to pursue the case. As such, although attorneys will direct the work of the forensic accountant or fraud examiner, the professional must take the initiative to look into issues that require further examination beyond those flagged by counsel.

In a pure litigation support effort, the attorney will have the case first. At the inception of the forensic engagement, the attorney should be giving the professional copies of court pleadings, interrogatories, whatever financial evidence has been accumulated thus far (e.g., selected depositions or portions of depositions that may impact the antifraud or forensic accounting professional’s work), and opposing expert testimony and reports. After an initial review of this material, the fraud examiner or forensic accountant will have more questions than answers, and it’s time to communicate with the attorney. Let the attorney know what’s missing, what is confusing, what doesn’t seem to make sense, and, perhaps most importantly, what data, information and evidence is needed. The documentary evidence will usually be less than one would like to have; that is just a fact of the profession. Some evidence will be lost; some may be destroyed; some may go too far back in time. Nevertheless, the forensic accountant needs to keep digging, keep thinking, and keep asking questions of the attorneys and themselves.

At all times, the fraud examiner or forensic accountant is an independent, objective professional who works to evaluate evidence from every angle. This means that forensic accountants need to examine every piece of paper that comes across their desks and consider its implications in the case, if any. Data may need to be obtained independently; for example, industry data can be collected from the SEC’s Edgar or other data sources. Consider a claim that unfair business practices forced a small enterprise to underperform—at least that was the allegation. Yet after “Googling” information about the business’s area of industry, a relatively unknown trade association was discovered. A brief phone call to the trade association found that it tracked key performance metrics for the United States and broke down those metrics into eight regions. The annual reports had a cost of $40 per year, and the reports revealed that although the business climate where the plaintiff operated was challenging, the plaintiff operated at or above the industry averages for all periods except for a partial startup year. This type of information was greatly appreciated by the attorneys, and invaluable when developing conclusions and opinions.

As noted above, one of the major challenges is identifying any missing data. This challenge is ongoing. As long as the expert requested the data—even if it wasn’t provided—he or she has minimized the risk of criticism for not being thorough. When the opposing attorney confronts the antifraud and forensic accounting professional with insinuations that he or she did not evaluate all the data needed, the response is twofold: (1) we asked for that data and it wasn’t provided, and (2) if you will provide me with that data now, I’d be happy to reconsider my conclusions and opinions in light of any new information. This response provides an excellent safe haven. It communicates the professional’s willingness to keep an open mind. Thus, the fraud examiner or forensic accountant’s opinions and conclusions are based on the evidence provided to date and are subject to change based upon new evidence. One should always reserve the right to modify or supplement analyses and other work as necessary, should additional information become available, facts become known, or additional inquiry arise.

While working with law enforcement, attorneys, and other professionals, your critical thinking, analytical reasoning, and brainstorming skills are some of your greatest strengths. The fraud examiner or forensic accountant should keep asking questions:

  • Where does the information lead?
  • Are things as they appear?
  • Has this scenario been seen before (experience has no substitute)?
  • Is data “mysteriously” missing?
  • How are various items or facts connected?

Keep asking who, what, where, when, why, and how.

View from the Trenches: Obtaining the Necessary Evidence

Jim DiGabriele, CPA, PhD, CVA, is the author of Forensic Accounting in Matrimonial Divorce and has extensive experience in a wide range of litigation and forensic accounting assignments. His major areas of expertise include business valuation, economic damages, matrimonial disputes, partner/shareholder disputes, tax fraud, and commercial damages.

From Dr. DiGabriele…

Over more than 30 years, I have observed forensic accounting experts attempt to navigate the uncertainties, pitfalls and perils that are inherent in expert testimony. From my perspective, the primary purpose of deposition testimony is for future use by opposing counsel. A savvy opposing attorney will attempt to impeach the testimony of a forensic accounting expert witness at trial based on the answers given during the deposition.

Example: during a deposition, the forensic accounting expert was asked, “Was this tax return relied upon in the preparation of your report on lost profits?

During the deposition, the expert answered, “no.

During court testimony on direct examination, the expert was asked the same question but, responded “yes.

Opposing counsel could hardly wait! During cross-examination, the opposing attorney showed the jury using a huge video screen the expert’s deposition transcript - illustrating “no,” a different answer. The expert’s credibility was impaired.

Lesson Learned: It is essential to read your deposition transcript before trial testimony and remember the details.

Example: In a tax fraud case, a forensic accounting expert had a convincing direct examination regarding the ordinary and necessary business expenses deducted by the defendant.

On cross-examination, the opposing attorney went through each business expense that the forensic accounting expert testified to, under oath, as a legitimate tax deduction.

As each “business” expense was presented to the expert, the cross-examining attorney showed the jury a stipulation provided by the expert’s client, where the taxpayer stated that each of these was personal—not a business expense. (The forensic accounting expert had not been provided the stipulations before the trial.)

The final question by opposing counsel to the forensic accounting expert, “does your opinion change regarding the deductibility of these expenses?” Answer: “yes.

Lesson Learned: It’s critical to keep asking for all relevant facts, circumstances, documents, necessary to maintain credibility in the eyes of the judge and jury.

Evaluation of the Evidence

When evaluating the evidence, the fraud examiner or forensic accountant is expected to be independent. The professional should ensure that all conclusions and opinions are grounded in the evidence, supportable, and defensible. This leaves open the possibility that others may interpret the evidence differently; however, your conclusions and opinions are defensible because they are reasonable based on the entirety of the evidence evaluated.

The professional should identify key assumptions behind their conclusions and opinions. As noted in the earlier chapters of this book, the danger is not in dealing with identified assumptions but in assumptions made subconsciously. A conclusion that may seem obvious to one person may not be as apparent to another; the major difference is in the basic assumptions that the two have made.

To the extent possible, the antifraud professional should identify any research literature, theories, or other resources used as a basis for the work performed and conclusions and opinions reached. Examinations may be challenged by the opposition based on missing data or other limitations. Antifraud and forensic professionals should be aware of potential weaknesses and vulnerabilities in the examination. Once the evaluation is complete, the fraud examiner or forensic accountant needs to write a written report, if it is requested. After the report is written, the examination is not necessarily complete. One should continue to follow up, as necessary, if additional information becomes available, facts become known, or other inquiries arise.

Report Writing

During the examination, the antifraud professional or forensic accountant has likely developed a number of analyses and graphics. Some of these presentation tools may include the following:

  • Link charts
  • Events and activities charts
  • Timelines
  • Commodity and flow diagrams
  • Direct and indirect financial analyses
  • The evidence/hypothesis matrix

These analyses will address the central issues of the examination:

  • The Elements of Fraud: the act, concealment, and conversion
  • The Fraud Triangle: pressure, opportunity, and rationalization to the extent grounded in the evidence
  • M.I.C.E. (money, ideology, coercion, and ego) to the extent grounded in the evidence

The analyses and central issues should be presented in a coherent storyline—clear, accurate, precise, and relevant to the issues under consideration; presented in reasonable depth to establish credibility; and logical. Most importantly, the storyline needs to be grounded in the evidence. The fraud examiner or forensic accountant could have vulnerability where the storyline is supported by weak evidence or the logical leap is rather large. All facts should be reported without bias or commentary and all relevant information should be included in the report, regardless of which side it favors or what it appears to prove or disprove.

Normally, the fraud examiner or forensic accountant will orally report preliminary findings prior to submitting a formal written report. This gives the entire examination team a chance to learn what has been found and to put the findings in context, identify next steps, and develop a plan for moving forward.

Although each fraud examiner or forensic accountant has his or her own style, the report generally can be divided into several sections. First, the executive summary provides an overview of the case, the major issues considered, all opinions and conclusions, and the primary basis and reasons therefore. This can be challenging at first. As an examiner, accountant, or investigator, we have usually built the case from symptoms and red flags until we have conclusions and opinions that we feel are reasonable and grounded in the evidence. In contrast, rather than building the case in the report, the report starts with the ending: the conclusions and opinions. Then, the report dives into an introduction, an optional section that provides further information about the background of the case: where it came from, the major issues under consideration, and other investigative aspects that were considered. From there, the details of the case examination and findings are presented in the case material section. This is the body of the report, develops an in-depth basis for all conclusions and opinions, and is where all of the presentation tools are reviewed and discussed. Finally, a concluding section summarizes the major points of the report.

Conclusions and opinions, though related, are distinct. Conclusions are positions grounded in the evidence, whereas opinions are based on the fraud examiner or forensic accountant’s interpretation of the facts. Opinions require the professional to connect the dots. Normally, the conclusions are self-evident, but it is likely that opposing counsel will try to interpret the facts in such a way as to draw different opinions. Fraud examiners and forensic accountants should avoid opinions regarding the guilt or innocence of any person or party. This is the responsibility of the judge or the jury based on the entirety of the case in which the fraud or forensic accounting professional is only one player among many. As the writing progresses, you should remember that your report will be carefully scrutinized and that you will have to defend it. Some of the places where that defense occurs include the following:

  • Deposition testimony
  • Trial testimony
  • Questioning by client’s attorney
  • Questioning by opposing attorney
  • Preparation for trial testimony
  • Rebuttal testimony (the other expert)

In addition, it is highly likely that the fraud examiner or forensic accountant will be asked to examine the expert report for the opposing side. Whether an alternative expert report is presented is dependent on the judgment of opposing counsel. One thing is for certain, you can expect to be rigorously examined over your work. Thus, your ethics and professionalism will come into play. A professional should do the best job possible for the client, but the way to do that is by being independent, objective, maintaining confidentiality, avoiding conflicts of interest, and not accepting any contingency fees based on the outcome of the case. An open, honest assessment of the facts and circumstances is the best approach to high-quality client service.

While not applicable to all engagements, the following report writing checklist may help guide the process.

Forensic Accounting and Fraud Examination
Report Writing / Presentation Checklist

Evaluation
Is the written report length appropriate, given the complexity of the case and evidence?
Is the presentation length consistent with the expectations of the parties?
Is the style: high quality / focused on evidence?
Is the evidence organized to tell a coherent story?
Are conclusions, findings and expert opinions grounded in the evidence?
Does the style follow evidence and avoid bias or unsubstantiated commentary?
Does the report avoid the use of emotive words and slang?
Are the report exhibits referenced throughout the body of the written report?
Is an Executive Summary section included?
Are key dollar amounts presented?
Is an Introduction section included?
Are the possible law violation(s) discussed?
Is a Case Material / Investigation section included?
Does the case material address:
 Act?
 Concealment?
 Conversion?
 Opportunity?
Are dollar amounts presented and do they tie to key dollar amounts?
Is the investigative approach creative, thoughtful and thorough?
Does the report end with a Conclusion?
Does the report have reservations and/or limiting conditions?
Is the report signed?
Are Exhibits (1-page)?
Possible exhibits:
 Link Charts (include dollar amounts / totals)
 Flow analyses (include dollar amounts / totals)
 Events / Activities (include dollar amounts / totals)
 Time / Dates / Timeline (include dollar amounts / totals)
 Monetary Flow (include dollar amounts / totals)
 Non-Financial Analyses (e.g., capacity, counts, quantities, prices)
 Direct Financial Analyses
 Indirect Financial Analyses (Net Worth, lifestyle, Bank Records)
 Invigilation
 Reconciliation of financial and tax data
Are the exhibits 1-page?
Are the exhibits easy to understand?
Do the exhibits EXCLUDE raw evidence?
If exhibits longer than 1-page are required, are they appropriately referenced / described?

The following sample reports are attached as Appendices to this chapter:

For Appendices BD, the case facts, analyses, and calculations were examined in the previous chapter. As noted on each sample report, it is not necessarily inclusive of all necessary report elements. Further, each report should reflect relevant case attributes and examination outcomes. Finally, professional standards may dictate various required report elements and professional standards should be consulted, as needed.

Credibility

Throughout this chapter, the issue of credibility has been implicitly examined. For the fraud examiner or forensic accountant, credibility is essential—in substance and in appearance. It is earned as the professional performs his or her role as a teacher, investigatory guide, and advisor. It is a function of plain language—making complicated matters seem simple—and ensuring that the “audience,” such as lawyers, opposing counsel, the judge, and jury can follow the work through each step so that conclusions and opinions developed will seem reasonable and logical. The short of it is: that credible information, presented credibly, is more likely to be believed and accepted. Furthermore, credibility is protected by being independent, honest, objective, and ethical.

If only one side’s opinions were offered, credibility would be easier. But the essence of criminal and civil litigation is controlled confrontation—both sides get the opportunity to present the facts and circumstances from their opposing perspectives. Thus, the fraud examiner or forensic accountant, especially in civil litigation, is likely to face a situation of “dueling experts,” in which each side takes roughly the same facts and circumstances and comes to different conclusions and opinions. How does one navigate through these troubled waters?

The answer lies in the professional’s underlying theories, interpretation of evidence, and attention to detail. These issues are paramount. Without a solid underlying methodology to the examination and evidence-based conclusions and opinions, the expert will lose not only the case but his or her credibility. The weaker side usually has a weaker methodological approach or ignores key facts and figures during their work to draw conclusions and opinions. It is only with attention to detail that the professional can identify the facts and information omitted.

Who ultimately decides on the issue of credibility? The judge and jury do. But importantly, as the counsel you are working for and the opposing counsel approach the negotiating table, one of the items that determine their position is your work and the outcomes of your examination—your conclusions and opinions.

When considering credibility, it is important to understand how listeners evaluate your work.2 First, they will set up a baseline by listening to the background information. This is the responsibility of both attorneys during their opening arguments. Once the judge and jury have a basic storyline, they will add and incorporate new information into their pre-existing notions. The essence of this act is that people try to make decisions quickly based on their first impressions and are subsequently reluctant to revise prior beliefs.

It is also important to consider that this decision-making occurs almost instantly after opinions are offered. Therefore, you should be clear and concise and get to the most important points first. Then, you, as the expert, can drill down into the details that further solidify your credibility in the eyes and minds of the judge and jury. As new facts and information are presented, the judge and jury will interpret that information for consistency within their pre-existing beliefs. Typically by the time the expert testifies, the jury may have already “made up their minds.” If an expert is trying to change those pre-existing beliefs, he or she needs to clearly, concisely, and quickly explain the conclusions and the main reasons why the opposing expert’s testimony is in error. Otherwise, the decision-makers may reject your new information because it is inconsistent with their current beliefs.

Because most testimonies have gaps, the jury and judge will likely fill in the gaps as needed and make their own connections, inherently drawing their own conclusions and opinions. How does the dueling expert deal with this issue of pre-existing beliefs? Story-framing. One of the best techniques for getting a person to believe your version over an alternative account is to present a better narrative, one grounded in the evidence and one that is complete with regard to attention to detail. Of course, the expert witness has a challenge—to provide enough detail to establish credibility without overcomplicating the issues and boring the listeners. The expert witness should work with counsel and pay attention to the jury’s reaction to his or her testimony.

Rapport is another key attribute of the credible expert witness. The person needs to be likeable, interesting, interested, and lively. At the same time, each person has his or her own persona and personality; be natural but leverage your personal strengths and minimize your weaknesses to strike a chord with the jury.

Other attributes that help are to avoid bias in reporting, presentation, choice of methods, and use of facts. Fluency of communication also adds to your credibility. Professional accomplishments such as education, training, experience, familiarity with research in the field, professional organization affiliations, publications, and prior testimony experience all provide a foundation for credibility but are not sufficient by themselves.

Presenting a positive appearance can bolster credibility. Aspects of a positive appearance include the following:

  • Body language, including attentiveness and sitting up straight
  • Eye contact
  • Business attire
  • Concise organization
  • Conversational language
  • Varied formats throughout the presentation
  • Illustrations and analogies
  • Confidence
  • Knowledge

In contrast, the expert witness can also present a negative impression through:

  • Abrupt or argumentative responses
  • Rambling answers
  • Hesitation when answering questions, especially from opposing counsel
  • Constant self-references
  • Anger or aggression
  • Arrogance or condescension
  • Shifting posture
  • Folded arms
  • Opinions without substance

Deposition Testimony

A deposition is a pretrial process during which the parties to a civil litigation are allowed to examine the other side’s fact and expert witnesses. Generally, depositions do not occur in criminal litigation; although many of the witnesses may have been interviewed, those interviews are typically not under oath. Essentially, based on discovery in civil litigation (including depositions), each side knows the other side’s theory of the case and what the witnesses are expected to say. As such, the civil trial becomes, to some extent, an act of presentation and choreography. The function of a deposition is to do the following:

  • Gather testimonial and documentary evidence from witnesses
  • Limit the scope of what witnesses may say when the actual trial occurs
  • Test or confirm theories and hypotheses
  • Develop a record under oath and thereby “freeze” a witness’s testimony
  • Evaluate the credibility and persuasiveness of witnesses as well as their work, conclusions, and opinions
  • Move the case toward settlement or trial
  • Compare the deposition testimony to prior statements and statements made by other witnesses
  • Test the expert witness’s report

In preparation for a deposition, expert witnesses should thoroughly review their report and the underlying data. Additionally, in a pre-deposition meeting, the fraud examiner or forensic accountant should meet with counsel to review the report and answer questions. Counsel will normally have one of two strategic goals for the expert with regard to the deposition: (1) show the strength of their hand and (2) limit the areas of inquiry to those examined by opposing counsel. Assuming that the attorney you are working with believes in the strength of the case and the opposing side understands the depth and import of your work, they will more than likely move to settle. Retained counsel will want their experts to be clear, be concise, and expound on their opinions. Of course, there is risk in this approach.

If the case does not settle, opposing counsel will have a thorough understanding of your conclusions and opinions and be in the best position to attempt to undermine your work. In other cases, counsel will recognize that the case is going to trial and will be heard by a jury and judge. In that situation, as an expert witness, you must be clear and accurate in your testimony. Interestingly, opposing counsel may not explore every aspect of your work; your attorney may prefer that you only respond to those areas in which opposing counsel asks questions. Of course, if opposing counsel asks the blanket question, “Are those all of the conclusions and opinions that you plan to offer at trial?”, the expert will need to articulate areas not already explored.

The format of a deposition is more akin to cross-examination by opposing counsel. Though the attorney who retained you may ask some “clean up” questions near the end, it is common for only opposing counsel to ask questions. Although the deposition typically takes place in an attorney’s conference room or some other mutually agreed upon place, many aspects are similar to a trial. First, the testimony is recorded under oath by a stenographer. It will be prepared in transcript form and may be reviewed prior to finalization to ensure that the record is accurate. Further, opposing experts may observe the testimony of the fraud examiner or forensic accountant. When subpoenaed, the expert witness may receive a subpoena duces tecum, which requires that he or she arrive with his or her report and all documents that he or she reviewed, evaluated, and/or relied upon to develop his or her conclusions and opinions.

Direct Examination

Direct examination is the intersection of credibility and preparation.3 It is the heart of the case for the attorney and a chance to frame the issues and the evidence from his or her perspective for the jury and judge. The presentation of direct testimony is in the form of question and answer; the attorney who retained the expert witness will frame the question and the expert witness must answer that specific question. Thus, the attorney must navigate through the goals and objectives of the direct testimony by carefully asking questions that elicit the topical information needed. The expert witness must be careful to listen to and then answer the questions presented. Even though the form is question and answer, the goal is to present the narrative logically and carefully.

The expert witness may use analogies and metaphors to make difficult and technical testimony more understandable for the jury. Such tools should be developed carefully in advance so that the explanations are sound and do not allow opposing counsel to reframe the analogy or metaphor to its advantage. Examples that make the testimony more accessible and understandable for the jury and judge may be used. For example, if you state that the company spent $2.5 million for an airplane, hanger, fuel, and maintenance over a seven-year period, you could then explain that this breaks down to approximately $350,000 a year or almost $1,000 per day. Noting that a round-trip airline ticket from Pittsburgh to Atlanta costs about $350, this company with four executives, two hundred employees, and one location would have had to send three people to and from Atlanta almost every day for seven years to justify this expense. It’s easy now for the jury to understand what an expense of $2.5 million for an airplane may mean for a relatively small entity, their financial performance, and financial condition, and it’s easy to see that the expense may be unnecessary for the few flights the company might require annually.

Other key points related to direct examination:

  • Listen
  • Watch the jury and judge to ensure that they seem to understand
  • Use summaries of testimony and exhibits
  • Enumerate points (1, 2, 3, etc.)
  • Demonstrate “open-mindedness” without compromising the integrity of your conclusions and opinions
  • Use visual aids to maintain attention

By the time the expert witness has finished testifying during direct examination, the jury should understand the following:

  • Your conclusions and opinions
  • The evidence upon which your conclusions and opinions are based
  • How your work fits into the greater case narrative: who, what, when, where, how, and possibly why
  • How your work explains the act, concealment, and conversion
  • How your work considered the fraud triangle: pressure, opportunity, and rationalization
  • How your work considered the motivation of the defendant to the extent possible: M.I.C.E.

Cross-Examination

Cross-examination is designed to be a search for the truth. The thinking goes that if testimony can withstand the onslaught of cross-examination by a skillful attorney, then the testimony must be credible. To a certain extent, that is true; however, skillful attorneys can lead unwary expert witnesses in directions they don’t want to go and to conclusions the expert doesn’t believe or intend to convey. Thus, in a perfect world, the truth may come out during cross-examination; but, it’s far better to be prepared and understand how opposing counsel may twist your testimony to their advantage.

The first goal of the opposing attorney during cross-examination is to challenge the expert’s credibility, if possible. As noted above, credibility is earned and derives its power from a number of sources. Opposing counsel can attack credibility on any number of fronts. For example, the opposing attorney may ask if you are an industry expert; the answer is “no.” If left at that, the expert’s credibility in the eyes of the jury may be damaged. The better answer is “No, but I am a forensic accountant and the tools of my trade are examining books and records, income statements, balance sheets, cash flows, and the like. With those tools and techniques, I am an expert and I applied my expertise to my work in this case.”

At the same time that opposing counsel is trying to challenge the other side’s experts, they are trying to enhance their own theory of the case and minimize the impact of the expert’s testimony. In contrast, the fraud examiner or forensic accountant should maintain a commitment to their objectives: keep teaching and using evidence-based conclusions and opinions while maintaining credibility and control of one’s own testimony. For instance, in the example above, an answer of “no” would have been accurate and defensible. Nevertheless, in the eyes of the jury it could have been misleading; thus, the need to answer “no but.” That is an example of an expert not surrendering control of their testimony.

Opposing counsel may try to accomplish their goals by carefully controlling what they ask. Controlled confrontation occurs when opposing counsel continues to try to weave their own narrative by selectively asking questions of the expert. The opposing attorney may even go so far as to repeat his or her own narrative, using the expert to answer only selected inquiries where damage will be minimized. The question format for cross-examination is normally yes or no. While on direct, the attorney wants the expert to present the narrative and expound; on cross, opposing counsel does not want to give the opposing expert a chance to retell the opposition’s narrative; thus, the strategy of asking yes or no questions. This technique limits the opportunity for explanation. The questions are usually safe. The expert needs to listen carefully and give a yes or a no answer when appropriate but be sure to explain when a yes or no answer may be misleading or misinterpreted. Although the expert might prefer to explain every answer, it will appear argumentative if he or she does not concede yes or no answers when, in the eyes of the judge or jury, they are appropriate.

During cross-examination, the fraud examiner or forensic accountant has several goals:

  • Be cooperative. An uncooperative expert diminishes his or her own credibility.
  • Maintain the credibility of his or her conclusions and opinions.
  • Be alert for reasonable and proper opportunities to provide explanation and disagree.

The fraud examiner or forensic accountant should understand that the opposing lawyer will do the following:

  • Learn your field
  • Know your report
  • Know your resume
  • Try to limit the scope of testimony
  • Stress missing credentials
  • Contrast your credentials with those of opposing experts
  • Contrast your conclusions and opinions with those of opposing experts

Even if your work is completed to the highest quality levels and your conclusions and opinions are reasonable and are grounded in the evidence, opposing counsel will try nevertheless to “score points.” For example, they may ask you to agree with an opposing expert’s data or assumptions so that it appears you are agreeing with the opposing expert’s conclusions and opinions. The fraud examiner or forensic accountant may be asked to criticize the conduct of his or her client or the shortcomings of issues in question.

In addition, opposing counsel may attempt to get the opposing expert to acknowledge a lack of knowledge about certain aspects of the case, even if the expert was not expected to be knowledgeable in that area. This creates the appearance of credibility problems where none exist. The opposing attorney may also challenge the professional’s objectivity and the sources of information relied upon. It is also common for an opposing attorney in a position of weakness to offer “what if” scenarios that require facts and circumstances different from those of the examination you conducted. Such hypothetical questions must be answered, but it is also reasonable to point out where the facts and circumstances differ from those in the actual case.

Some of the techniques used in cross-examination are listed:

  • The Primrose Path: Using only selected and possibly hypothetical facts, the opposing attorney paints a picture differing from the one that existed in the real case. This is done by limiting testimony to “yes” and “no” questions and then offering a different conclusion: “Well, if that were true, you must agree that … .”
  • The Nodding Chicken: Similar to the primrose path, except the opposing attorney attempts to lull the expert into a false sense of security by asking a series of questions where the appropriate answer is “yes.” Then, once the expert is nodding his or her head and saying “yes,” a question that is better answered with a “no” or “yes, with explanation” is offered and the expert continues to answer “yes” before realizing what just happened.
  • Ask Until You Admit: Using this technique, opposing counsel keeps reframing the question until they have it in such a way that the “yes” or “no” answers are favorable to their client, at which time, they are done asking questions.
  • You’ve Got to Be Kidding!: Opposing counsel takes particular aspects of your testimony or report out of context and acts indignant about the conclusion or opinion because, out of context or without additional evidence, it appears nonsensical or unsupported.
  • This Means Nothing: This is an attempt to get an admission that in the bigger picture, the findings are of minimal importance and have little bearing on the case or are applicable only to a small portion of it.
  • You Really Didn’t Mean to Say … : Using this technique, opposing counsel attempts to minimize the impact of your testimony by suggesting that certain small aspects, taken out of context, seem to make little sense.

The fraud examiner or forensic accountant should remember to be alert for tricks such as these and to make sure to provide a response and an explanation when needed. For example, it may be okay to answer “yes” to two or three questions in a row, but after a few “yes” answers, the savvy expert tries to see where the opposing attorney is heading and limit his or her ability to score points that are form more than substance. At the same time, antifraud and forensic accounting professionals need to understand that skillful attorneys have destroyed many a good expert witness’s report—not because the work wasn’t excellent or the conclusions and opinions weren’t supportable and grounded in the evidence but because the opposing attorney was able to wage a war of words and win. The fraud examiner or forensic accountant needs to understand that our world is fundamentally composed of numbers and that understanding and interpreting them is second nature. Following the money through complex schemes that include skillful concealment is what we do, but when we walk into a deposition or courtroom, we move from an environment in which numbers are the primary focus to one in which words carry the day. Expert witnesses need to develop knowledge, skills, and abilities in this world of words.

How the expert witness deals with the world of words:

  • Draw reasonable conclusions and opinions that are grounded in the evidence.
  • Know your case and get the information that you need.
  • Exhibit self-confidence.
  • Maintain a steady focus and concentration.
  • Listen and think.
  • Stay in your sandbox!!!
  • Periodically ask the attorney to clarify a question.
  • Cooperate within limits, but stand your ground.
  • Maintain your credibility.
  • Do not shoot from the hip.
  • Admit the unfavorable or unknown when it is reasonable to do so.
  • Be a teacher.

Testifying Can Turn Nasty

Jacqueline Harper is a retired Internal Revenue Service, Criminal Investigator with more than 25 years of government service. She began her career as a special agent and ended her career as a supervisory special agent, overseeing approximately 10 to 12 agents and support staff. As an agent, her investigations included the financial investigations of organized crime families, narcotics, and various white-collar financial investigations. In the following, she notes that sometimes, questioning by opposing counsel may turn personal, and she offers advice to help you anticipate and respond to such attacks.

From Jackie Harper…

When an opposing attorney cannot argue the facts or evidence, he or she will frequently call the forensic accountant’s or fraud examiner’s credibility into question. The forensic professional is often held to a higher standard than a fact witness and, opposing counsel may hire investigators to find areas in the forensic accountant’s life—both professional and, possibly, personal—that can be exploited to discredit the forensic accountant in the eyes of a judge or jury. As an IRS Criminal Investigator, an agent with numerous years’ experience, an actual incident in an investigation clearly demonstrates this concern.

An agent who had direct knowledge of an illegal gambling business testified regarding placing bets with the subject(s) of the criminal investigation in an undercover capacity. The agent was cross examined by defense counsel.

Defense counsel in this investigation was a former government attorney, who had worked closely with the testifying agent on other, past investigations before leaving government service. When the agent and attorney worked together previously, they frequently got together with other friends and played poker “for fun and small bets.

During cross examination, defense counsel questioned the agent about his fondness for playing cards. Defense counsel made effective use of their recreational card-playing days before the jury. While it is not illegal for a group of friends to play poker for entertainment, it is illegal for the “house” or unlicensed gambling business to take a percentage of the proceeds for the “house.” The agents and defense counsel who played for “fun and small bets” had done nothing illegal; but, to the jury, it looked otherwise, and former friends saw themselves at professional odds.

Defense counsel took advantage of a situation most people would consider part of their personal life that would not, or should not, have any impact on their professional life. It is situations, such as this—when defense counsel cannot attack the evidence—some will attack the witness. In this example, while undercover, the agent gambled with the individual(s) under investigation. Since the facts entered into evidence could not be argued, the attorney took a personal situation and used it to discredit the agent. It is unlikely the agent ever thought that such an inconsequential situation in his or her personal life would be used in such a manner.

With today’s social media, the forensic professional should be cautioned about their online posts and how they may be used to discredit them in the future. An innocent enough picture or post, which in hindsight the professional may view as stupid or inconsequential, can and will be used by opposing counsel to substantially disgrace or discredit the professional and his or her testimony.

In another situation, the government was prosecuting an individual for financial crimes. Voluminous documents and financial records had been entered into evidence to prove the government’s theory of the case. Most of the records were the subject’s own records and were corroborated through records of various third parties’ and witnesses’ testimony.

When defense counsel could not attack the records and third party testimony, they attacked the agent. For an approximate four (4) week trial, defense counsel referred to the agent as a “nut case.” During 5-6 hours of questioning, defense counsel repeatedly referred to the agent as a “nut case” who had a bias against the subject’s business and industry.

It is very difficult to not let situations such as this become personal. Fraud examiners and forensic accountants must maintain a professional demeanor, even when being personally attacked. If they understand that while this type of personal attack is uncomfortable and, sometimes, even painful, it is because the evidence gathered is so strong and persuasive that defense counsel has nothing else to attack.

Depositions are another avenue where defense attorneys will personally attack the agent. Because there is not a judge present, defense counsel can ask the agent anything and the agent must answer. The attorney representing your investigation can object to the question but the witness must still answer. The defense attorney may use the personally insulting questions just to shatter your confidence or composure.

As an example, an employee asked for a meeting with a supervisor. As the employee entered the supervisor’s office, he or she would close the door for privacy. During a deposition, opposing counsel asked why the office door was closed—was the supervisor having sex on the desk with the employee? Opposing counsel knew this was not true, and had no basis for the question; but while the government attorney objected, the question had to be answered in a calm professional manner.

One must understand, opposing counsel was trying to get an antagonistic or hostile reaction from the agent to use in their defense. As stated repeatedly in this chapter, maintain your professionalism and answer the questions in a calm and professional manner. Do not react in the manner in which they hoped you would respond.

Module 4: Restructure the Internal Control Environment

Once bitten, twice warned.

Fool me once, shame on you; fool me twice, shame on me.

One of the attributes of the antifraud professional or forensic accountant is a willingness to prevent or deter future undesirable activity. Even in civil litigation, an examination of policies and procedures should be carried out to determine what led to the dispute, how it evolved into litigation, and what could be done to prevent such actions in the future. Once an issue, such as a civil dispute, gets into the legal system, everyone loses something and expends significant time and money.

Unfortunately, it is often only with the pain of civil or criminal litigation or a large financial loss that a company critically assesses its antifraud and compliance programs. A root cause analysis will identify the antifraud or other breakdown that gave rise to the bad acts. Once the root causes have been identified, tools and techniques can be used to repair the internal control or antifraud framework, as necessary.

Root Cause and Critical Thinking

The following is adapted from a post by Jonathan T. Marks, CPA, CFF, CFE to his blog, BoardandFraud.com, on February 2, 2018.

Mr. Marks has more than 30 years of experience working closely with clients, their board, senior management, internal audit, and law firms on fraud, misconduct, cyber (data breach), global bribery (FCPA, UKBA), and whistleblower matters and, when appropriate, conducting investigations (10A, cross-border, etc.), performing root cause analyses, developing remedial procedures, designing or enhancing governance, global risk management, and compliance systems, along with internal controls, and policies and procedures to mitigate future potential issues. Marks is a highly regarded speaker, author, and thought leader in the governance, risk assessment, risk management, compliance, and fraud areas.

From Jonathan Marks…

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If you don’t ask the right questions, you don’t get the right answers. A question asked in the right way often points to its own answer. Asking questions is the ABC of diagnosis. Only the inquiring mind solves problems.”—Hodnett

Root cause analysis is a tool to help identify not only what and how an event occurred, but also why it happened. When we are able to determine why an event or failure occurred, we can then recommend workable corrective measures that deter future events of the type observed.

When conducting a root cause analysis, many use the 5 Why’s technique. By repeatedly asking the question “Why”, you can peel away the layers of symptoms, which can help lead to the root cause of a problem. The 5 Why’s is a stand-alone technique, but is often used in connection with the fishbone (Cause and Effect or Ishikawa) diagram. The fishbone diagram helps explore potential or real causes that result in a single defect or failure. Once all inputs are established on the fishbone, you can use the 5 Why’s technique to drill down to the root causes.

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It’s important the individual(s) conducting the root cause analysis is/are thinking critically by asking the right questions (sometimes probing), applying the proper level of skepticism and, when appropriate, examining the information from multiple perspectives.

In order to ask “why,” questions need to be asked, received, and feedback delivered. The use of Socratic questioning is a nice tool that could help in a variety of ways.

Socratic questioning is at the heart of critical thinking and is based on logic and structure that emphasizes that any single statement only partially reveals a piece of thinking underlying it. The purpose is to expose the logic of someone’s thoughts.

Socratic questioning is disciplined questioning that can be used to pursue thought in many directions and for many purposes, including: to explore complex ideas, to get to the truth, to open up issues and problems, to uncover assumptions, to analyze concepts, to distinguish what we know from what we don’t know, to follow logical implications of thought, or to control the discussion.

Over the years, I have cobbled together from various sources, some examples of Socratic questions, as follows:

  • Questions for clarification – Prove the concepts behind their argument. Use basic tell me more questions that get them to go deeper.
    • Why do you say that?
    • How does this relate to our discussion?
    • Can you give me an example?
    • Can you rephrase that?
  • Questions that probe assumptions – Probing their assumptions makes them think about the presuppositions and unquestioned beliefs on which they are founding their argument.
    • What could we assume instead?
    • How can you verify or disapprove that assumption?
    • What would happen if …?
  • Questions that probe reasons and evidence – When they give a rationale for their arguments, dig into that reasoning rather than assuming it is a given. People often use un-thought-through or weakly understood supports for their arguments.
    • What would be an example?
    • What is … analogous to?
    • What do you think causes this to happen …? Why:?
    • What evidence is there to support what you are saying?
    • On what authority are you basing your argument?
  • Questions about Viewpoints and Perspectives – Most arguments are given from a particular position. So attack the position. Show that there are other, equally valid, viewpoints.
    • What would be an alternative?
    • What is another way to look at it?
    • Would you explain why it is necessary or beneficial, and who benefits?
    • Why is this the best …?
    • What are the strengths and weaknesses of …?
    • How are … and … similar?
    • What is a counter argument for…?
  • Questions that probe implications and consequences – The argument that they give may have logical implications that can be forecast.
    • Do these make sense? Are they desirable?
    • What generalizations can you make?
    • What are the consequences of that assumption?
    • What are you implying?
    • How does … affect …?
    • How does … tie in with what we learned before?
    • What is the best …? Why?
  • Questions about the question – And you can also get reflexive about the whole thing, turning the question in on itself. Use their position against themselves. Bounce the ball back into their court, etc.
    • What was the point of this question?
    • Why do you think I asked this question?
    • What does … mean?

The key to distinguishing Socratic questioning from questioning per se is that Socratic questioning is systematic, disciplined, and deep, and usually focuses on fundamental concepts, principles, theories, issues or problems.

Overview of an Antifraud Environment

Creating an antifraud and compliant environment requires critical thinking and an ability to solve problems in an innovative way. If one can identify the risk, a system of internal controls, policies, and procedures can be created to prevent it or minimize negative impacts, if such acts occur. The challenge is to find out how others, for example, a potential perpetrator, might exploit the system for gain. To identify opportunities to exploit control weaknesses, the fraud examiner or forensic accountant must “think like a criminal.” Further, they should understand the effective antifraud and compliance environment and its related processes and controls: “tone at the top,” an ethical culture, a strong control environment, code of conduct, open communications with suppliers and customers, employee monitoring, hotlines, whistleblower protection, willingness to enforce penalties against perpetrators, and proactive fraud auditing.4 The professional must then analyze potential frauds to identify systemic vulnerabilities and implement procedures to reduce the risk.

Internal Control Policies and Procedures

A company should develop a system of internal controls that provides reasonable assurance that assets are protected and financial statements are fairly presented. Of course, even the best system of internal controls may be at risk when employees collude to beat the system or management and executives override that system. Thus, despite efforts to install and maintain a reliable and effective system of internal control, it is impossible to prevent all frauds and acts of noncompliance. That is not to suggest that antifraud procedures cannot be established to prevent most specific types of fraud; however, when considering the entire company, the focus needs to shift from prevention to deterrence to create an antifraud environment.

A good system of internal controls has four separate areas of responsibility: one person is responsible for safeguarding the assets; another person has authority over transactions associated with the asset; a third person is responsible for recording transactions for assets; and a fourth person should orchestrate a system of audits, physical inventories, and reconciliations. A system with these attributes will not eliminate fraud and noncompliance but can alert the appropriate individuals to the occurrence of bad acts at the earliest possible moment.

In addition to the above controls that are already in place, a system to constantly monitor the control environment is also necessary. The entity must undertake periodic risk assessment. What could go wrong? How could the system of internal controls be exploited? What new aspects of our business have arisen for which assets need identification and protection? A good control environment also generates information so that responsible persons can monitor it and facilitate communication. The control environment also includes the following5:

  • Integrity and ethical values
  • A commitment to competent employees
  • An active board of directors and audit committee
  • Clear signals from management about its philosophy and commitment to ethical operations
  • An organizational structure that defines authority, responsibility, record keeping, and audit expectations
  • Periodic assessment of the organizational structure
  • Human resource policies and practices that facilitate a good control environment

Risk Assessment and Internal Control

At the inception of an examination, the fraud examiner or forensic accountant needs to develop an understanding of the control environment. This can be accomplished by discussing internal controls with executives, management, and other employees. Such an understanding can be documented in narrative form that addresses the origination or source of the documents, the processing that takes place, the disposition of those documents, their recording in the system, and an assessment of the control risk. This kind of narrative supplemented with a graphic, such as a flowchart, can be very helpful in assessing risk. Each step in the process can be identified on the flowchart and an assessment done at each important point in the process. Internal questionnaires, pre-developed checklists, and policy and procedures manuals can also be used to develop an understanding of the system of internal controls.

Once this has been completed, the professional can then test the system by tracing documents and information through that system to determine whether it functions as designed. Operational breakdowns indicate that even though the system may be properly designed, it may not be functioning as planned. Such tests should address each aspect of the internal control environment: responsibility for physical safeguard, authority for transactions, record keeping, and the audit (reconciliation) process. Tests require the professional to scrutinize not only the flow of paper but also to examine documents and records, observe activities as they occur, discuss policies and procedures with line personnel, and re-perform aspects of the procedures to ensure that the outcomes are accurate.

At this point, the fraud examiner or forensic accountant should also consider those key controls that should be in place but appear to be absent. Once vulnerabilities are identified, the professional needs to communicate those findings and assist management in developing an appropriate cost-justified response. Ultimately, success requires a questioning mind, examining policies and procedures at the operational level, and looking for opportunities for management override.

The Importance of Corporate Governance

Corporate governance is the set of processes, customs, and policies that affect the way an organization is directed. It also considers the relationships among the stakeholders and the goals of the organization. The principal organizational leaders responsible for corporate governance include the board of directors, the audit committee, executives, management, and the shareholders. Other stakeholders with an interest in corporate governance include employees, suppliers, customers, banks and other creditors, regulators, and the community in which the organization operates. In general, corporate governance deals with issues of accountability and fiduciary duty, essentially those attributes advocating the implementation of guidelines and mechanisms to ensure good behavior by the organization and the protection of shareholder value.

The corporate governance fabric is critical for creating an environment in which the risk of fraud is minimized through a combination of fraud prevention, deterrence, and early detection and resolution tools and techniques. At a minimum, corporate governance should address three issues6:

  1. Creating and maintaining a culture of honesty and high ethics
  2. Evaluating fraud risks and implementing programs and controls to mitigate them
  3. Developing an appropriate antifraud oversight process

Based on the concept that employees follow their leaders, first responsibility of management and executives is to set an ethical “tone and conduct at the top,” creating a culture that reinforces honesty and integrity. Beyond that, good corporate governance also fosters the following:

  • Establishing a positive work environment by implementing programs and initiatives to enhance employee morale
  • Hiring and promoting employees who meet the high ethical standards of the entity (including background checks, verifying employment and education, and contacting personal references)
  • Training
  • Supervising
  • Confirming commitment to the code of conduct by educating personnel
  • Disciplining those employees who fail to follow the code of conduct
  • Identifying and measuring fraud risks
  • Mitigating fraud risks within reasonable limits of cost constraints
  • Monitoring fraud prevention programs and controls

The audit committee is an integral player in corporate governance, especially when it comes to financial reporting. The audit committee should manage the annual audit and also have internal audit report directly to them.

The Risk of Management Override

One of the most disturbing aspects of the audit process and corporate governance responsibility is that a certain cohort can do almost anything they want despite the systems of checks and balances designed to prevent asset misappropriation and financial statement fraud. This is referred to as management override. This issue is of such a concern that in 2005 the AICPA issued “Management Override of Internal Controls: The Achilles’ Heel of Fraud Prevention.” Essentially, the audit committee and the board of directors have the responsibility to address fraud risk. The document tasks audit committees as follows:

  • Maintain skepticism
  • Strengthen the audit committee’s understanding of the business
  • Brainstorm to identify fraud risks
  • Use the code of conduct to assess the financial reporting culture
  • Cultivate a vigorous whistleblower program
  • Develop a broad information and feedback network including internal auditors, independent auditors, the compensation committee, and key employees

From a practical perspective, the audit committee should make sure that the auditors have examined journal entries and other adjustments for evidence of possible misstatement due to fraud, review accounting estimates for biases, and evaluate the business rationale for significant unusual transactions. Audit committees should be vigilant for the following7:

  • Discrepancies in the accounting records
  • Conflicting or missing evidential matter
  • Problematic or unusual relationships between management and auditors
  • Results from audit testing that indicate previously unidentified risks of fraud
  • Responses to management inquiries that are vague or implausible

Early Reaction to Symptoms

Albrecht notes six types of symptoms that may indicate a fraud is occurring8:

  • Accounting anomalies including irregular, unusual, or missing source documents, faulty journal entries, and inaccuracies in ledgers and subledgers
  • Internal control weaknesses including the lack of segregation of duties, physical safeguards, independent checks, proper authorization of documents and records; override of existing controls by executives or management; and inadequate accounting and other (nonfinancial) information systems.
  • Analytical anomalies including shortages of inventory and cash, deviations from design and quality specifications, excessive scrap, excessive voids, excessive purchasing levels, ratios that do not make sense, nonfinancial numbers that do not correlate with account balances and numbers presented in the financial statements, strange financial relationships, and excessive late charges
  • Extravagant lifestyles including new and expensive cars, expensive clothing, new or remodeled homes, and expensive recreational toys such as boats, cabins, and motor homes
  • Unusual behavior generated by stress including offering excuses for shortcomings, excessive frustration, being overly defensive, argumentative, irritable, suspicious or belligerent, complaints of sleeplessness, excessive drinking, or taking drugs
  • Tips and complaints from employees, customers, suppliers, family, and friends

A good antifraud environment requires awareness of these types of symptoms and, once observed, quick reaction to ensure that any possible fraud or noncompliance is caught at the earliest possible moment. Eliminating fraud and noncompliance completely is impossible, but companies can be vigilant and react quickly by investigating the red flags that may indicate that a bad act is taking place. The following is a five-step approach to fraud prevention, deterrence, and detection:

  1. Know the exposures (brainstorming, risk assessment, audit planning).
  2. Translate exposure into likely symptoms.
  3. Always be on the lookout for these symptoms.
  4. Build supervisory, review and audit programs to look for symptoms.
  5. Follow up on these issues to their logical, evidence-based conclusions.

AICPA Statement on Auditing Standard (SAS) No. 99, “Risk Factors Relating to Misstatements Arising from Fraudulent Financial Reporting”

The following are examples of risk factors relating to misstatements arising from fraudulent financial reporting.

Incentives/Pressures

  1. Financial stability or profitability is threatened by economic, industry, or entity operating conditions such as (or as indicated by):
    • High degree of competition or market saturation, accompanied by declining margins
    • High vulnerability to rapid changes, such as changes in technology, product obsolescence, or interest rates
    • Significant declines in customer demand and increasing business failures in either the industry or overall economy
    • Operating losses making the threat of bankruptcy, foreclosure, or hostile takeover imminent
    • Recurring negative cash flows from operations or an inability to generate cash flows from operations while reporting earnings and earnings growth
    • Rapid growth or unusual profitability, especially compared to that of other companies in the same industry
    • New accounting, statutory, or regulatory requirements
  2. Excessive pressure exists for management to meet the requirements or expectations of third parties due to the following:
    • Profitability or trend level expectations of investment analysts, institutional investors, significant creditors, or other external parties (particularly expectations that are unduly aggressive or unrealistic), including expectations created by management in, for example, overly optimistic press releases or annual report messages
    • Need to obtain additional debt or equity financing to stay competitive, including financing of major research and development or capital expenditures
    • Marginal ability to meet exchange listing requirements or debt repayment or other debt covenant requirements
    • Perceived or real adverse effects of reporting poor financial results on significant pending transactions, such as business combinations or contract awards
  3. Information available indicates that personal financial situation of management or the board of directors is threatened by the entity’s financial performance arising from the following:
    • Significant financial interests in the entity
    • Significant portions of their compensation (e.g., bonuses, stock options, and earn-out arrangements) are contingent upon achieving aggressive targets for stock price, operating results, financial position, or cash flow
    • Personal guarantees of the entity’s debts
  4. There is excessive pressure on management or operating personnel to meet financial targets set by the board of directors or management, including sales or profitability incentive goals.

Opportunities

  1. The nature of the industry’s or the entity’s operations provides opportunities to engage in fraudulent financial reporting that can arise from:
    • Significant related-party transactions not in the ordinary course of business or with related entities not audited or audited by another firm
    • A strong financial presence or ability to dominate a certain industry sector that allows the entity to dictate terms or conditions to suppliers or customers that may result in inappropriate or nonarm’s-length transactions
    • Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgments or uncertainties that are difficult to corroborate
    • Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult “substance over form” questions
    • Significant operations located or conducted across international borders in jurisdictions where differing business environments and cultures exist
    • Significant bank accounts or subsidiary or branch operations in tax-haven jurisdictions for which there appear to be no clear business justifications
  2. There is ineffective monitoring of management as a result of:
    • Domination of management by a single person or small group (in a non-owner-managed business) without compensating controls
    • Ineffective board of directors or audit committee oversight over the financial reporting process and internal control
  3. There is a complex or unstable organizational structure, as evidenced by:
    • Difficulty in determining the organization or individuals that have controlling interest in the entity
    • Overly complex organizational structure involving unusual legal entities or managerial lines of authority
    • High turnover of senior management, counsel, or board members
  4. Internal control components are deficient as a result of:
    • Inadequate monitoring of controls, including automated controls and controls over interim financial reporting (where external reporting is required)
    • High turnover rates or employment of ineffective accounting, internal audit, or information technology staff
    • Ineffective accounting and information systems, including situations involving reportable conditions

Attitudes/Rationalizations

Risk factors reflective of attitudes/rationalizations by board members, management, or employees that allow them to engage in and/or justify fraudulent financial reporting may not be observable by the auditor. Nevertheless, the auditor who becomes aware of the existence of such information should consider it in identifying the risks of material misstatement arising from fraudulent financial reporting. For example, auditors may become aware of the following information that may indicate a risk factor:

  • Ineffective communication, implementation, support, or enforcement of the entity’s values or ethical standards by management, or the communication of inappropriate values or ethical standards
  • Nonfinancial management’s excessive participation in, or preoccupation with, the selection of accounting principles or the determination of significant estimates
  • Known history of violations of securities laws or other laws and regulations, or claims against the entity, its senior management, or board members alleging fraud or violations of laws and regulations
  • Excessive interest by management in maintaining or increasing the entity’s stock price or earnings trend
  • A practice by management of committing to analysts, creditors, and other third parties to achieve aggressive or unrealistic forecasts
  • Management failing to correct known reportable conditions on a timely basis
  • An interest by management in employing inappropriate means to minimize reported earnings for tax-motivated reasons
  • Recurring attempts by management to justify marginal or inappropriate accounting on the basis of materiality
  • The relationship between management and the current or predecessor auditor is strained, as exhibited by:
    • Frequent disputes with the current or predecessor auditor on accounting, auditing, or reporting matters
    • Unreasonable demands on the auditor, such as unreasonable time constraints regarding the completion of the audit or the issuance of the auditor’s report
    • Formal or informal restrictions on the auditor that inappropriately limit access to people or information or the ability to communicate effectively with the board of directors or audit committee
    • Domineering management behavior in dealing with the auditor, especially involving attempts to influence the scope of the auditor’s work or the selection or continuance of personnel assigned to or consulted on the audit engagement

AICPA Statement on Auditing Standard (SAS) No. 99 (AU 316), “Consideration of Fraud in a Financial Statement Audit” (Supersedes SAS No. 82, “Risk Factors Relating to Misstatements Arising from Misappropriation of Assets”) and SAS 109 (AU 314), “Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement”

Both SAS 99 and SAS 109 formalize an auditor’s responsibility to (1) obtain knowledge about an entity’s business and the industry in which it works; and (2) make inquiries to identify the risks of material misstatement. Risk factors that relate to misstatements arising from misappropriation of assets are also classified according to the three conditions, generally present when fraud exists: incentives/pressures, opportunities, and attitudes/rationalizations. Some of the risk factors related to misstatements arising from fraudulent financial reporting may also be present when misstatements arising from misappropriation of assets occur. For example, ineffective monitoring of management and weaknesses in internal control may be present when misstatements due to either fraudulent financial reporting or misappropriation of assets exist. The following are examples of risk factors related to misstatements arising from misappropriation of assets.

Incentives/Pressures

  1. Personal financial obligations may create pressure on management or employees with access to cash or other assets susceptible to theft to misappropriate those assets.
  2. Adverse relationships between the entity and employees with access to cash or other assets susceptible to theft may motivate those employees to misappropriate those assets. For example, adverse relationships may be created by the following:
    • Known or anticipated future employee layoffs
    • Recent or anticipated changes to employee compensation or benefit plans
    • Promotions, compensation, or other rewards inconsistent with expectations

Opportunities

  1. Certain characteristics or circumstances may increase the susceptibility of assets to misappropriation. For example, opportunities to misappropriate assets increase when there are:
    • Large amounts of cash on hand or processed
    • Inventory items that are small in size, of high value, or in high demand
    • Easily convertible assets, such as bearer bonds, diamonds, or computer chips
    • Fixed assets that are small in size, marketable, or lacking observable identification of ownership
  2. Inadequate internal control over assets may increase the susceptibility of misappropriation of those assets. For example, misappropriation of assets may occur because there is:
    • Inadequate segregation of duties or independent checks
    • Inadequate management oversight of employees responsible for assets, for example, inadequate supervision or monitoring of remote locations
    • Inadequate job applicant screening of employees with access to assets
    • Inadequate record keeping with respect to assets
    • Inadequate system of authorization and approval of transactions (e.g., in purchasing)
    • Inadequate physical safeguards over cash, investments, inventory, or fixed assets
    • Lack of complete and timely reconciliations of assets
    • Lack of timely and appropriate documentation of transactions, for example, credits for merchandise returns
    • Lack of mandatory vacations for employees performing key control functions
    • Inadequate management understanding of information technology, which enables information technology employees to perpetrate a misappropriation
    • Inadequate access controls over automated records, including controls over, and reviews of, computer systems event logs

Attitudes/Rationalizations

Risk factors reflective of employee attitudes/rationalizations that allow them to justify misappropriations of assets are generally not susceptible to observation by the auditor. Nevertheless, the auditor who becomes aware of the existence of such information should consider it in identifying the risks of material misstatement arising from misappropriation of assets. For example, auditors may become aware of the following attitudes or behavior of employees who have access to assets susceptible to misappropriation:

  • Disregard for the need for monitoring or reducing risks related to misappropriations of assets
  • Disregard for internal control over misappropriation of assets by overriding existing controls or by failing to correct known internal control deficiencies
  • Behavior indicating displeasure or dissatisfaction with the company or its treatment of employees
  • Changes in behavior or lifestyle that may indicate assets have been misappropriated

Lessons Learned

Finally, the examination process, including deposition and courtroom testimony, provides an excellent foundation for developing a knowledge repository for sharing lessons learned. This concept was developed at the Financial Investigative Services Division of the Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF) under the direction of its chief, Franco Frande. This repository can be used as a basis for new employee training and periodic staff training and education and as a place for investigative ideas. The tools and techniques of the fraudster and others who steal, conceal their efforts, and benefit from those efforts (the conversion) are only limited by the human imagination, and a knowledge repository is a perfect mechanism for gathering and storing lessons learned so that future fraud examiners and financial forensic professionals can be brought up to speed quickly and generate ideas as effectively and efficiently as possible.

Forensic accounting, as defined in this book, is the use of accounting for possible courtroom purposes. The reader has been exposed to a wide variety of concepts, including the core foundation related to forensic accounting and fraud examination; careers in this field; who commits fraud and why; the legal, regulatory, and professional environment; various schemes used to perpetrate fraud; fraud’s red flags and targeted risk assessment; evidence-based fraud examinations; effective interviewing and interrogation techniques; how to use information technology for fraud examination and financial forensics; complex frauds and financial crimes; cybercrime; antifraud and compliance strategies; consulting, litigation support, and expert witnessing; and remediation and litigation advisory services.

But a major aspect is fraud; it may even be the largest single segment of forensic accounting, which is why the topic is covered so extensively in these pages. Fraud is frequently investigated by those with little or no accounting knowledge. Except for fraudulent financial statements, not much accounting knowledge is needed to trace ill-gotten gains, examine bank accounts, or inspect phony documents. The fraud examiner is part accountant, part detective, part legal scholar, and part criminologist. In short, all fraud examiners are not forensic accountants and vice versa, which is why the authors have made the distinction.

Both fraud examination and forensic accounting are growing fields with much career potential for the right individuals. They are both adversarial in nature—you are trying to prove something while your opponent is attempting to disprove it—and many people are uncomfortable with confrontation. In a civilized world, the courtroom is the ultimate venue for controlled confrontation.

Ultimately, the keys to advancement in any career are knowledge and experience. This book, which is a beginning, will add to your knowledge, but experience must be gained the old-fashioned way—by working in the field.

The authors close with this advice: By being thorough, detailed, knowledgeable, and scrupulously honest, you will win even if your case does not.

We have eight types of assignments for instructors to choose from:

  1. Critical Thinking
  2. Review Questions
  3. Multiple Choice Questions
  4. Fraud Casebook
  5. Brief Cases
  6. Major Case Investigation (MCI)
  7. IDEA Exercises
  8. Tableau Exercises

CRITICAL THINKING

  1. CT-1 Relationships Can Be Complicated: Part 1. A man and his son are in a car accident. The father dies on the scene, but the child is rushed to the hospital. When he arrives the surgeon says, “I can’t operate on this boy, he is my son!” How can this be?
  2. CT-2 Relationships Can Be Complicated: Part 2. A woman had two sons who were born on the same hour of the same day of the same year, but they were not twins. How can this be?

REVIEW QUESTIONS

  1. What is meant by remediation?
  2. What two points must an injured party prove to recover money in a civil lawsuit?
  3. What are the types of losses available for recovery?
  4. How does the legal system differentiate between “following” versus “tracing” the money?
  5. What legal mechanisms may be used to recover assets in the civil or criminal justice systems?
  6. What is the difference between fact witnesses and expert witnesses?
  7. In what types of cases may a forensic accountant serve as an expert witness?
  8. When may an expert’s opinion be subject to challenge?
  9. What is a deposition and why is it used?
  10. What is meant by corporate governance and why is it important?

MULTIPLE CHOICE QUESTIONS

  1. Which of the following is not part of the remediation process as it relates to fraud examination and forensic accounting?
    1. Identify and assess the control weaknesses that led to the original investigation.
    2. Assist in the recovery of money and assets.
    3. Testify, if needed.
    4. Investigate fraud act or forensic accounting issue.
  2. In a civil lawsuit, an injured party must demonstrate three attributes to recover money. Which of the following is not one of those attributes?
    1. The defendant was the proximate cause of the damages.
    2. The defendant caused the damages.
    3. Reasonable certainty with regard to the amount of damages.
    4. The defendant could reasonably predict the results of their actions.
  3. Which of the following is not an asset available for recovery?
    1. Money
    2. Damaged asset value
    3. Lost credit rating
    4. Market declines
  4. Select the statement that is least accurate:
    1. “Following the money” can only be performed if those assets remain in their original identifiable form as they flow from place to place or person to person.
    2. “Following the money” and “tracing the money” are essentially the same activity.
    3. “Tracing the money” is a process of identification: both the present location and form of value are relevant to a claim brought by a plaintiff or victim.
    4. “Following the money” assumes an ability to directly track funds from the victim to the alleged perpetrator and involves specificity, whereby the investigator can track the exact assets in question from the plaintiff or victim to the defendant.
  5. Which of the following is not a legal mechanism to recover assets through the civil or criminal justice systems?
    1. Jury order
    2. Freezing order
    3. Judgment
    4. Forfeiture
  6. Which of the following is least accurate with regard to a fact witness versus an expert witness?
    1. Fact witnesses may offer opinions based on specialized knowledge required as part of their normal responsibilities.
    2. Expert witnesses are limited to testify about firsthand facts and knowledge.
    3. The fact witness may offer an opinion based on the witness’s personal perceptions.
    4. The expert witness may offer opinions, which are the product of reasoning processes familiar to the average person in everyday life.
  7. Of all the attributes necessary for an investigation to be successful, with which of the following characteristics should the professional be most concerned?
    1. Credibility
    2. Defendable report
    3. Winning cross-examination
    4. Professional demeanor
  8. Related to cross-examination, which of the following statements is most accurate?
    1. Opposing counsel will know the expert’s field.
    2. Opposing counsel is not permitted to challenge the expert’s credibility unless errors are discovered.
    3. Opposing counsel will attempt two goals: destroy the credibility of unfavorable expert opinions and enhance their own theory of the case.
    4. Opposing counsel is not permitted to get angry and raise the level of his or her voice when questioning expert witnesses (only adverse fact witnesses).
  9. Which of the following is most accurate with regard to a deposition?
    1. Depositions are far more pleasant than trial testimony.
    2. The credibility of the expert witness is more important during deposition testimony.
    3. Engagement counsel will likely ask more questions during a deposition than opposing counsel.
    4. Questioning from opposing counsel in deposition testimony is likely to be far more extensive than the court room cross-examination.
  10. Which of the following is not considered part of corporate governance?
    1. Executive management
    2. Consultants to the board of directors
    3. The audit committee
    4. Internal audit

FRAUD CASEBOOK

HealthSouth

Read the following articles or other related articles regarding the HealthSouth case and then answer the questions below:

Sources:

  • Voreacos, David , “HealthSouth Executives Plead Guilty,” The Globe and Mail (Canada), April 4, 2003.
  • Vicini, James , “HealthSouth’s Scrushy to Face Criminal Charges: Fraud, Money Laundering,” National Post’s Financial Post and FP Investing (Canada), November 5, 2003.
  • Whitmire, Kyle , “HealthSouth to Pay $3 Million in U.S. Accounting Fraud Case,” The New York Times, May 19, 2006.
  • Romero, Simon and Kyle Whitmire, “Former Chief of HealthSouth Acquitted in $2.7 Billion Fraud,” The New York Times, June 29, 2005.
  • Davidson, Laurence Viele , “Scrushy, Ex-Governor Convicted,” The Philadelphia Inquirer, June 20, 2006.
  • Davidson, Laurence Viele , “HealthSouth’s Scrushy Gets 6 Years in Prison,” The Washington Post, June 29, 2007.
  • Rappeport, Alana , “Scrushy at Home on the Ranch,” CFO.com, June 6, 2008.

Short Answer Questions

  1. Of what offense was Scrushy ultimately convicted?
  2. How long was Mr. Scrushy’s prison sentence?
  3. What were the losses at HealthSouth associated with the fraud?
  4. How many former HealthSouth executives testified against Mr. Scrushy?
  5. How long was the Scrushy trial?
  6. Despite Mr. Scrushy’s acquittal, how many other HealthSouth executives went to jail?

Discussion Questions

  1. In your opinion, why did prosecutors fail to win a conviction of Scrushy in the HealthSouth accounting fraud case?
  2. How can an expert witness protect their credibility?
  3. An expert witness is hired by either the prosecution (plaintiff) or defense (defendant). Given that the expert witness has been hired by one side, how does he or she address challenges to their credibility?

MAJOR CASE INVESTIGATION

The Chapter 16 MCI assignment is Case Findings Communications: Written Report/PowerPoint Presentation. The following report writing/presentation checklist can be used as a rubric to evaluate the quality of the students’ work. A detailed overview of the case solution is provided in Chapter 15.

Student Material for step-by-step screenshots for completing the assignment are available from your instructor.

IDEA EXERCISES: ASSIGNMENT 16

ideaCase background: See Chapter 1.

Assignment: Write a report.

The written report should describe in some detail the anomalies identified in this forensic audit of the payroll records. The anomalies are summarized in the table prepared as part of Assignment 15, and additional details are provided for each assignment solution.

TABLEAU EXERCISES: ASSIGNMENT 16

tableauCase tableau background: See Chapter 1.

Assignment: Write a report that includes select Tableau graphics.

The written report should describe in some detail the anomalies identified in this forensic audit of the payroll records and present the Tableau graphical presentations. The anomalies are summarized in the table prepared as part of Assignment 15, and additional details are provided for each assignment solution.

Endnotes

Appendix A Fraud/Financial Crimes Report

NOTES:

  • Some exhibits referenced in this example are not attached. The topics discussed in the report are available in the text.
  • This example is not necessarily inclusive of all report elements.
  • Each fraud and/or financial crime report should be reflective of relevant case attributes and examination outcomes.

1. Executive Summary

Franklin and Bridget Campanella are co-owners of an enterprise, Campos, LLC, equipped with legally registered gambling machines, Donnie’s Players Lounge. The local police conducted a raid on one of four establishments, believed to be the headquarters, based on a tip from a former employee that illegal forms of gambling were also taking place. During this raid, $18,000 in cash was seized.

The Campanellas and Campos, LLC have been linked to four video poker gambling establishments in central and southern West Virginia. For the year 20×8, cash deposits to four bank accounts labeled Campos, LLC are being made on a regular basis. The total deposits for the period January through December 20×8 are $1,449,097. This amount is larger than reasonable given the capacity of the gambling business operation. Five months of 20×8 surveillance (April, May, June, July, and August) yielded average video gambling machine usage of 62%. Given the average customer spend per visit (per WV Gaming Commission data) and 62% capacity utilization, the maximum revenue that could be generated from the businesses is $547,200, a difference of $901,897. Further, Campos reported cost of goods sold on the 20x8 tax return of approximately of $383,000. This corresponds to a gross margin of 30% (($547,200 – 383,000 = 164,200)/547,200 = .300). 30% gross margin ties to industry and WV Gaming Commission gross margins for small video gambling operations. See analysis of surveillance, gross margins, and WV/industry data on Exhibit 1 (not included).

With the exception of credit card payments received in the form of a check from the credit card company totaling $89,251 for 20×8, more than 98% of cash deposits for the business were greater than $9,000 but less than $10,000 thereby avoiding federal Currency Transaction Report (CTR) reporting requirements. See analysis of deposits on Exhibit 2 (not included).

Illegal narcotics sales evidence indicates employees are likely being compensated for selling illegal narcotics. One of the employees, Louis Roland, was stopped for a routine traffic violation. Three ounces of cocaine and $14,500 in cash were in his possession. An informant has also witnessed Franklin Campanella meeting with known heroin and methamphetamine dealers and then later the same day with James Henry. James Henry, a convicted drug trafficker, was stopped on entry to the Grand Caymans on July 26, 20×7. An inspection of his baggage revealed $135,000 in cash.

Investigators have obtained additional information relating to the Campanellas’ personal assets and the financial activities of the business operations. Personal assets owned by the Campanellas support the money laundering proceeds possibly associated with illegal gambling and narcotics sales. Asset holdings appear suspicious due to the amount, location, and method acquired. The lifestyle examination of the Campanellas also supports a 20×8 money laundering scheme. The money laundering proceeds that remain in the possession and/or control of the Campanellas are not reported on their 20×8 tax return, consistent with tax evasion.

The evidence is consistent with the conclusion that Franklin and Bridget Campanella are involved in money laundering scheme, possibly associated with the alleged sale and distribution of controlled substances as well as tax evasion (fraud). The evidences examined and presented herein suggest that, after sale and distribution of the product, the illegally obtained funds are laundered through four gaming locations in central and southern West Virginia.

2. Scope

A tip from a disgruntled ex-employee resulted in the local police opening an investigation and conducting an early morning raid. The local police requested an examination of the financial records seized during the raid, supplemented with records subpoenaed from Campos’ and Campanellas’ bank, tax returns, and other sources of evidence to determine whether that evidence is consistent with illegal activity having occurred in businesses operated by Bridget and Franklin Campanella.

3. Sources of Evidence

  • 20×6, 20×7, 20×8 tax returns: Campos, LLC
  • 20×7 and 20×8 bank account statements and canceled checks of the Campos, LLC
  • 20×7 and 20×8 WV Gaming Commission records for Paula’s High Stakes Hotspot, Donnie’s Players Lounge, High Rollers Hang-out and Lou’s High Life
  • 2017 and 2018 Campanella Personal tax returns
  • Campanella credit card records subpoenaed from bank
  • Surveillance records
  • WV Secretary of States Corporate Filings records: Campos, LLC and Video Gambling America

4. Background

Starting in 20×6, Bridget and Franklin Campanella became co-owners of a small local restaurant that had a gaming room in the back. In late 20×6, the restaurant operations were almost completely shut down and the dining space repurposed for video gambling. The gaming room consists of five video poker and slot machines that pay winning customers in tickets redeemable by cashing-out. A woman who had been employed by the Campos described a high stakes poker game that allegedly took place twice a month. Surveillance documented that Franklin Campanella hosted a high stakes poker game at least two Fridays per month in the gaming room attended by several prominent local businessmen and a regional mob boss.

Evidence was discovered at a murder scene at the home of Franklin Campanella’s parents (John and Martha Campanella) as seen in the crime scene evidence log, Exhibit 3 (not included). Pictures of the crime scene document where physical, electronic, and document evidence were found within the home were included with the log. This evidence and additional evidence provided by Lilly Duanne, CPA, and SA Cafrelli is consistent with alleged drug activity as further discussed below.

A link analysis, Exhibit 4 (not included), shows that Franklin and Bridget Campanella are owners of or are connected to three additional gambling establishments in central and southern West Virginia. Bridget is listed with the WV Gaming Office as the manager and operator of both Paula’s High Stakes Hotspot and Donnie’s Players Lounge. Franklin is listed with the WV Gaming Office as the manager and operator of High Rollers Hang-out and Lou’s High Life list, an address that is also shared by a bank account that is the same as that of Campos, LLC. The primary full-time employee of each of the above (4) locations has prior known activity associated with narcotics trafficking.

Several hypotheses were developed in this case, and most were not supported by the evidence. A careful review and analysis suggests that two hypotheses were most likely to be relevant to the examination: (1) Franklin and Bridget Campanella are laundering money and committing tax fraud through their businesses, possibly from the sale of narcotics; (2) Franklin and Bridget Campanella are not laundering money through their businesses. Evidence was classified for each hypothesis within the triangle of fraud action: the act, the benefit (conversion), and the concealment.

5. Examination

5a. The Act

Financial data from four bank accounts were analyzed for the period January 1, 20×7 through December 31, 20×8. The results for 20×8 are presented in the bank account analysis; see Exhibit 5 (attached). The results are as follows:

  • Bank of America account number 876523345 in the name of Bridget Campanella with a mailing address of 8766 Wiley Street, South Charleston, WV 26601 indicates during that time frame a total of $366,562 was deposited. During the same period, a total of $133,481 was claimed expenses of the gaming operation; with the exception of depreciation, the amounts for bank account disbursements tie to amounts on the tax return. However, while $366,562 was deposited, only $129,200 of revenue was reported on the tax return. $129,200 ties to WV Gaming Commission Records. Not reported on the tax returns but identified as bank account disbursements memoed as “supplies” paid to the order of Video Gambling America of $232,000, approximately the difference between tax return revenue and bank account deposits.
  • BB&T account number 676765347 in the name of Bridget Campanella with a mailing address of 76534 Morgantown Street, Summersville, WV 26554 indicates during that time frame a total of $362,873 was deposited. During the same period a total of $143,991 was claimed expenses of the gaming operation; with the exception of depreciation, the amounts for disbursements tie to the amounts on the tax return. However, while $362,873 was deposited, only $144,400 of revenue was reported on the tax return. $144,400 ties to WV Gaming Commission Records. Not reported on the tax returns but identified the disbursements as supplies paid to the order of Video Gambling America of $218,000, approximately the difference between tax return revenue and deposits.
  • BB&T account number 744320988 in the name of Franklin Campanella with a mailing address of 2344 Kentucky Avenue, Clarksburg, WV 26301 indicates deposits of $354,167 from January through December 20×8. During that same period, a total of $139,523 was claimed expenses of the gaming operation; with the exception of depreciation, the amounts for disbursements tie to the amounts on the tax return. However, while $354,167 was deposited, only $135,400 of revenue was reported on the tax return. $135,400 ties to WV Gaming Commission Records. Not reported on the tax returns but identified as disbursements as supplies paid to the order of Video Gambling America of $215,000, approximately the difference between tax return revenue and deposits.
  • Bank of America account number 65987456 in the name of Franklin Campanella with a mailing address of 3244 Riverview Drive, Madison, WV 26554 indicates deposits of $365,495 from January to December 20×8. During that same period, a total of $141,421 was claimed expenses of the gaming operation; with the exception of depreciation, the amounts for disbursements tie to the amounts on the tax return. However, while $365,495 was deposited, only $138,200 of revenue was reported on the tax return. $138,200 ties to WV Gaming Commission Records. Not reported on the tax returns but identified as disbursements as supplies paid to the order of Video Gambling America of $225,000, approximately the difference between tax return revenue and deposits.

Information provided by the gaming commission in Exhibit 6 (not included) indicates that the Campanellas have been operating a total of twenty gambling machines, five at each location. Commission records also indicate that these machines generate an average of $76 in revenue per day. $76 × 20 machines are equal to $1,520 per day. Assuming a seven-day operation week, there are 360 days from January through December: $1,520 × 360 = $547,200. With the exception of supplies “purchases” from Video Gambling America, tax return expenses equal revenues and reported taxable income is a small loss of $11,216.

Known deposits by the Campanellas for that period total $1,449,097, leaving a total of $901,897 ($1,449,097 – $547,200) unaccounted for. Each cash deposit made is over $9,000 but less than $10,000, indicating avoidance of Federal Reporting requirements of the Currency Transaction Report (CTR) and consistent with structuring, an illegal act. For example, the deposits for the month of January 20×8 (acct#876523345) are as follows: 01/07-$9,999.98, 01/22-$9,988.34, 01/31-$9,567.23.

In 20×7, this same approach was used to analyze and reconcile the Campos LLC bank account activity to the 20×7 tax return without exception. No payments to Video Gambling America were identified in the 20×7 bank records. As such, the activities described above appear to have been restricted to 20×8.

Primary evidence reviewed strongly indicates drug trafficking as illustrated in the commodity flow analysis in Exhibit 7 (not included). A memorandum from Lori Dunne, CPA, dated, 01/10/x9, states that Detective Davis has indicated an informant revealed separate meetings with known heroin and methamphetamine dealers and Franklin Campanella at 123 Henry Avenue. During such meetings, the dealer would bring an attaché case and would leave without it.

There is also surveillance evidence to support the contention that four full-time employees on the payroll for the High Roller’s Bar Hot Spot are selling illegal narcotics. Franklin Campanella would meet James Henry at an undisclosed location and exchange a briefcase. An informant and police surveillance suggest that the briefcase contained money from the illegal activity. James Henry made ten trips to the Grand Caymans during June and July 20×8. On the July 26, 20×8 trip, he claimed not to be carrying any cash in excess of $10,000 and when searched was carrying $135,000 cash. His address for these trips was indicated on the passenger listing as 123 Henry Ave in WV.

Based on a memorandum by SA Cafrelli, Mary O’Whitney of Bogota Columbia was stopped at the airport on October 13, 20×8. A search of her bag revealed 3 kg of white powder concealed in a bag. Upon further questioning, she claimed her business was with Bridget Campanella of Paula’s High Stakes and that Bridget had provided her with a ticket, $1,000 cash, a bag containing 3 kg of cocaine, and instructions to contact Louis Roland (a full-time employee of the High Roller’s) upon arrival. On November 22, 20×8, Louis Roland was stopped at a routine traffic stop, he was in possession of cocaine and carrying $14,500 cash, the vehicle was listed under the name of Donnie’s Player’s Lounge, 3244 Riverview Drive, Fairmont, WV.

5b. Concealment

The evidence analyzed related to checks written to Video Gambling America leads us to the conclusion that some of the funds deposited in the Campos bank account but not reported on the tax return are being laundered through a fictitious company, Video Gambling America, and expenditures from the fictitious company’s bank account are an effort to conceal the activity.

Secretary of States records indicate only one officer of Video Gambling America, Mr. Johnson P Lang. Birth and social security records indicate that Johnson P Lang is the son of Bridget Campanella, by her former husband, Danny Lang, and that in 20×8, Johnson P Lang would only be ten years old, had he not passed of pneumonia when he was three years old.

Subpoenaed bank records indicate checks written from the Video Gambling America bank account to employees of the four Campos video establishments, a local mob boss, and other known narcotics traffickers.

Further, the only source of deposits/revenue for Video Gambling America is Campos, LLC. Thus, the company has only one customer, has a PO Box for an address, and appears to have no known physical address.

Checks distributed from Video Gambling America’s bank account total $545,697; in addition, cash withdrawals totaling $356,200 from the Video Gambling America bank account were identified in 20×8. As noted on the timeline, Exhibit 8 (not included), while Campos has been in existence since 20×6, Video Gambling America was registered with the WV Secretary of State’s Office on December 28, 20×7. The number of bank accounts and various addresses listed on accounts and property holdings define a web of legal confusion that is consistent with concealment.

5c. Conversion (The Benefit)

The Campanellas own both real and personal property in West Virginia (home) and Florida (cabin) as well as an apartment complex, an office building, two luxury autos, an art collection, and investment portfolio. Documentary evidence indicates that many of the assets were acquired in 20×8. A net worth analysis as well as a source and use of funds (lifestyle) analysis was performed on the Campanellas personal accounts as well as known bank accounts. The net worth and lifestyle indirect methods suggest approximately zero income from unknown sources in 20×7 but approximately $356,200 in income from unknown sources in 20×8. This amount is approximately equal to the cash withdrawals from Video Gambling America discussed above. See Exhibit 9, Panels A and B (attached).

An examination of the Campanellas personal bank account, as well as their W-2s and tax returns, indicates that the Campanellas’ earned income from their regular full-time employment of $65,000 in 20×7 and $75,000 in 20×8; both work part-time as realtors for Hopkins Realty Company, devoting most of their work effort to Campos, LLC. Further, a review of their bank and credit card account activity, receipts, and canceled checks suggests that they spent about $55,000 and $70,000 for living expenses in 20×7 and 20×8, respectively.

6. Conclusion

The evidence examined and analyzed in this case is consistent with Franklin and Bridget Campanella being involved in alleged illegal activity of money laundering, structuring, and tax evasion (fraud). In addition, based on the evidence provided within the case, the source of the illegal funds may be illegal drug trafficking.

7. Caveat/Reservation

This report is based on the information received and examined as of the date of this report. Should additional information become available, facts become known, or additional inquiry arise, I reserve the right to modify or supplement the analysis as necessary. I may use graphics or other demonstrative exhibits, enlarged, colored, or otherwise adapted to illustrate or to help explain testimony at trial.

Respectfully,

{Electronic signature}

Richard A. Perot, CPA, CFE, CFF, CVA

Note: Exhibits 1, 2, 3, and 4 are not provided.

Exhibit 5: Campos LLC Analysis of Bank Account Activity

Tax Return Revenue Payouts Salary Rent Utilities, Insurance & Maintenance Depreciation Phone Supplies and Other Total “Income” Deposits Purchases to Video Gambling America Bank Balance
Deposits Bank of America Checking Acct# 65987456
$138,200 $96,750 $29,991 $8,500 $3,250 $1,850 $420 $660 $141,421 -$3,221 $365,495 $225,000 -$926
                           
BB&T Checking Acct# 744320988
  $135,400 $94,750 $31,133 $6,800 $3,350 $1,850 $450 $1,190 $139,523 -$4,123 $354,167 $215,000 -$356
                           
BOA Checking Acct#876523345
  $129,200 $90,450 $30,524 $7,500 $1,847 $1,850 $390 $920 $133,481 -$4,281 $366,562 $232,000 $1,081
                           
BB&T Checking Acct# 676765347
  $144,400 $101,050 $30,067 $7,000 $2,359 $1,850 $425 $1,240 $143,991 $409 $362,873 $218,000 $882
                           
Total Bank Account Activity $547,200 $383,000 $121,715 $29,800 $10,806 $7,400 $1,685 $4,010 $558,416 -$11,216 $1,449,097 $890,000 $681
    70.0%             $558,416 -$11,216     $681
  Gross  $164,200                      
  Profit                        
    30.0%               Tax         
                    Income      
Tax Return
Amounts
$547,200 $383,000 $121,775 $30,125 $10,800 $7,400 $1,695 $3,915 $558,416 -$11,216 $0 $0 n/a
                           
Differences $0 $0 -$60 -$325 $6 $0 -$10 $95 -$294 $0 $1,449,097 $890,000 n/a

Note: Exhibits 6, 7, and 8 are not provided.

Exhibit 9, Panel A: Camponellas Indirect Method of Income Analysis

Lifestyle - Sources and Application of Funds Method 20×6 20×7 20×8
Gross Income from Wages and Salaries (W-2/Tax Returns) 65,000 75,000
Application of Funds:
Mortgage Payments - Home 4,500 4,100
Mortgage Payments - Cabin 2,900 10,100
Mortgage Payments - Office Building 0 70,000
Mortgage Payments - Apartment Complex 0 20,000
Car Payments - Porsche 3,000 12,000
Car Payments - Mercedes 0 109,000
Art Collection 0 38,000
Stocks 0 98,000
Living Expenses (estimated from review of bank, CC statements/Cxl checks) 55,000 70,000
Total Application of Funds: 65,400 431,200
Income from Unknown Sources: $400 $356,200

Exhibit 9, Panel B: Camponellas Indirect Method of Income Analysis

Net Worth Method 20×6 20×7 20×8
Assets
House (453 Lexington Ct Morgantown) (Country Court House Records) 197,000 197,000 197,000
Lake Cabin (Country Court House Records) 97,000 97,000 97,000
Apartment Complex (Country Court House Records) 0 0 190,000
Office Building (Country Court House Records) 0 0 100,000
20×6 Porche (Dealership Records) 54,500 54,500 54,500
Mercedes 500 SEL (Dealership Records) 0 0 109,000
Art Collection (Reported to Art Club) 0 0 38,000
Stock Portfolio (Investment Statements) 0 0 98,000
Total 348,500 348,500 883,500
Liabilities
Mortgage on 453 Lexington Ct Morgantown (Mortgage Statement) 148,600 144,100 140,000
Mortgage on Lake Cabin (Mortgage Statement) 76,000 73,100 63,000
Mortgage on Apartment Complex (Mortgage Statement) 0 0 120,000
Mortgage on Office Building (Mortgage Statement) 0 0 80,000
Note Payable-Mercedes (Loan Statement) 15,000 12,000 0
Note Payable-Mercedes (Loan Statement) 0 0 0
Total 239,600 229,200 403,000
Net Worth 108,900 119,300 480,500
Changes in Net Worth 10,400 361,200
Add: Living Expenses 55,000 70,000
Total Income 65,400 431,200
Less: Income from Known Soruces 65,000 75,000
Income from Unidentified Sources 400 356,200

Appendix B Commercial Damages/Lost Profits Report

NOTES:

  • The analyses to support this report were examined in the prior chapter.
  • This example is not necessarily inclusive of all report elements.
  • Each commercial damages case report should be reflective of relevant case attributes and examination outcomes.

RE: Genuine Coal Corporation (Genuine) v.

Western USA Mineral Rights, Inc. Civil No. 18-254

Dear Mr. Steven,

I have reviewed the “closing documents” (contracts) for the purchase and sale of Genuine Coal and various financial information for the purposes of expressing an opinion on Genuine’s financial performance and financial condition. While I was given additional information to review, my opinions are based primarily on the following:

  1. Closing documents from the Agreement for Purchase and Sale
  2. Internal financial information, general ledgers, journal postings reports, internal financial statements, payroll records, and tax returns
  3. Depositions of Genuine’s former owner Mortar and new owner Pestle
  4. Various related party contracts and their WV Secretary of State online filings
Summary of Opinions
  1. Genuine earned just shy of $12,250,000, recovering 5 million tons of clean coal, approximately $2.45 per ton, from mining operations between 2014 and 2018. The sales price for clean coal during this period was $20 per ton (per long-term base coal contract).
  2. Despite these positive earnings, Genuine reported “book” and “tax” losses of ($1,250,000) or ($0.25) per ton on its 2014–2018 tax returns. The “book” losses agree to the amounts reported on internal financial statements for all years.
  3. The reason for the disparity between reported earnings and estimated actual earnings is expenses (disbursements) to related party companies, related to either former owner Mortar and/or new owner Pestle. Positive cash inflow before related party transactions totaled approximately $13.5 million, approximately $2.70 per ton. Alternatively stated:
    • Related parties billed Genuine for operating expenses in excess of $13.5 million.
    • The differential ($1,500,000) was loaned back to Genuine by another related party, Mountain Finance, LLC.
    • Outstanding debt to Mountain Finance, LLC, which is owned and controlled by former owner Mortar, totaled $1.5 million by December 31, 2018. This amount was secured by the assets of Genuine.
    • Despite discovery requests and deposition inquiries, no invoices for the disbursements by Genuine to related parties were provided by the plaintiff (Genuine).
    • Further, these vendors did not exist prior to 2014.
    • Additionally, the vendors that had been providing services to Genuine during the 2009–2013 period, in general, continued to do so at level correlated with the amount of coal mined by Genuine.
    • No business purpose for the expenditures by Genuine to its related party vendors could be established by discovery interrogatories, requests for production of documents, nor deposition testimony.
  4. Genuine’s reported losses and excess liabilities would likely give uninformed readers of the financial statements the impression of a failing company.
  5. Genuine’s transfer of cash flow to related party companies created an environment where Genuine did not replace aging equipment.
  6. The decline in tons produced, deteriorating financial condition, and lack of investment in mining equipment are consistent with Genuine’s cancelation of a coal supply agreement dated December 31, 2017 that included language that stated that Genuine determined to “discontinue its plans to pursue further mining/coal reserve activities.”
  7. Genuine’s transfer of cash flow to related party companies, its decline in assets, its debt to Mountain Finance, LLC is such that Genuine will be unable to satisfy its pension and healthcare benefits obligations to retired employees and other unsecured creditors.

    Overall, given that over a period of years, Genuine’s clean ton production was declining, Genuine’s overhead was increasing, and significant cash flow was being disbursed for the benefit of related parties and replaced with a loan to another related party, Genuine’s operations were such that the company was bound to result in this type of poor financial condition. Such a sustained pattern of business operations and financial performance would necessarily result in a company that was no longer financially viable and would be unable to meet its remaining financial obligations.

Background

Genuine had been mining for Western since 2009. During the period 2009–2018, Genuine had two contracts to mine two separate tracts of coal for Western. The tracts of coal were contiguous, mined in the same seam of coal, and premining engineering studies indicated that the geological characteristics of the tracts were indistinguishable. The first tract was mined during the period 2009–2013 and Genuine was paid for 7,500,000 tons of clean coal averaging $20 per ton, the contract price. The second tract was mined during the years 2014–2018; Genuine was paid for 5,000,000 tons of clean coal averaging $20 per ton, the contract price. In 2018, Genuine bid on a third contiguous tract of land at $21 per ton; however, Western awarded the mining to a competitor of Genuine for $20 per ton. At that point, Genuine filed suit against Western, alleging three issues (see Complaint Civil No. 18-254):

  1. The bidding process was unfair and that Genuine was entitled to the third contract with Western.
  2. During the second contract, premining engineering studies consisted of “core” drilling. This core drilling indicated that approximately 50.6% of the core was coal. In contrast, during the second contract, Genuine was only paid for clean coal percentage averaging 44.6%. As such, Genuine was underpaid by 6% of the clean coal. Thus, instead of mining and being paid for 5,000,000 clean tons, Genuine alleges that during the period 2014–2018, the company should have been paid for 5,673,000 tons.
  3. As a result of the underpayment and the failure to receive the third contract, Genuine was in a precarious financial position at the end of 2018 and may be forced to seek bankruptcy.

See Exhibit 1 for the Complaint Civil No. 18-254.

  1. Impact of Sale of Genuine on December 31, 2014
    1. On approximately December 31, 2014, an “Agreement for Purchase: Genuine Coal” was executed between former owner Mortar and new owner Pestle. The terms of the agreement included the following:
      1. A fixed payment amount in the form of a $2,400,000 promissory note by Genuine (0% interest, payable over 5 years at the rate of $40,000 per month) payable to former owner Mortar—secured with the assets of Genuine and characterized as “salary.”
      2. New owner Pestle signed a notes payable to Genuine in the amount of $500,000. A review of the cash account and officer receivable accounts indicates that this amount was never paid to Genuine.
    2. In addition to the agreement outlined in (i) above, some of the other agreements with the closing documents included the following:
      1. Payment amounts for ten (10) years at 20% of “projected earnings” (2014–2023) payable to Administration Consultancy Group, LLC—controlled by former owner Mortar and secured with the assets of Genuine.
      2. A tonnage Royalty of $0.25 per ton of clean coal mined—payable to Coal Operations Consulting, LLC—controlled by former owner Mortar and secured with the assets of Genuine.
      3. A management fee of $25,000 per month payable to Management Consultants, LLC—controlled by former owner Mortar and secured with the assets of Genuine.
      4. An “Aircraft Time Share” with Aeronautical, LLC, which required Genuine for a term of 5 years (and thereafter, month to month) to pay $250,000 per year plus all maintenance, upkeep, and rebuilding of the aircraft or its systems. Aeronautical, LLC is controlled by former owner Mortar and secured with the assets of Genuine.
      5. A “Coal Sales Agreement” with Mountain Ridge Sales, LLC. Mountain Ridge was granted an exclusive right to market any and all coal produced from January 1, 2014, for a period of 10 years for a commission in the amount of 5% of net proceeds for each ton of coal produced. Mountain Ridge is controlled by former owner Mortar and secured with the assets of Genuine. All coal produced by Genuine was already under contract to Western and was unable to be sold to any other party.
      6. A “Supply Agreement” with Western Mine Supply. Western charged a fee equal to 10% of the amount of all purchases processed through accounts payable for a period of approximately 8 years.
      7. An “Employment Agreement” with new owner Pestle for a term of 5 years (and thereafter year to year) for compensation of $100,000 per annum. New owner Pestle had no coal mining experience and did not maintain an office at Genuine. Payroll disbursements and cash records indicate that Pestle was paid all amounts.
      8. Former owner Mortar maintained one office at Genuine for the years from inception through 2018.
    3. The commitments related to the purchase and other closing agreements with former owner Mortar and other related parties altered the cost structure of Genuine by adding or increasing the following expense line items:
      • Administration and Accounting Expense
      • Management Expense
      • Travel—Airfare Expense
      • Sales Brokerage Expense
      • CEO Salary Expense
      Prior to 2014 these deduction (expense) line items had zero balances.

      The impact of these expenses on the financial performance of Genuine during the period 2014–2018 is as follows:

      2014–2018 Per ton
      Clean Coal in Tons 5,000,000
      Book income (loss) per tax returns ($1,250,000) ($0.25)
      Administration Consultancy Group, LLC 2,500,000 0.50
      Coal Operations Consulting, LLC 1,250,000 0.25
      Management Consultants, LLC 1,500,000 0.30
      Aeronautical, LLC 1,250,000 0.25
      Mountain Ridge, LLC 5,000,000 1.00
      Western Mine Supply 1,500,000 0.30
      Employment Agreement: Pestle 500,000 0.10
      Total 13,500,000 2.70
      Adjusted book income $12,250,000 $2.45
    4. New owner Pestle became the sole shareholder by agreeing to contribute $500,000 for the purchase of one share of stock by tendering a demand note. According to the 2018 tax return, as of December 31, 2018, this amount had not been paid to Genuine. New owner, Pestle, admitted during deposition to playing a very small role in the management of the business and having no coal mining experience. Related party disbursements and expenses are summarized by year as follows:
      Accounting General Ledger Related Parties 2009–2013 2014 2015 2016 2017 2018 5-Yr Total Per Ton
      Administration & Accounting Administration Consultancy Group, LLC 0 500,000 500,000 500,000 500,000 500,000 2,500,000 0.50
      Management Coal Operations Consulting, LLC 0 375,000 312,500 250,000 187,500 125,000 1,250,000 0.25
      Management Management Consultants, LLC 0 300,000 300,000 300,000 300,000 300,000 1,500,000 0.30
      Travel – Airfare Aeronautical, LLC 0 250,000 250,000 250,000 250,000 250,000 1,250,000 0.25
      Sales Brokerage Mountain Ridge, LLC 0 1,500,000 1,250,000 1,000,000 750,000 500,000 5,000,000 1.00
      Administration & Accounting Western Mine Supply 0 450,000 375,000 300,000 225,000 150,000 1,500,000 0.30
      CEO Salary Employment Agreement: Pestle 0 100,000 100,000 100,000 100,000 100,000 500,000 0.10
      3,475,000 3,087,500 2,700,000 2,312,500 1,925,000 13,500,000 2.70

      The legitimacy of billings by related parties was not able to be established either through review of invoices nor through deposition testimony.

      In addition to the expenses added as part of the purchase and sale transactions, mining operations (tons produced) declined every year between 2014 and 2018. Nevertheless, mining profits per ton (revised upward for expenses added as part of the purchase and sale transactions) and total costs per ton declined almost every year. However, because overhead charged to the mining operations generally increased, reported losses were significant in the years 2017–2018.

      2009-2013 2014 2015 2016 2017 2018 5-Yr Total
      Revised Operating Expenses 26,400,000 17.60 26,250,000 21,850,000 17,500,000 13,200,000 8,950,000 87,750,000
      17.50 17.48 17.50 17.60 17.90 17.55
      Revised Net Income 3,600,000 2.40 3,750,000 3,150,000 2,500,000 1,800,000 1,050,000 12,250,000
      2.40 2.50 2.52 2.50 2.40 2.10 2.45

      For a more comprehensive presentation of the above, see Exhibit 2. Panel A presents the financial performance for the years 2009–2018 with and without the related party transactions. Panel B presents the balance sheet as reported by Genuine, 2013–2018.

  2. Impact of Financial Performance on Investments in Mining Equipment

    After a significant initial investment in equipment in 2009–2013, Genuine made very little investment in fixed assets during the period 2014–2018. This lack of investment was not offset by increased equipment rentals.

    2009-2013 2014 2015 2016 2017 2018 5-Yr Total
    Investments in Property, Plant & Equipment 2,625,000 524,000 476,000 125,000 - - 1,125,000
    Equipment Rental Expense 10,000,000 1,800,000 1,200,000 775,000 400,000 200,000 4,375,000
  3. Impact of Related Party Cash Flows on Liabilities and Stockholders’ Equity

The assets of Genuine (before and after reduction for related party receivables) and stockholders’ equity declined. In contrast, net liabilities (including loans to Genuine from the related party Mountain Finance, LLP) increased. Based on the net of stockholders’ equity at December 31, 2018, Genuine was technically bankrupt and did not have the ability to pay its Retiree Employment Benefit Obligation of $5,000,000.

See Exhibit 2b.

Payments to related parties during the period 2014–2018 of $13,500,000 would have been sufficient to pay the Retiree Employee Benefit Obligation of $5,000,000 with $8,000,000 left to distribute to Genuine stockholders.

As the cash flow of Genuine was passed to related party companies, Genuine was required to borrow money from Mountain Finance, LLP (a former owner Mortar related party company) creating a debt of $1,500,000. Loans from Mountain Finance, LLP were secured by the assets of Genuine.

Reservation:

This report is based on the information received and examined as of the date of this report. Should additional information become available, facts become known, or additional inquiry arise, I reserve the right to modify or supplement the analysis as necessary. I may use graphics or other demonstrative exhibits, enlarged, colored, or otherwise adapted to illustrate or to help explain testimony at trial.

Respectfully,

{Henry Lester, Jr. electronic signature}

HENRY LESTER, JR., PHD, CPA, CFE, CFF, CVA

Exhibit 1

Genuine - Financial Information 2018
Projected Earnings 2,500,000
Coal – Tons Mined 500,000
Clean ton % 45%
Income Statement
Revenues 10,000,000 20
Operating Expenses 10,875,000 21.75
Net Income (875,000) (1.75)
Net Income per Ton (1.75)
Balance Sheet
Cash 84,000
Accounts Receivable – Western 900,000
Accounts Receivable – Owner 500,000
Other Current Assets 1,484,000
Property, Plant and Equipment
Historical Cost 11,075,000
Accumulated Depreciation 6,810,000
Net PP&E 4,265,000
Total Assets 5,749,000
Accounts Payable 250,000
Long-term Loan – Mountain Finance 1,337,500
Accumulated Employee Benefit Obligation 5,000,000
6,587,500
Stockholders’ Equity
Contributions 500,000
Retained Earnings (1,338,500)
(838,500)
5,749,000
Projected Earnings
2014 2,500,000
2015 2,500,000
2016 2,500,000
2017 2,500,000
2018 2,500,000

Exhibit 2a

Analysis of Genuine Financial Performance 2009–2013 2014 2015 2016 2017 2018 5-Yr Total
Projected Earnings 5-Yr Average 2,500,000 2,500,000 2,500,000 2,500,000 2,500,000 12,500,000
Coal – Tons Mined – Paid 1,500,000 1 1,500,000 1,250,000 1,000,000 750,000 500,000 5,000,000
Clean ton % 45% 46% 44% 42% 46% 45% 45%
Income Statement – Reported on Internal Financial Statements and Tax Returns
Revenues 30,000,000 20 30,000,000 25,000,000 20,000,000 15,000,000 10,000,000 100,000,000
Officers Salary / Fixed Payment 600,000 0.4 600,000 600,000 600,000 600,000 600,000 3,000,000
Equipment Rental Expenses 2,000,000 1,800,000 1,200,000 775,000 400,000 200,000 4,375,000
Operating Expenses 23,800,000 27,325,000 23,137,500 18,825,000 14,512,500 10,075,000 93,875,000
15.87 18.22 18.51 18.83 19.35 20.15 18.78
Net Income 3,600,000 2.4 275,000 62,500 (200,000) (512,500) (875,000) (1,250,000)
Net Income per Ton 2.4 0.18 0.05 (0.2) (0.68) (1.75) (0.25)
Coal – Tons Mined – Claimed 1,650,000 1,437,500 1,204,762 825,000 562,222 5,679,484
0.506 0.506 0.506 0.506 0.506 0.507
Accounting General Ledger Related Parties 2009–2013 2014 2015 2016 2017 2018 5-Yr Total Per Ton
Administration & Accounting Administration Consultancy Group, LLC 0 500,000 500,000 500,000 500,000 500,000 2,500,000 0.5
Management Coal Operations Consulting, LLC 0 375,000 312,500 250,000 187,500 125,000 1,250,000 0.25
Management Management Consultants, LLC 0 300,000 300,000 300,000 300,000 300,000 1,500,000 0.3
Travel – Airfare Aeronautical, LLC 0 250,000 250,000 250,000 250,000 250,000 1,250,000 0.25
Sales Brokerage Mountain Ridge, LLC 0 1,500,000 1,250,000 1,000,000 750,000 500,000 5,000,000 1
Administration & Accounting Western Mine Supply 0 450,000 375,000 300,000 225,000 150,000 1,500,000 0.3
CEO Salary Employment Agreement: Pestle 0 100,000 100,000 100,000 100,000 100,000 500,000 0.1
3,475,000 3,087,500 2,700,000 2,312,500 1,925,000 13,500,000 2.7
2009–2013 2014 2015 2016 2017 2018 5-Yr Total
Revised Operating Expenses 26,400,000 17.6 26,250,000 21,850,000 17,500,000 13,200,000 8,950,000 87,750,000
17.5 17.48 17.5 17.6 17.9 17.55
Revised Net Income 3,600,000 2.4 3,750,000 3,150,000 2,500,000 1,800,000 1,050,000 12,250,000
2.4 2.5 2.52 2.5 2.4 2.1 2.45
3,600,000 2.4 3,750,000 3,150,000 2,500,000 1,800,000 1,050,000 12,250,000

Exhibit 2b

Analysis of Genuine Financial Condition 2013 2014 2015 2016 2017 2018
Total Assets 7,100,000 7,999,000 8,286,500 7,345,000 6,725,000 5,911,500
Accounts Payable 1,750,000 975,000 600,000 450,000 350,000 250,000
Long-term Loan Mountain Finance, LLC (R.P.) - 1,275,000 1,937,500 1,346,000 1,338,500 1,500,000
Retiree Employee Benefit Obligation 5,100,000 5,000,000 5,000,000 5,000,000 5,000,000 5,000,000
Total Liabilities 6,850,000 7,250,000 7,537,500 6,796,000 6,688,500 6,750,000
Stockholders’ Equity
Contributions 1,000 500,000 500,000 500,000 500,000 500,000
Retained Earnings 249,000 249,000 249,000 49,000 (463,500) (1,338,500)
Total Stockholders’ Equity 250,000 749,000 749,000 549,000 36,500 (838,500)
Total Liabilities & Stockholders’ Equity 7,100,000 7,999,000 8,286,500 7,345,000 6,725,000 5,911,500

Appendix C Valuation Report

NOTES:

  • The analyses to support this report were examined in the prior chapter.
  • This example is not necessarily inclusive of all report elements.
  • Each valuation report should be reflective of relevant case attributes and examination outcomes.

TABLE OF CONTENTS
EXECUTIVE SUMMARY 3
INTRODUCTION 4
Identity of the Client 4
Purpose and Intended Use 4
Intended Users 4
Report Form 4
Valuation Date 4
Standard of Value 4
Premise of Value 5
Sources of Information 5
Assumptions and Limiting Conditions 6
Scope of Work and IRS Revenue Rulings 6
Work of a Specialist 7
Hypothetical Conditions 7
Subsequent Events 7
BACKGROUND INFORMATION 9
History and Ownership 9
Nature of the Business 9
Products and Services 9
Competitors and Market Share 10
Operating and Investment Assets 10
Capital Structure 11
Sales and Accounting Records 11
Management 11
Related Party Transactions 11
Expectations 11
ECONOMIC ANALYSIS AND OUTLOOK
National Economic Summary
Regional Economic Summary 12
INDUSTRY ANALYSIS AND OUTLOOK
Forecasts 14
Application of National, Regional, and Local Economic and Industry Trends to Rosewood Florist Shop, LLC.
FINANCIAL ANALYSIS
Balance Sheet
Income Statement
Comparative Industry Data
Common Size
Ratio (Trend) Analysis
Normalization Adjustments
Balance Sheet Adjustments
Income Statement Adjustments
17
VALUATION APPROACHES AND METHODS 31
Market Approach 31
Income Approach 31
Asset Approach 32
Summary of the Valuation Approaches and Methods 32
METHODS CONSIDERED AND REJECTED
Asset-Based Approach
Market Approach / Guideline Transactions Method
Bizcomps Data
Application of the Bizcomps Data in the Guideline Transactions Method
IBA Data
Application of the IBA Data in the Guideline Transactions Method
Pratt’s Stats Data
Application of the Pratt’s Stats Data in the Guideline Transactions Method 33
VALUATION APPROACHES AND METHODS USED
Income Approach/Capitalization of Adjusted Net Earnings
Determination of the Capitalization Rate—Cost of Equity 43
CONCLUSION OF VALUE 48
Appendix A 49

Executive Summary

Report Summarized: The valuation report summarized here contains 51 pages and was issued December 31, 2018 by C.A.D. Bell, Jr. The Exhibits and Appendices are integral parts of this report.

Subject Interest: 40.0% ownership interest in Rosewood Florist Shop, LLC
Valuation Date: December 31, 2018
Purpose of Valuation: United States gift tax compliance and reporting
Standard of Value: Fair market value
Premise of Value: Going concern
Valuation Method Used: Income approach
Fair Market Value of the Subject Interest: $2,820,000

Introduction

Identity of the Client

C.A.D. Bell, Jr. (hereinafter, the “Valuation Analyst”) was retained by Ms. Linda Rosewood, Owner and Operator (hereinafter, the “client”) of Rosewood Florist Shop, LLC (hereinafter, “Rosewood” or the “Company”) to estimate the fair market value of a 40.0% ownership interest (hereinafter, the "Subject Interest") of the Company as of December 31, 2018 on a noncontrolling, nonmarketable basis.

Purpose and Intended Use of the Valuation

The report has been prepared for the exclusive use of the owners of Rosewood Florist Shop, LLC and its attorneys to estimate the fair market value of a 40% ownership interest in Rosewood Florist for estate tax purposes. The use of the conclusion is specifically limited to that purpose and is valid only for the valuation date. No other purpose is intended or should be inferred. Neither the report, its contents, nor any attachments thereto may be used in whole or in part by anyone other than the owner of Rosewood Florist and its attorneys. The report should not be considered to be investment advice within the meaning of applicable securities laws.

The appraisal estimate of the fair market value reached in this report is necessarily based on the definition of the fair market value as stated in the “Standard of Value” section. An actual transaction in the shares might be concluded at a higher value or lower value, depending on the circumstances surrounding the Company, the appraised business interest, and/or the motivations and knowledge of both the buyers and sellers at that time. No guarantees are made as to what values individual buyers and sellers might reach in an actual transaction.

Intended Users

The distribution and use of the valuation report is restricted to the Client, the Client’s legal and financial advisors, and the Internal Revenue Service for the attachment to a gift tax return (Form 709), if required. The valuation report shall not be distributed to outside parties to obtain credit or for any other purposes. Possession of the valuation report does not carry with it the right of publication of all or part of it, nor may it be provided to any third parties other than in connection with required judicial procedures. I do not assume any liability, obligation, or accountability to any unauthorized third-party users of the valuation report under any circumstances.

Report Form

As part of the valuation engagement, I have agreed to document the findings in the form of a summary valuation report, which explains the valuation procedures followed, the reasoning that supports the analyses, opinions and conclusions, and any additional information that might be appropriate.

Valuation Date

The result of this valuation is the conclusion of value as of December 31, 2018. I have requested and analyzed financial data up to and including the valuation date and have made inquiries into material subsequent events that may be known or knowable at December 31, 2018.

Standard of Value

As was appropriate, this valuation engagement used fair market value as the standard of value. Fair market value is defined in The International Glossary of Business Valuation Terms, issued by the American Institute of Certified Public Accountants (AICPA), the American Society of Appraisers, the Canadian Institute of Chartered Business Valuators, the National Association of Certified Valuators and Analysts, and the Institute of Business Appraisers, as

The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

Premise of Value

The premise of value is the assumption regarding the circumstances in which an entity, or the entity’s assets, would be sold. The International Glossary of Business Valuation Terms defines the following premises:

Going Concern Value – the value of a business enterprise that is expected to continue to operate into the future. The intangible elements of Going Concern Value result from factors such as having a trained workforce, an operational plant, and the necessary licenses, systems, and procedures in place.

Liquidation Value – the net amount that would be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either “orderly” or “forced.

Orderly Liquidation Value – liquidation value at which the asset or assets are sold over a reasonable period of time to maximize proceeds received.

Forced Liquidation Value – liquidation value, at which the assets or assets are sold as quickly as possible, such as at an auction.

As of the valuation date, the Company was not contemplating liquidation. Accordingly, the Company was valued as a going concern entity.

Sources of Information

In performing the valuation engagement, I was provided with, and relied upon various documents including, but not limited to, the following:

Various discussions with management

  1. Historical Financial Information provided by Rosewood
    • Rosewood Florist Historical Balance Sheet Summaries: 2008–2018
    • Rosewood Florist Income Statement Summaries: 2008–2018
  2. 2018 Valuation Yearbook data
    • SBBI 2018 Yearbook
  3. Industry Information for NAICA Code: 453100
    • First Research Industry Reports
    • RMA Industry Data
  4. National and Regional Economic Information
  5. Local Economic Information
  6. Guideline Transaction Data
    • BizComps Transactions Data
    • IBA Comps Export Data
    • Pratts Stats Transactions

These sources of data and their use are described in more detail throughout the report, exhibits, and appendices.

Assumptions and Limiting Conditions

The valuation presented in this report is contingent on the assumptions and limiting conditions found elsewhere in this report. (The Clients were provided with a copy of this report prior to its final issuance to ensure the accuracy of facts and statements attributed to the Client and Company management.)

Scope of Work and IRS Revenue Rulings

The analysis and report are in compliance with the National Association of Certified Valuators and Analysts (NACVA) Professional Standards for conducting and reporting on business valuations.

This analysis is also in conformance with various Internal Revenue Service pronouncements including Revenue Ruling 59-60, which is acknowledged as a primary authority and guideline for the valuation of closely held businesses for income tax purposes. Revenue Ruling 59-60 outlines the approaches, methods, and factors to be considered in valuing shares of the capital stock of closely held corporations for federal tax purposes. I consider the dictates of Revenue Ruling 59-60; however, as an independent appraisal expert, I retain the right and obligation to differ from any opinions expressed in the rulings or court decisions when I conclude that such ruling or decisions are contrary to generally accepted business valuation techniques and practices.

Specifically, Revenue Ruling 59-60 states that the following factors should be carefully considered in deriving a fair market value:

  1. The nature of the business and the history of the enterprise from its inception.The five most recent years’ financial statements were analyzed. In addition, Rosewood’s operations and history are discussed in the “Company Background” section of this Report.
  2. The economic outlook in general and the condition and outlook of the specific industry in particular.The effect of the Economic Outlook and Industry Outlook on Rosewood has been included in those respective sections of this Report.
  3. The book value of the stock and the financial condition of the business.The Rosewood’s book value was $10,594,000 as of the valuation date and based on the analysis in the “Financial Analysis” section of this report; the Company is in a good financial condition.
  4. The earning capacity of the company.Rosewood’s earning capacity was analyzed as part of the Income Approach.
  5. The dividend-paying capacity.Rosewood’s dividend-paying capacity is intrinsic in its cash flows and is reflected in the Income Approach. Rosewood does not have a significant history of distributing its cash flows to its shareholders.
  6. Whether or not the enterprise has goodwill or other intangible value.Rosewood’s intangible asset value is reflected in the cash flows it generates which are, in turn, included in the Income Approach to valuation.
  7. Sales of the stock and the size of the block of stock to be valued.There have been no transfers of ownership interests since inception. The Subject Interest of this valuation engagement is a 40.0% ownership interest.
  8. The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.Transactions involving companies in the same line of business have been researched as part of this valuation engagement.

Although the factors found in Revenue Ruling 59-60 refer to “stock” and “dividend-capacity” of corporations, these factors are applicable to the ownership interests and distributions of other business interests of any type as noted in Revenue Ruling 68-609.

I analyzed Rosewood’s financial and operational information as detailed in the exhibits and made inquiries of the Rosewood’s management and the client. I also researched the industry in which Rosewood operates and the general economic conditions as of the valuation date.

All relevant valuation approaches and methods were considered in performing the valuation of the Subject Interest. The conclusion of value reflects these findings, judgment and knowledge of the marketplace, and expertise in valuation. In the performance of this valuation, I considered and relied upon the concepts and methods presented in a substantial number of appraisal texts and other writings.

The reader of this report should be mindful that any citations of law or court cases are for illustration and clarification purposes only. I do not practice law, nor do I base valuation opinions on the decisions of various courts. The opinions are based upon knowledge and analysis of the facts. However, I realize that certain parties who may read this report are oriented to laws and court cases that relate to the purpose of this valuation. For that reason, I may cite applicable laws and interpretive materials that have affected the valuation, as well as court cases that have opined on various valuation issues.

Work of a Specialist

The work of two outside specialists was considered in this valuation report. First, Career Development (Morgantown, West Virginia) provided information regarding the compensation of owners Linda and Daniel Rosewood. Further, Burton Appraisal Company (Morgantown, West Virginia) provided information regarding the appraised value of the equipment owned and used by Rosewood. Finally, Commercial Realty Company provided the fair market value of the leased spaced.

Hypothetical Conditions

Hypothetical conditions were not included in this valuation engagement.

Subsequent Events

Generally, the valuation analyst should consider only circumstances existing at the valuation date and events occurring up to the valuation date to form his/her conclusion of value. Subsequent events are indicative of conditions that were not known or knowable at the valuation date. The valuation would not be updated to reflect those events or conditions. I did not, in the course of the engagement, note any subsequent events that would warrant disclosure in this report.

Background Information

History and Ownership

Rosewood Florist Shop, LLC is a florist company headquartered in Morgantown, West Virginia. Ms. Rosewood started the company in 1983.

Nature of the Business

Rosewood Florist Shop, LLC now has gross sales of approximately $24 million and employs about 210 people. In 1986, Rosewood Florist had annual sales of $100,000 and only five employees. The employee turnover rate is very low by industry standards, which implies a high degree of employee satisfaction and a relative constant level of florist work. There is an adequate supply of labor in the area when occasional help is needed, and the compensation for these individuals is average for the area.

Products and Services

Rosewood offers a wide range of services, including retail sales, weddings, corporate and special events, has contracts with numerous area businesses to provide all plant and florist needs and some maintenance contracts.

A 0.5% decline was noted in Florist revenues from 2017 to 2018. Ms. Rosewood suggested that the decline was associated with retail sales. New competitors and cheaper retail options from Wal-Mart, Kroger, Giant Eagle, and other national chains have reduced the walk-in retail sales. Delivery retail sales have also seen a decline as edible eats and other delivered gifts have entered the market. The comparison of revenue by service from 2017 to 2018 shows growth in weddings and corporate and special events, while business contracts and maintenance were relatively flat. Ms. Rosewood indicated that these trends are likely to continue. Her assessment is consistent with industry trends.

Rosewood Florist Shop LLC
Analysis of Revenues by Service Line

Florist Services 2017 2018 Percent Growth
Retail - Walk-in 2,260,000 1,921,000 7.8% -15.0%
Retail - Delivery 2,270,000 2,179,200 8.9% -4.0%
Weddings 3,900,000 4,017,000 16.3% 3.0%
Corporate and Special Events 5,850,000 6,201,000 25.2% 6.0%
Business Contracts 6,450,000 6,256,500 25.4% -3.0%
Maintenance 3,992,000 4,012,513 16.3% 0.5%
24,722,000 24,587,213 100.0% -0.5%

Nearly all of Rosewood Florist’s customers are located in Morgantown, Fairmont and Bridgeport/Clarksburg, West Virginia, and most of the company’s customers are located within 75 miles of Morgantown, West Virginia metropolitan area. However, Rosewood Florist does have two large accounts in Pittsburgh, Pennsylvania (approximately 90 miles north of Morgantown). The clients the Pittsburgh Steelers and Pittsburgh Penguins are responsible for about $400,000–$500,000 in revenue per year. Ms. Rosewood has known the Steeler and Penguin owners for more than a decade, attends almost all home games, and occasionally sits in the owners’ box.

Rosewood Florist obtains a significant amount of revenue from a relatively small number of customer accounts. In recent years, the company had 20–25 customer accounts that each generated more than $250,000 of annual revenue. Discussions with Ms. Rosewood and review of accounting revenue summary schedule pulled up on the Rosewood computer monitor indicate that no customer is responsible for revenue of more than $250,000. The listing of large customers viewed on the Rosewood computer monitor suggests that the 20–25 large customers pretty evenly span a range of $100,000–$250,000. The 25 customers average $175,000 each; given that average, the 25 customers account for $4,375,000 of revenue or about 18% of total revenue. A comparison of these top customers across time suggests some turnover; however, turnover has declined in more recent years because Rosewood Florist’s “one-stop” shop approach makes companies less inclined to defect.

Sales are somewhat cyclical with most Florist occurring in the nine-month period from August through April, matching the changes in Morgantown demographics associated with West Virginia University that occur in the fall, winter, and spring seasons. Because Morgantown and surrounding areas are a major portion of their metropolitan statistical area, the seasonality tends to be light. With a stronger emphasis on contract, seasonality has been less of an issue in recent years.

Competitors and Market Share

A Web search suggests that Morgantown, West Virginia, has more than 20 florists in the region. However, many of those are “mom-and-pop” shops. According to Ms. Rosewood and her sales representatives, Rosewood faces three major competitors:

  • Sunshine Florist Services (4250 118th Ave N, Morgantown, WV, 26508 (304) 291-1763)
  • Max and Wilma Plants and Florist Services (123 W. Seneca Ave, Morgantown, WV 26501)
  • Gardens, Plants and More, Inc. aka GPM (202 S 22nd St, Morgantown, WV 26505, (800) 249-2961)

Rosewood ranks second in market share estimated at 10%, while the largest, Sunshine, is estimated to have 10–15% of the market; the other two, Max and GPM, are estimated at 8–9% each. Each of these three competitors has significant facilities, comparable to Rosewood and comparable service offerings. The next six competitors, all smaller than Rosewood, are estimated to have between 5% and 6% of the market with service offerings that capture customers with similar needs to those of Rosewood.

Operating and Investment Assets

According to Ms. Rosewood, Rosewood Florist has pretty much state-of-the-art florist, delivery, and operations services. Rosewood made capital expenditures in 2015–2017 when it moved into its new facility at the Westover Building. This also corresponded with a new website, app-based ordering, and state-of-the-art contract/ordering electronic systems. This assessment was confirmed through a walking tour with the operations manager and discussions with the sales representatives and operations management. This allows Rosewood to be price competitive while offering services that are comparable to those of their competition. However, the technology of the florist business is somewhat dynamic and is expected to require continued capital expenditure, though not as high as the upgrade required when the company moved facilities. However, state-of-the-art technologies offered by key competitors suggest that Rosewood is not able to obtain price advantages of its competition nor lower production costs.

Capital Structure

The operation has some current liabilities and no long-term financing. The company’s banking relationship is excellent—they have a $1.50 million credit line at their bank, which they rarely need to utilize.

Sales and Accounting Records

Financial statements for Rosewood Florist Shop, LLC are prepared annually on an accrual basis and are reviewed by the outside CPA. The financial statements are compiled by the outside CPA and are available two weeks after the end of each month. Tax planning is done annually.

Rosewood has a manager of accounting and finance who supervises the entire accounting department and is responsible for accounts receivables. The company also employs one accounts payable clerk and a payroll clerk. The administrative assistant to the manager of accounting and finance completes bank and other account reconciliations monthly, and those reconciliations along with the accounting activity are provided to the CPA firm who compiles the financial statements monthly, prepares annual financial statements on an accrual basis, reviews transactions, and completes the tax return. While separation of controls is not optimal, Ms. Rosewood is a stickler for detail and tends to carefully review the financials and bank statements monthly. In addition, Ms. Rosewood holds a weekly accounts receivables meeting with the Controller, 16 Sales Representatives, and the VP of Operations. Cash balances have been growing and accounts receivable and payable have remained roughly in line with revenue changes.

Management

Management below the owner level is capable. They are able to perform their duties without extensive supervision or control. The owners (Linda and Daniel) worked 100% of the time in the business. Linda Rosewood (age 64) is the president of Rosewood Florist and Daniel Rosewood (age 60) was the office manager. Each owner was paid $10,000 per month. It is expected that an adequate replacement for Daniel can be found at an annual salary of $65,000–$75,000. Linda’s salary is at the market rate for the area. The company’s other key employees include Eric Forest (VP of Operations and Delivery), Kurt Davidson (VP of Weddings and Special Events), Dan Richardson (Manager of the Retail Department), Sam Erickson (Manager of Accounting and Finance), and Tammie Samuelson (Manager of the Contracts and Maintenance). Rosewood Florist currently has 16 sales people, all of whom are located in Morgantown. In the future, Rosewood Florist anticipates that salespeople will be added in other geographic areas. However, no definitive plans for geographic expansion existed as of December 31, 2018.

Related Party Transactions

The company leases real estate from Linda & Daniel Family Limited Partnership, which is owned by the company’s principal shareholders, Linda and Daniel Rosewood. The lease agreement includes Rosewood Florist’s Morgantown facility and an additional property known as the Westover Building. The lease payment is $41,167 per month. This is the only related-party transaction in which the company is involved. Rosewood Florist subleases approximately one-half of the space in the Westover Building to another company.

Expectations

Discussion with Ms. Rosewood and the sales representatives are optimistic that Rosewood’s market share is solid and that the company is well positioned for the future.

Economic Analysis and Outlook

The following sections summarize the current economic data from a national, regional, and local perspective.

National Economic Summary

According to the United States Commerce Department, the U.S. economy, real gross domestic product (GDP) increased at an annual rate of 1.9% in the fourth quarter of 2018 after a third quarter, real GDP increase of 2.5%. Further, in December 2018, real disposable personal income increased 0.2%. According to the Organization for Economic Co-operation and Development (OECD), economic growth in the United States was set to strengthen in 2017 and 2018, as an assumed fiscal stimulus boosts the economy and the effects of dollar appreciation, declines in energy investment, and a substantial inventory correction abate. Employment has risen steadily, although the pace is expected to ease somewhat in 2019. A pick-up in wages will further support growth, offsetting somewhat sluggish external demand.

Further, the OECD suggests that monetary policy has remained very accommodative, consistent with inflation running below target. As economic slack is eliminated and pressure on resources emerges, policy rates will gradually increase. The OECD indicates that fiscal policy was broadly neutral in 2018. The administration in the White House began implementing its policy priorities in 2018.

Regional Economic Summary

The following section is derived from the WVU Bureau of Business and Economic Research “West Virginia Economic Outlook 2019–2023” prepared during 2018.

West Virginia’s economy has struggled dramatically over the past year, primarily driven by the state’s energy sector, where continued losses in coal jobs have been coupled with a longer-than-expected slowdown in natural gas. West Virginia as a whole fell into recession in 2017 and six counties have suffered “Great Depression” magnitude employment losses over the past few years.

Highlights related to West Virginia’s recent economic performance are as follows:

  • After consistent and healthy job growth between 2014 and early 2017, the state has seen employment decline for much of the last four years, with a cumulative loss of around 17,000 jobs.
  • A significant portion of the state’s job losses can be traced to the downturn in the coal industry, although weak levels of construction activity and weakness in natural gas employment over the last year have contributed. Over this period, job gains have been recorded in several of the state’s largest service-providing industries, but these gains fail to offset the losses in coal.
  • The state’s unemployment rate has been volatile over recent years. Currently, West Virginia’s jobless rate is higher than around 45 other states.
  • Only 53% of West Virginia’s adult population is either working or looking for work. This is the lowest rate of labor force participation among all 50 states. This problem represents a significant hurdle for long-run economic prosperity.
  • Per capita personal income in West Virginia grew in 2017. However, growth has failed to match that at the national level for each of the past four years.
  • Overall, per capita personal income in West Virginia stands at 77% of the national average.
  • West Virginia’s real GDP fell in 2017. Real GDP growth in the state has fallen short of national GDP growth for each of the past four years. Overall, the value of economic output in West Virginia (inflation adjusted) is roughly equal to its 2014 level.

Highlights related to West Virginia’s economic outlook are as follows:

  • Employment in West Virginia is estimated to increase 0.6% per year on average through 2023, compared to an expectation of 1.0% for the nation as a whole.
  • West Virginia’s baseline forecast calls for job losses in coal to subside within the near term; however, the outlook is subject to considerable downside risk depending on the environmental regulatory climate and conditions in the global coal market.
  • Low prices and regional infrastructure bottlenecks that have weighed on the natural gas industry will subside over the next year or so. The Bureau anticipates that conditions will improve considerably in 2019/2020 thanks to new pipeline capacity and ever-growing natural gas use in baseload electricity generation. Overall, production and employment are expected to increase at average annual rates of around 9% and 4–5%, respectively, through 2023.
  • Construction is expected to add jobs at the fastest rate going forward, but the service-providing segment will tend to pace the state’s overall performance during the next five years, led by professional and business services, leisure and hospitality, and health care.
  • The state’s unemployment rate is expected to remain around 5% throughout the outlook period.
  • Per capita personal income is expected to grow at an annual average rate of % over the next five years, equal to the national rate. Growth will be driven largely by nonwage income, such as Social Security Benefits.

Importantly, for this valuation, the Bureau of Business and Economic Outlook report notes that economic performance is expected to remain extremely variable across West Virginia’s counties.

Industry Analysis and Outlook

The following section summarizes the commercial florist industry. The discussion was developed primary from the First Research Industry report (Dunn & Bradstreet).1

Companies in this industry sell cut flowers, floral arrangements, potted plants, and other gifts from physical retail establishments. The retail and commercial florist industry includes florist services done for outside customers on a job order (walk-in and delivery) and contractual basis. Mass plant and flower retailers (e.g., Lowes, Home Depot) are not included. Floral order-taking services such as 1-800-FLOWERS.COM and FTD provide orders to independent florists but are also competitors. Florists often provide contractual services to customers, such as wedding and corporate events as well as regular florist and plant maintenance and services to business customers. In general, commercial and retail florist is a local activity, because many vegetative materials are maintenance-sensitive, challenging to ship without special handling and/or require face-to-face collaboration between the florist and customer.

This U.S. industry comprises establishments primarily engaged in florist activities without gardening and outdoor plant and flower operations. This industry includes establishments engaged in job order and contractual sales.

For the past twenty years, the commercial florist industry has found itself on the wrong side of a technological revolution. The spread of personal computing, first to the office, factory, and home, combined with the steadily increasing power and convenience of communication devices, has increased Americans’ appetite for convenient forms of shopping (e.g., “apps”) but also florists have faced competition from new competitors such as confectionaries and fruit and vegetable edibles that can be delivered as gifts.

“Digital’s influence is now a constant and significant factor in every sector, segment and sub-segment of US business,” said James Khale, President of U.S. Florist Association. “At the same time as digital technology and innovation continue to spur growth in the florist industry and propel the industry forward. In addition, emerging digital monitoring are significantly changing consumption habits and maintenance needs among both institutional and consumer end-users. These developments will drive digital-related expenditures to constitute nearly 40% of the overall U.S. Florist Industry capital spending by 2020.”

Factors that affect the U.S. commercial and retail florist industry include general economic conditions, demographic trends, and corporate and consumer spending. A growing economy often leads to increased demand for commercial and retail florist products. It is expected that commercial and retail florists will gain business as corporations and similar organizations move to outsource more of their florist requirements.

Forecasts

  • Retail florist revenue is projected to increase 1.0% annually
  • Digital florist demand: Digital florist revenue is expected to replace traditional walk-in traffic and experience annual gains of 1–2% annually.
  • Wedding florist services: Wedding and special event florist revenue is forecast to increase 3.3% annually.
  • Maintenance and contractual florist sales: Aggregate revenue generated by all other commercial and retail florist processes is projected to rise 3–4% per year between 2019 and 2024.
  • Estimates the compound annual growth rate of the global market in the period 2019–2021 are predicted to be 3.5%.

Application of National, Regional, and Local Economic and Industry Trends to Rosewood Florist Shop, LLC.

While the national and regional economic outlooks are cautiously optimistic, West Virginia in general and the Morgantown and greater MSA are projecting growth at a slower pace. As such, Rosewood has the limited opportunity to enjoy industry-level growth in the foreseeable future. In the near term, Rosewood should experience growth in 2019, comparable to sales growth in 2014 and 2018. Wages, the largest percentage of Rosewood’s cost structure after cost of goods sold, should remain stable with increases no greater than any sales growth Rosewood might realize.

The industry outlook suggest that growth of 3.5% annually based on the global trends appears too aggressive for Rosewood. Rosewood, operating in Morgantown, Fairmont, and Bridgeport/Clarksburg, West Virginia, an area expected to realize growth that is less optimistic than the national and regional economy, has the potential to realize sales growth in 2019–2023 that slightly underperforms the global trends for the commercial and retail florist industry.

Rosewood has realized revenue gains in 2018 from two sources expected to be key factors in industry revenue growth across the next several years: weddings and special corporate events. In both trends, Rosewood is positioned to enhance its revenue growth at a pace faster than the industry. Overall, Rosewood’s estimated growth of approximately 2.5% annually appears to be reasonable.

Financial Analysis

Rosewood ownership has been conservative in its financial management of the company. The company has a large historical cash balance that has been increasing across the years 2014–2018 and far exceeds the industry comparable cash balances. Further, the company has no debt on the balance sheet. The company has a $1.50 million credit line at their bank, which they rarely need to utilize.

Accounts receivables and accounts payables have been increasing and declining in the same direction as changes in sales. Net income margins have generally been in line with those of the industry and the company sustained net income in 2015 through 2018.

According to information gathered from company sources, accrual basis financial statements for Rosewood Florist Shop, LLC are prepared annually and are reviewed by an outside CPA. Monthly financial statements are compiled by the outside CPA and are available two weeks after the end of each month. Tax planning is done annually.

Balance Sheet

The balance sheet reports a company’s assets, liabilities, and owner’s equity as of a specific date. This financial statement provides information about the nature and amounts of investments in enterprise resources, obligations to creditors, and the owner’s equity in net resources. The balance sheet provides a basis for computing rates of return, evaluating the capital structure of the enterprise, and assessing its liquidity and financial flexibility.

A summary of the Company’s historical unadjusted balance sheets is shown below:

ROSEWOOD FLORIST SHOP, LLC

Historical Balance Sheet Summary
As of December 31 (in 000’s) 2014 2015 2016 2017 2018
  Current Assets
  Cash & Equivalents 860 2,090 3,600 4,810 4,970
  Accounts Receivable 3,610 2,870 3,130 3,220 2,680
  Inventory 590 830 680 890 990
  Other Current Assets 650 480 560 410 570
  5,710 6,270 7,970 9,330 9,210
  49.1% 55.8% 65.5% 71.3% 74.5%
  Fixed Assets
  Land 450 450 450 450 450
  Leasehold Improvements 340 340 340 340 340
  Furniture, Fixtures & Equipment 20,710 20,630 20,240 19,390 19,570
  Vehicles 230 270 250 280 260
  Total Fixed Assets 21,730 21,690 21,280 20,460 20,620
  Less: Accumulated Depreciation (16,460) (17,400) (17,780) (17,480) (17,930)
  Net Fixed Assets 5,270 4,290 3,500 2,980 2,690
  45.3% 38.2% 28.8% 22.8% 21.7%
  Other Assets
  Cash Surrender Value of Life Insurance 430 450 470 490 470
  Investments 220 220 230 280 -
  Total Other Assets 650 670 700 770 470
  5.6% 6.0% 5.8% 5.9% 3.8%
TOTAL ASSETS 11,630 11,230 12,170 13,080 12,370
  100.0% 100.0% 100.0% 100.0% 100.0%

ROSEWOOD FLORIST SHOP, LLC

Historical Balance Sheet Summary
As of December 31 (in 000’s) 2014 2015 2016 2017 2018
Liabilities & Equity
  Current Liabilities
  Notes Payable 550 - - - -
  Accounts Payable 940 850 1,009 1,033 516
  Customer Deposits 100 270 160 240 140
  Accrued Wages & Bonuses 430 490 730 910 400
  Profit Sharing Contribution 60 70 150 170 150
  Other Accrued Liabilities 100 110 110 120 120
  2,180 1,790 2,159 2,473 1,326
  18.7% 15.9% 17.7% 18.9% 10.7%
  Long-Term Liabilities
  Long-Term Debt - - - - -
  Deferred Income Taxes 260 220 300 480 450
  260 220 300 480 450
  2,440 2,010 2,459 2,953 1,776
  21.0% 17.9% 20.2% 22.6% 14.4%
Stockholders’ Equity
  Common Stock 10 10 10 10 10
  Additional Paid-In Capital 600 600 600 600 600
  Retained Earnings 8,580 8,596 9,091 9,487 9,984
  Unrealized Gain/(Loss) on Investments - 14 10 30 -
  9,190 9,220 9,711 10,127 10,594
  79.0% 82.1% 79.8% 77.4% 85.6%
TOTAL LIABILITIES & EQUITY 11,630 11,230 12,170 13,080 12,370

Rosewood Florist appears to be conservative with regard to financial condition. Assets have ranged between $11.6 million and $13.1 million over the period 2014–2018. Cash has been increasing each year, including 2018, despite a slight decline in sales. The cash balance appears to far exceed amounts needed to support operations, beyond providing a safety net. Other major noncash asset categories include accounts receivables and fixed assets. Accounts receivable balances have generally followed trends similar to that of sales revenues. Note: $106,000 of current deferred tax assets are included in other current assets.

Fixed assets balances have been stable across the most recent five years. This stabilization of fixed asset balances is a net of investments in new assets while disposing of older, less efficient equipment. More specifically, the florist industry requires continuous investments in property, plant and equipment and more recently in technology, and Rosewood has made significant investments in recent years. The company also rigorously monitors and inventories its fixed assets each year; fixed assets no longer in service are either disposed and removed from the accounting records or sold to smaller companies. The net of these activities is little change in fixed assets balances while maintaining required investments in florist technology.

  • Inventory. Rosewood Florist utilizes last-in, first-out (LIFO) for costing inventory for tax purposes, having a reported balance of $990,000. The inventory value under first-in, first-out, a value closer in approximation to fair market value, as of December 31, 2018, is $1,000,000, $10,000 more than the LIFO amount.
  • Land. Land on the balance sheet is related to a piece of vacation property purchased by the company in 2007, just before the real estate bust as part of the 2008–2009 financial crisis. Discussions with Ms. Rosewood and a site visit to the property indicate that the land was zoned commercial and had been part of a plan to build a new facility. However, in January 2017, Rosewood leased the Westover Building and is holding the land for the foreseeable future. The 2008–2009 financial crisis resulted in a significant decline in commercial real estate; however, recent years have seen a rebound. Discussions with the realtor who represents several adjacent commercial properties indicate the current value approximates what Rosewood paid for the land. A site visit and examination of other commercial land offered in the vicinity suggests that the land value approximates what Rosewood paid for the property. Land is not used in operations and will be treated as a nonoperating asset, valued at the amount on the balance sheet ($450,000).
  • Leasehold improvements. Leasehold improvements are related to the leased facilities prior to moving to the Westover Building in 2017. The leasehold improvements are fully depreciated but have not been removed from the balance sheet. These assets have no value.
  • Furniture, fixtures & equipment (including vehicles). Burton Appraisal Company estimated the market value of equipment to be $3,600,000 at December 31, 2018.
  • Vehicles. Vehicles were purchased in 2016 and are fully depreciated but have not been removed from the balance sheet. These assets have no value.
  • Liabilities and long-term debt. The company has no long-term debt but access to a $1.5 million line of credit, which the company has rarely needed to utilize. The company’s stockholder’s equity section exceeds $9 million in all years and is composed almost entirely of retained earnings, earnings accumulated across time that have not been distributed to the shareholders. In conclusion, Rosewood has a solid financial condition, relatively few liabilities and no needs for long-term financing.

Income Statement

The income statement is the report that measures the success of enterprise operations for a given period of time. The business and investment community uses this report to determine profitability, investment value, and credit worthiness. It provides investors with information that helps them predict the amounts, timing, and uncertainty of future cash flows. Elements of the income statement include revenues, costs of goods sold, operating expenses, and gains and losses (peripheral or incidental transactions of an entity).

A summary of the Company’s historical unadjusted income statements is shown below:

ROSEWOOD FLORIST SHOP, LLC
HISTORICAL INCOME STATEMNETS SUMMARY

(Thousands, ooo)
For the Year Ended December 31 (in 000’s) 2014 2015 2016 2017 2018
Revenue
Gross Revenues $21,820 $22,110 $23,470 $24,722 $24,587
Cost of Sales $16,120 $15,960 $16,340 $17,150 $17,137
Gross Profit $5,700 $6,150 $7,130 $7,572 $7,450
Gross Margin 26.1% 27.8% 30.4% 30.6% 30.3%
Operating Expenses
Depreciation $450 $940 $380 $400 $450
Lease Expense $290 $290 $290 $530 $530
Officer Compensation $240 $240 $240 $240 $240
Advertising & Sales $110 $120 $120 $110 $60
Salaries & Wages $3,310 $3,350 $3,360 $3,370 $3,430
Repairs & Maintenance $120 $240 $100 $70 $190
Bad Debts $20 $20 $20 $20 $20
Pension & Profit Sharing $220 $230 $230 $230 $230
Meals & Entertainment $20 $20 $20 $30 $20
Legal & Professional $290 $330 $380 $370 $340
Other Expenses $800 $360 $1,440 $1,730 $1,580
Operating Expenses $5,870 $6,140 $6,580 $7,100 $7,090
  26.9% 27.8% 28.0% 28.7% 28.8%
Income From Operations $(170) $10 $550 $472 $360
  -0.8% 0.0% 2.3% 1.9% 1.5%
Other Income
Interest Expense $ - $ - $ - $ - $ -
Gain/Loss on Sale of Assets $(20) $(20) $10 $ - $80
Miscellaneous Other Income $30 $20 $40 $110 $120
Total Other Income/(Expense) $10 $ - $50 $110 $200
Net Income Before Taxes $(160) $10 $600 $582 $560
Income Taxes $ - $(6) $105 $186 $63
Net Income $(160) $16 $495 $396 $497
  -0.7% 0.1% 2.1% 1.6% 2.0%

After realizing revenue growth in 2015–2017, Rosewood suffered a slight decline in revenue in 2018. Ms. Rosewood noted that the decline was associated with sale representative turnover. A new salesperson hired in December 2018 had a huge month; Ms. Rosewood expects sales to rebound in 2019. The regional economic outlook for Morgantown suggests that Ms. Rosewood has reason for cautious optimism.

Rosewood, like other companies in the florist industry, has considerable fixed costs. As such, profitability is conditional on sales revenue. This is most apparent in 2016–2017 when the company reported record sales and record net income. In 2018, sales declined. While the company maintained profitability, income as a percentage of sales was lower than in 2017 and 2018. Over the period 2016–2018, other expenses increased dramatically, reflecting their move to the Westover Building in 2017 and technology needs in the florist industry.

  • Sales. After realizing revenue growth in 2015–2017, Rosewood suffered a slight decline in revenue in 2018. Ms. Rosewood noted that the company lost one salesperson at the beginning of 2018; that salesperson was replaced in early February; however, the replacement salesperson did not “work out” and after several months of mentoring was terminated in late November 2018. By December 1, 2018, a new sales person was hired and that person had years of experience with a competitor and according to Ms. Rosewood, “hit the ground running,” convincing a major Morgantown manufacturer to move their florist requirements to Rosewood. The salesperson had a huge month in December 2018 and Ms. Rosewood expects sales to rebound in 2019. The regional economic outlook for Morgantown suggests that Ms. Rosewood has reason for optimism.
  • Gross margin. Gross margins increased 3–4% in 2016–2018 over 2014–2015 and have remained above 30% in 2016, 2017, and 2018. Rosewood’s gross margins exceed the industry average but declined slightly in 2018 compared to 2017. Ms. Rosewood expects gross margins to rebound in 2019, increasing 0.5%, and remain stable in the foreseeable future.
  • Lease expense. From 2014 to 2016, lease expense was $290,000 per year. In 2017 and 2018, lease expense increased to $530,400 per year, $41,166.67 per month. The company leases real estate from Linda & Daniel Family Limited Partnership, which is owned and controlled by the company’s principal shareholders, Linda and Daniel Rosewood. The lease agreement includes Rosewood Florist’s Morgantown facility and an additional property known as the Westover Building. This is the only related-party transaction in which the company is involved. Rosewood Florist subleases approximately one-half of the space in the Westover Building to another company.

    According to the Commercial Realty Company “survey of rents” dated November 31, 2018, the rent for a comparable facility ranges from $39,000 per month. Further, the estimated market value of rent is $39,000. The variance between the rent to LDFLP ($41,167 for 2018 and 2017) and $39,000 is $2,167 or approximately 5.6% greater than the market value estimate.

    The income from subrental of half of the Westover Building is a contra-expense account accumulated in “other expenses.” While the subrental is a nonoperating income item, lease expense is overstated by the same amount.

  • Officer compensation. The owners (Linda and Daniel) worked 100% of the time in the business. Linda Rosewood (age 64) is the president of Rosewood Florist and Daniel Rosewood (age 60) was the office manager. Each owner was paid $10,000 per month. It is expected that an adequate replacement for Daniel can be found at an annual salary of $65,000–$75,000. Linda’s salary is at the market rate for the area. According to Career Development “annual salary surveys,” Daniel Rosewood’s annual salary would be reasonable at approximately $70,000 per year. A lesser qualified candidate would command a lower salary by about 20%; however, Ms. Rosewood appreciates the professionalism and independence of the more experienced office manager and plans to hire an office manager to replace Daniel Rosewood at competitive market salary with 25+ years of experience.
  • Other expenses. Other expenses increased dramatically in 2016 and remained high in 2017 and 2018. An examination of accounting detail as well as discussions with Ms. Rosewood and the companies CPA firm suggest that the increase arose from one source. In 2016, Linda and Daniel Rosewood were sued in connection with an accident where Mr. Rosewood ran into a children’s school bus on the way to the office. Because Mr. Rosewood was texting on his cell phone at the time of the accident, his personal auto liability insurance company initially denied coverage. The lawsuit with the victims and the insurance company ended in 2018 with a settlement paid by the insurance company but the attorney’s fees paid on behalf of the Rosewood’s by the company were exceptional. Attorney fees totaled $1,000,000, $1,400,000, and $1,000,000 in the years 2016, 2017, and 2018, respectively. These amounts are not related to the operations of Rosewood, are treated as a distribution (dividend) to the Rosewood’s for this valuation, and are eliminated from the operating results of the company.
  • Other Income (expense). This category includes gains and losses on sales of property plant and equipment and other income. The gains and losses from disposition of noninventory assets are observed in four of the five years, 2014–2018 and are considered recurring in nature based on Rosewood’s approach to fixed asset management discussed in the balance sheet section. Historically, other income is derived from sales (less costs) of florist-related materials to clients. This is a convenience service offered to clients. The increase in other income in 2018 was primarily related to “outsourcing” service revenues. Many companies are outsourcing internal florist operations, and Ms. Rosewood indicates that a significant source of future revenue gains will be from businesses outsourcing their florist operations, especially plant care and maintenance. While not included in Rosewood’s core florist business, the income (expense) is expected to recur and be part of the company in the foreseeable future.

Comparative Industry Data

Comparative analysis uses information gleaned from the two sources, common-size analysis and ratio “trend” analysis. As indicated by its title, comparative analysis involves comparison of the subject Company’s status and performance with those of specific other companies or industry averages. Comparative analysis can involve either a comparison over a historical period of more than one year or over the latest complete 12-month period. In many cases, specific competitor data for comparison is not available, and the analyst will need to use general industry information. In the following sections, the “Industry” is referring to the database for NAICS code 453100, SIC Code 5992. Two sources for general industry information used in this analysis include the following:

  • Risk Management Association (RMA) Annual Statement Studies2:RMA financial ratio benchmarks are derived from more than 200,000 statements of financial institution borrowers and prospects and include over 700 industries. The data include income statement and balance sheet common-size comparisons as well as 19 operating ratios. The RMA Valuation Edition features not only the national data contained in the standard RMA Annual Statement Studies® database but also enhanced financial ratios, national and regional data, percentages and real dollar values, and industry growth rates. I primarily utilized a five-year industry financial profile for NAICS code 453100 from RMA. The data reported herein contain comparable metrics summarized from 21 firms in the $10–$25 million dollar sales class located in the southeastern region of the United States.
  • First Research Industry:First Research provides industry profiles covering over 1000 industry segments. Updated on a monthly basis, First Research Industry profiles contain critical analysis, statistics, and forecasts to help your engage key prospects, coach key clients, and deepen customer relationships.

Common Size

The conversion of balance sheet and income statement line items into percentages of a total is often referred to as placing the statements on a “common-size” basis. For the purposes of common-size statements, balance sheet line items are presented as a percentage of total assets and income statement line items are presented as a percentage of total net sales or gross revenue.

Converting the subject Company’s balance sheets and income statements into a common-size basis assists in identifying internal trends. Common-size statements also facilitate comparison with other companies in the same industry.

Rosewood unadjusted historical common-size balance sheet data in comparison to RMA industry data appears as follows:

ROSEWOOD FLORIST SHOP, LLC

Historical Income Statements Summary
As of December 31 (in 000’s) 2018 R.M.A.
  Current Assets
  Cash & Equivalents 4,970 40.2% 9.0%
  Accounts Receivable 2,680 21.7% 30.0%
  Inventory 990 8.0% 11.0%
  Other Current Assets 570 4.6% 2.0%
  9,210 74.5% 52.0%
  Fixed Assets
  Net Fixed Assets 2,690 21.7% 42.0%
  Other Assets
  Total Other Assets 470 3.8% 6.0%
TOTAL ASSETS 12,370 100.0% 100.0%
  100.0%
  Current Liabilities
  Notes Payable - 0.0% 7.0%
  Accounts Payable 516 4.2% 15.0%
  Other Accrued Liabilities 810 6.5% 15.0%
  1,326 10.7% 37.0%
  Long-Term Liabilities
  Long-Term Debt - 0.0% 24.0%
  Other LT/Deferred Income Taxes 450 3.6% 5.0%
  450 3.6% 29.0%
  1,776 14.4% 66.0%
  14.4%
Stockholders’ Equity
  10,594 85.6% 34.0%
TOTAL LIABILITIES & EQUITY 12,370 100.0% 100.0%

As noted above, Rosewood cash balances are much higher than the industry averages because Rosewood has not distributed dividends to owners in recent years. The primary offset for this condition is related to total equity, which is also much higher than the industry averages.

Rosewood unadjusted historical common-size income statement data in comparison to RMA industry data appears as follows:

ROSEWOOD FLORIST SHOP, LLC
HISTORICAL INCOME STATEMENTS SUMMARY

(Thousands, ooo)
For the Year Ended December 31 (in 000’s) 2018 R.M.A.
Revenue
Gross Revenues $ 24,587 100.0% 100.0%
Cost of Sales $ 17,137 69.7% 71.0%
Gross Profit $ 7,450 30.3% 29.0%
Operating Expenses $ 7,090 28.8% 25.0%
Income From Operations $ 360 1.5% 4.0%
Total Other Income/(Expense) $ 200 0.8% -1.0%
Net Income Before Taxes $ 560 2.3% 3.0%

Rosewood income and operating efficiency are below the industry in 2018. Gross profit margins are slightly above the industry average for 2018. Net income margin fell slightly below the industry in 2018. First Research Industry results were comparable to those presented above.

Ratio (Trend) Analysis

Financial ratios are measures of the relative health of a business. A financial analysis examines a company’s growth, cost control, turnover, profitability, and risk. Like the common-size metrics, company ratios are compared with generally accepted guidelines. Ratio analysis is an effective tool to assist the analyst in answering some basic questions, such as: How well is the company doing? What are its strengths and weaknesses? And, what are the relative business and operating risks to the company? Although an analysis of financial ratios will help identify a company’s strengths and weaknesses, it has its limitations and will not necessarily identify all strengths and weaknesses, nor will it provide the solutions or cures for the problems it identifies. For instance, off-balance-sheet financing techniques are not included or reflected in the balance sheet.

Ratio analysis allows comparison of the subject Company to industry peers. There are at least three major categories of ratios that offer numerous metrics to examine:

  1. Liquidity ratios (also referred to as solvency ratios) measure a firm’s ability to pay its near-term financial obligations.
  2. Operating ratios measure the efficiency and profitability used in the evaluation of management performance.
  3. Coverage ratios measure the inclusion of debt in a firm’s financial structure.

The ratio (trend) analyses are presented for select metrics whose comparison of Rosewood to the RMA industry data suggests that the company ranks only in the lowest 25% or above the highest 75% of the industry. Note: The remainder of ratios were examined and Rosewood fall within the range of 25–75% of industry participants.

The following liquidity ratios are compared to the subject Company.

Current Ratio 2017 2018
Median 1.40 1.30
Mean 1.42 1.28
Rosewood 3.77 6.95
Quick Ratio
Median 1.00 1.00
Mean 0.98 1.02
Rosewood 3.25 5.77

These results appear to be driven by the excess cash balances. When excess cash is removed from the company, these ratios become more comparable to RMA industry ratios. First Research Industry results were comparable to those presented above.

Normalization Adjustments

It is commonly accepted that most financial statements, even if prepared using Generally Accepted Accounting Principles (GAAP) or using a Tax Basis of Accounting (TBA), often present a picture that is different from economic reality. As a result, the analyst will generally prepare economic or “normalized” financial statements. Normalized financial statements will allow the analyst to compare better the subject Company’s financial performance and position to similar companies or industry averages and also allow the analyst to measure better true economic income, assets, and liabilities.

The main objective for recasting or adjusting the financial statements of a closely held company can be stated as follows:

To adjust the financial statements or income tax returns of a business to more closely reflect its true economic financial position and results of operations on a historical and current basis.

Balance sheet adjustments are made to reflect the current market values of both assets and liabilities.

Income statement adjustments are made to reflect the true economic results of operation similar to what a prospective buyer might require to have reasonable knowledge of the relevant facts. Normalizing adjustments are hypothetical and are not intended to present restated historical results or forecasts of the future in accordance with AICPA guidelines.

Economic/normalized financial statements should be useful for

  1. Making comparisons to similar business or industry averages
  2. Making meaningful projections and forecasts
  3. Representing the level of benefits to potential investors
  4. Representing the market values of net assets

Categories (or areas) of normalization adjustments include the following:

  • Comparability adjustments: These adjustments are made to the subject Company’s financial statements in order to make the subject Company more comparable to companies in its respective industry that were used in comparative ratio analyses. For example, a comparability adjustment would be made if the subject Company uses the LIFO method to value inventory while the rest of the industry uses the FIFO method.
  • Nonoperating/nonrecurring adjustments: Nonoperating assets or liabilities are removed from the balance sheet in order to reflect a more reliable value of the operating company. Nonrecurring income or expense adjustments are removed from the income statement because they are either unrelated to the business operations or unlikely to recur in the future. The nonoperating assets or liabilities are then added to or subtracted from the indicated value to determine the total equity value of the subject Company. The nonrecurring adjustments are not replaced since they do not reflect the ordinary business operations of the subject Company.
  • Discretionary adjustments: Discretionary adjustments are usually expenses that are not essential for business operations. These expenses are generally under the sole discretion of management or, more commonly, the owners of the subject Company. Discretionary expenses are often described as personal wants or desires opposed to actual business needs. Therefore, the adjustments represent the difference between the recorded expense and what the expense would have been in a well-run public company.

Normalizing adjustments to the Rosewood’s balance sheets and income statements are discussed below.

Balance Sheet Adjustments

  • Excess cash. As noted above, Rosewood’s liquidity ratios, especially the current and quick ratios, suggest that Rosewood has excess working capital compared to the industry. Additional examination shows a significantly increasing cash balance. Discussion with Ms. Rosewood and examination of RMA data suggest that cash holdings exceed those necessary for normal operations. The offsetting account in the balance sheet appears to be retained earnings, suggesting that Rosewood has not distributed income generated in recent years.

    The results of this examination suggest that Rosewood has nonoperating cash of approximately $4 million as of December 31, 2018. This amount will be treated as a nonoperating asset for valuation purposes.

  • Inventory. Rosewood Florist utilizes LIFO for costing inventory for tax purposes. The inventory value under FIFO as of December 31, 2018, is $505,000, an increase over the reported amount of $496,000, or $10,000 and will be applied in the asset approach to valuation.
  • Deferred taxes. According to the NACVA workbook, Chapter 6, page 4, it states, “Not making an adjustment for deferred taxes would theoretically be justified in a situation where the analyst is valuing a business for purposes of an Asset Purchase / Sale. However, an adjustment for deferred taxes may be appropriate in a valuation of a C-Corporation when the equity securities of the corporation are to be valued and adjustment of has been made to the value of the assets from historical amounts to an economic / normalized balance sheet.” Deferred taxes (deferred tax asset and deferred tax liability) will be removed from the balance sheet when presenting the asset approach to valuation. Note: $106,000 of current deferred tax assets are included in other current assets.
  • Land. Land is a nonoperating asset held for investment purposes.
  • Furniture, fixtures & equipment (including vehicles). Quality Appraisal Company concluded that the current market value of equipment is to be $3,600,000 at December 31, 2018. Furniture, fixtures & equipment (including vehicles) will be set to $3,600,000 when presenting the asset approach to valuation.

The adjusted balance sheet is presented as follows:

2018 Adjusted Balance Sheet

  Year Ended Normalize/Adjust Normalized/Adjusted Notes
  31-Dec-18 31-Dec-18
Assets:
Current assets
Cash & Equivalents 4,970 −4,000 970 A - Adjust cash for excess, reduced to amount required to meet needs of Redmond
Total Accounts Receivable 2,680 0 2,680
Inventory 990 10 1,000 B - Adjustment to convert inventory from LIFO to FICO
Total Other Current Assets 570 −106 464 C - Eliminate deferred tax asset
Total Current Assets 9,210 −4,096 5,114
Fixed Assets - Cost 20,620 −450 20,170 D - Eliminate land from balance sheet as a nonoperating asset
Accumulated Depreciation −17,930 910 −17,020 E - Adjust net fixed assets to appraised value
Total Fixed Assets - Net 2,690 460 3,150
Cash Surrender Value of Life Insurance 470 −470 0 F - Eliminate nonoperating asset - cash surrender value of life insurance
Total Assets 12,370 −4,106 8,264
Liabilities and Equity:
Liabilities
Total Current Liabilities 1,326 0 1,326
Deferred Income Taxes 450 −450 0 G - Eliminate deferred tax liability from the balance sheet
Total Liabilities 1,776 −450 1,326
Total Equity 10,594 −3,656 6,938
Total Liabilities and Equity 12,370 −4,106 8,264

Income Statement Adjustments

  • Lease expense. The company leases real estate from Linda & Daniel Family Limited Partnership, which is owned by the company’s principal shareholders, Linda and Daniel Rosewood. The lease agreement includes Rosewood Florist’s Morgantown facility and an additional property known as the Westover Building. The lease payment is $41,167 per month. According to the Burton Appraisal Company “survey of rents” dated November 31, 2018, the estimated market value of rent is $39,000. The variance between the rent to limited partnership ($41,167 for 2018 and 2017) and $39,000 is $2,167 or $26,004 annually.
  • Officer compensation. The owners (Linda and Daniel) worked 100% of the time in the business. Linda Rosewood is the president of Rosewood Florist and Daniel Rosewood was the office manager prior to her death. Each owner was paid $10,000 per month or $120,000 per year. According to Personnel consultants “annual salary surveys,” Daniel Rosewood’s annual salary would be reasonable at approximately $70,000 per year. A lesser qualified candidate would command a lower salary by about 20%; however, Ms. Rosewood appreciates the professionalism and independence of the more experienced office manager and plan to hire an office manager to replace Mrs. Daniel Rosewood at competitive market salary with 25+ years of experience. A normalization control adjustment of $50,000 per year ($120,000–$70,000) will be incorporated into the analysis.
  • Other expenses. In 2010, Linda and Dianne Rosewood were sued in connection with an accident where Mr. Rosewood ran into a children’s school bus on the way to the office. Because Mr. Rosewood was texting on his cell phone at the time of the accident, his personal auto liability insurance company initially denied coverage. The lawsuit with the victims and the insurance company ended in 2018 with a settlement paid by the insurance company but the attorney’s fees paid on behalf of the Rosewood’s by the company were exceptional. Attorney fees totaled $1,000,000, $1,400,000, and $1,000,000 in the years 2016, 2017, and 2018, respectively. These amounts are not related to the operations of Rosewood, are treated as a distribution (dividend) to the Rosewood’s for this valuation, and are eliminated from the operating results of the company.
  • Taxes. The adjustment to income tax expense is related to the additional liability associated with lower lease, officer compensation, and other expenses.

The adjusted net income amount across the five-year period 2014–2018 is presented as follows:

Net Income to Adjusted Income Reconciliation

  Year Ending Year Ending Year Ending Year Ending Year Ending
  31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18
Historic Net Income −160 16 495 396 497
Lease Expense A 26 26
Officer Compensation B 50 50 50 50 50
Other Expenses C 1,000 1,400 1,000
Income Taxes Tax 22 −13 −309 −374 −315
Adjusted Net Income −88 53 1,236 1,498 1,258
Description of the adjustments:
(A) - Adjust lease to market value
(B) - Adjust for Excess Officers Compensation
(C) - Adjust for Personal Legal Costs
(Tax) - 20% - per tax table

Valuation Approaches and Methods

All relevant valuation approaches were considered in performing the valuation of Rosewood Florist. There are three recognized approaches to valuation: market approach, income approach, and asset approach.

Market Approach

The market approach calculates the value of a business, business ownership interest, security, or intangible asset by using one or more methods that compare the subject company to similar businesses, business ownership interests, securities, or intangible assets that have been sold.

Generally, this can be accomplished by a comparison to publicly traded guideline operating or investment companies or by an analysis of actual transactions of similar businesses sold. It may also include an analysis of prior transactions involving ownership interests in the entity, if any.

  • Publicly traded guideline companies method

    An attempt was made to locate publicly traded companies that would be comparable to the Company. Due to the nature of the operations of the Company, no publicly traded companies were identified to be sufficiently comparable to the Company to employ this valuation method.

  • Guideline transactions method

    I researched selected transaction databases including Bizcomps, IBA, and Pratt’s Stats using SIC Code “5992” as the key descriptive term. I located a number of transactions in each of the databases involving businesses that I deemed to be comparable to the Company. Using this data as described later in this report, I developed an estimate of the fair market value of the Subject Interest.

  • Prior transactions in ownership interests

    The market approach would also encompass prior transactions in ownership interests in the Company. I was not aware of any prior transactions involving ownership interests in the Company that would serve as a valid indication of the fair market value of the Company’s equity.

Income Approach

The income approach determines the value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated benefits into a present single amount.

The application of the income approach establishes value by methods that discount or capitalize earnings and/or cash flow, by a discount or capitalization rate that reflects market rate of return expectations, market conditions, and the relative risk of the investment. Generally, this can be accomplished by the capitalization of earnings or cash flow method and/or the discounted cash flow method.

  • Capitalization of earnings method

    The capitalized returns method is generally used when an entity’s future operations are not expected to change significantly from its current normalized operations. To apply this method, an entity’s current operations, either earnings or cash flow, are divided or multiplied by a capitalization rate to estimate value. An entity’s capitalization rate is generally derived from its discount rate and can be stated as either a divisor or multiplier.

  • Discounted cash flow method

    The discounted future returns method may be used when an entity’s future returns can be estimated and are expected to differ significantly from its current operations. To utilize this method, an entity’s future operations are estimated until a stabilized level is obtained and a terminal value is then determined. The entity’s estimated future returns and terminal value are then discounted to present value using a discount rate. The discount rate represents the total expected rate of return, stated as a percentage, that a buyer or investor would demand on the purchase of an asset given the level of inherent risk in the asset. The discount rate is not utilized as a divisor or multiplier; instead, it is used to determine present value factors, which convert a future benefit stream into a present value.

Asset Approach

The asset approach calculates the value of a business, business ownership interest, or security by using one or more methods based on the value of the assets of that business net of liabilities.

The approach can include the value of both tangible and intangible assets. However, this approach is often unnecessary in the valuation of a profitable operating company as a going concern, as the tangible and intangible assets are automatically included, in aggregate, in the market and income approaches to value.

Summary of the Valuation Approaches and Methods

As noted, in my determination of the fair market value of the Subject Interest, all three approaches to value were considered. I selected an income approach, specifically the capitalization of earnings method, as the most appropriate for the Subject Interest.

Methods Considered and Rejected

Asset-Based Approach

The asset-based approach measures the fair market value of the assets on the assumption that the value of the equity would be realized through a sale of the Company as a going concern. This is not a liquidation value analysis, which involves estimating the value of individual assets on an orderly or forced liquidation basis and requires inclusion of certain added costs of realizing equity value through the sale of individual assets.

The asset-based approach (adjusted fair market value method) requires the determination of the aggregate fair market value of the assets and liabilities of the entity, with the resulting difference being the equity value. As discussed above, since Rosewood Florist is an operating entity, I believe that the asset-based approach will not provide the most relevant indication of value in this instance and that other methods provide a better indication of value.

As presented below, the result of the adjusted book value method is $6,892,000.

Adjusted Asset Indicated Value

Adjusted Equity $6,937,861
Nonoperating assets
 Cash $4,000,000
 Land $900,000
 Cash Surrender Value of Life Insurance $470,000
  $5,370,000
  $12,307,861
Lack of Control Discount Percentage −20%
Lack of Control Discount ($2,461,572)
  $9,846,289
Lack of Marketability Discount Percentage −30%
Lack of Marketability Discount ($2,953,887)
Adjusted Fair Value of Net Assets $6,892,402
40% Equity Value $2,756,961
Application of a Discount for Lack of Control (i.e., Minority Interest Discount)

A discount for lack of control is a reduction to the initial indicated value due to a lack of control prerogatives such as declaring dividends, liquidating the company, going public, issuing or buying stock, directing management, setting management’s salaries. As discussed in greater detail later in this report, a discount for lack of control of 20.00% is deemed to be appropriate to apply in this method.

Application of a Discount for Lack of Marketability

As discussed in this report, a discount of 30.00% is required for the lack of marketability of the Subject Interest. The discount reflects an expectation for the lack of a secondary market in which to negotiate a quick sale.

Adjustment for Excess/Nonoperating Assets

Excess or nonoperating assets represent the value of resources the company has control of but are not required to operate the business. Examples are excess cash on hand, real estate, or other securities. In our judgment, excess and nonoperating assets that need to be added back and are part of the entity’s value total $5,370,000.

Indicated Value

As calculated and based on this methodology, the indicated fair market value of $6,892,000 and 40% of the equity of the Company is $2,757,000.

Market Approach/Guideline Transactions Method

Guideline companies are companies that provide a reasonable basis for comparison to the relevant investment characteristics of a company being valued. Guideline companies are most often publicly traded companies, although they may be private, in the same or similar business as the subject of this valuation. Guideline companies are used as a basis to develop valuation conclusions with respect to a subject Company under the presumption that a similar market exists for the subject Company as exists for the guideline companies.

Ideal guideline companies should be in the same business as the company being valued. However, if there is insufficient transaction evidence in the same business, it may be necessary to consider companies with an underlying similarity of relevant investment characteristics such as markets, products, growth, cyclical variability, and other salient factors.

The guideline transactions method uses a group of privately held companies that have been purchased/sold and that have been selected for their ability to provide valuation guidelines for the analyst. The most commonly used version of the guideline company method develops a ratio, such as the price/revenue ratio, with which to capitalize the base.

Bizcomps Data3

I searched the Bizcomps database for transactions involving privately held guideline companies. The Bizcomps database is a study of small business sales whereby relevant pricing information is collected from business brokers and transaction intermediaries on individual sales of small businesses.

I first identified the industry in which Rosewood Florist Shop, LLC operates and, using the Standard Industrial Classification Codes (SIC Codes) for the industry (5992), performed a search for a group of companies in a similar line of business as that of the Company. I screened this group further through the use of key words and phrases that are unique to describe the subject Company’s product or operations. Further analysis of the remaining companies in terms of operating, financial, geographical, industry, and/or market characteristics helped ensure that the guideline companies are reasonable for inclusion in the guideline company group.

Given these parameters, I found 26 transactions that meet the criteria for being included as guideline companies. The price to revenue (P/R) ratios averaged 0.31 and the median was 0.29. Given the comparison of Rosewood sale revenue to those in the Bizcomps sample, the selected P/R ratio was 0.29. The price to seller’s discretionary earnings (P/SDE) ratio averaged 3.41 and the median was 3.10. The selected P/SDE ratio was 3.10.

Estimate of Revenue Base

As shown below, I selected the Company’s most recent annual revenue amount as appropriate to use in the methodology.

ROSEWOOD FLORIST SHOP, LLC

Revenue Benefit Stream
For the Year Ended December 31 (in 000’s) 2014 2015 2016 2017 2018
Gross Revenues $ 21,820,000 $ 22,110,000 $ 23,470,000 $ 24,722,000 $ 24,587,000
Weight - - - - 1
  $ 24,587,000
Estimate of Seller’s Discretionary Earnings (SDE) Base

Like the revenue amount, I selected the Company’s most recent estimate of seller’s discretionary earnings to use in the methodology.

BIZCOMPS Seller’s Discretionary Earnings Base

  Year Ending Year Ending Year Ending Year Ending Year Ending
Adjusted 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18
Debt Free Pretax Income - Pre-adjustment −160,000 10,000 600,000 582,000 559,861
Lease expense A 26,000 26,000
Officer compensation B 50,000 50,000 50,000 50,000 50,000
Other expenses C 1,000,000 1,400,000 1,000,000
Income taxes Tax
Adjusted Pretax Net Income −110,000 60,000 1,650,000 2,058,000 1,635,861
Debt Free Pretax Income
Officers’ Compensation 190,000 190,000 190,000 190,000 190,000
Depreciation/Amortization 450,000 940,000 380,000 400,000 450,000
Seller’s Discretionary Earnings 530,000 1,190,000 2,220,000 2,648,000 2,275,861
Weight on SDE 1 1 1
Ongoing Seller’s Discretionary Earnings 2,381,287
SELECTED ONGOING SDE BASE 2,381,300

Application of the Bizcomps Data in the Guideline Transactions Method

As shown in the following calculation, I determined that, based on the analysis, the price to SDE multiple and the P/R multiple to be reasonable indications of value of the Subject Interest. BIZCOMPS Indicated Value

  Revenue Multiple SDE Multiple
Base 24,587,000 2,381,300
Multiple 0.12 1.75
Subtotal 2,950,440 4,167,275
Weight 1 1
Ongoing Value 3,558,858
Additions:
Cash 970,000
Accounts Receivable 2,680,000
Inventory 1,000,000
Other Current 464,000
Subtractions:
Accounts Payable −516,000
Other Current Liabilites −810,000
Subtotal 7,346,858
Minority Interest Discount 20.00%
Subtotal 5,877,486
Marketability Discount 30.00%
Operating Value 4,114,240
Excess/Nonoperating Assets
 Cash 4,000,000
 Land 900,000
 Cash Surrender Value of Life Insurance 470,000
 Excess/Nonoperating Assets 5,370,000
Apply Minority Interest Discount 20.00%
Apply Marketability Discount 30.00%
Adjusted Excess/Nonoperating Assets 3,007,200
Indicated Equity Value 7,121,440
SELECTED EQUITY VALUE 7,121,000
Application of a Discount for Lack of Control (i.e., Minority Interest Discount)

A discount for lack of control is a reduction to the initial indicated value due to a lack of control prerogatives such as declaring dividends, liquidating the company, going public, issuing or buying stock, directing management, setting management’s salaries. As discussed in greater detail later in this report, a discount for lack of control of 20.00% is deemed appropriate to apply in this method.

Application of a Discount for Lack of Marketability

As discussed later in this report, a discount of 30.00% is required for the lack of marketability of the Subject Interest. The discount reflects an expectation for the lack of a secondary market in which to negotiate a quick sale.

Adjustment for Excess/Nonoperating Assets

Excess or nonoperating assets represent the value of resources the company has control of but are not required to operate the business. Examples are excess cash on hand, real estate, or other securities. In the judgment, excess and nonoperating assets that need to be added back and are part of the entity’s value total $5,370,000.

Indicated Value

As calculated and based on this methodology, the indicated fair market value of $7,121,000 and 40% of the equity of the Company is $2,848,400 rounded to $2,848,000.

IBA Data4

I searched the IBA database for transactions involving privately held guideline companies. The IBA database is a study of small business sales whereby relevant pricing information is collected from business brokers and transaction intermediaries on individual sales of small businesses. The search parameters used in determining whether or not a particular transaction in the IBA database was comparable to the Company were based upon size and general description. Given these parameters, I identified 46 transactions that meet the criteria to be included as guideline companies. The selected price to revenue (P/R) ratio was 0.21. The selected price to seller’s discretionary earnings (P/SDE) ratio was 1.76.

Estimate of Revenue Base

As shown below, I selected the Company’s most recent annual revenue amount as appropriate to use in the methodology.

IBA Revenue Base

  Year Ending Year Ending Year Ending Year Ending Year Ending
Adjusted 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18
Revenue 21,820,000 22,110,000 23,470,000 24,722,000 24,587,000
Additional Adjustment
Total 21,820,000 22,110,000 23,470,000 24,722,000 24,587,000
Weight On Revenue 1
Ongoing Revenue 24,587,000
SELECTED ONGOING REVENUE BASE 24,587,000
Estimate of Seller’s Discretionary Earnings (SDE) Base

Similar to the revenue amount, I selected the Company’s most recent estimate of seller’s discretionary earnings to use in the methodology.

Application of the IBA Data in the Guideline Transactions Method

As shown in the following calculation, I determined that, based on the analysis, the price to seller’s discretionary earnings multiple and the P/R multiple to be reasonable indications of value of the Subject Interest. I assigned equal weight to the P/SDE multiple and to the P/R multiple.

IBA Indicated Value

  SDE Multiple Revenue Multiple
Base 1,971,000 24,587,000
Multiple 1.76 0.21
Subtotal 3,468,960 5,163,270
Subtotal 3,468,960 5,163,270
Weight 1 1
Weight × Value 1,734,480 2,581,635
Ongoing Value 4,316,115
Additions:
Cash 970,000
Accounts Receivable 2,680,000
Other Current 464,000
Subtractions:
Accounts Payable −516,000
Other Current Liabilites −810,000
Adjustment
Subtotal 7,104,115
20% Minority Interest Discount −1,420,823
Subtotal 5,683,292
30% Marketability Discount −1,704,988
Operating Value 3,978,304
Excess/Nonoperating Assets
Cash 4,000,000
Land 900,000
Cash Surrender Value of Life Insurance 470,000
Excess/Nonoperating Assets 5,370,000
Apply 20% Minority Interest Discount −1,074,000
Subtotal 4,296,000
Apply 30% Marketability Discount −1,288,800
Adjusted Excess/Nonoperating Assets 3,007,200
Indicated Equity Value 6,985,504
SELECTED EQUITY VALUE 6,986,000
40% EQUITY VALUE 2,794,400
Application of a Discount for Lack of Control (i.e., Minority Interest Discount)

A discount for lack of control is a reduction to the initial indicated value due to a lack of control prerogatives such as declaring dividends, liquidating the company, going public, issuing or buying stock, directing management, setting management’s salaries. As discussed in greater detail later in this report, a discount for lack of control of 20.00% is deemed appropriate to apply in this method.

Application of Discount for Lack of Marketability

As discussed later in this report, a discount of 30.00% is required for lack of marketability of the Subject Interest. The discount reflects an expectation for the lack of a secondary market in which to negotiate a quick sale.

Adjustment for Excess/Nonoperating Assets

Excess or nonoperating assets represent the value of resources the company has control of but are not required to operate the business. Examples are excess cash on hand, real estate, or other securities. In the judgment, excess and nonoperating assets that need to be added back and are part of the entity’s value total $5,370,000.

Indicated Value

As calculated and based on this methodology, the indicated fair market value of $6,986,000 and 40% of the equity of the Company is $2,794,400 rounded to $2,794,000.

Pratt’s Stats Data5

I searched the Pratt’s Stats database for transactions involving privately held and publicly traded guideline companies. The Pratt’s Stats database is a study of transactions involving publicly traded and privately held businesses. I researched guideline companies first by identifying the industry in which Rosewood Florist Shop, LLC operates, and using the Standard Industrial Classification Codes (SIC Codes) for the industry, I performed a search for a group of companies in a similar line of business as that of the subject Company.

I screened this group further through the use of key words and phrases that are unique to describe the subject Company’s product. Further analysis of the remaining companies in terms of operating, financial, geographical, industry, and/or market characteristics ensured that the guideline companies are reasonable for inclusion in the guideline company group.

I selected discretionary earnings and net sales as two possible financial bases to which I would apply the indicated multiple derived from the Pratt’s Stats data. Given these parameters, I found 61 transactions that meet the criteria to be included as guideline companies. The selected price to revenue (P/R) ratio was 0.31. The selected price to seller’s discretionary earnings (P/SDE) ratio was 3.50.

Estimate of Discretionary Earnings Base

As shown below, I selected the Company’s most recent annual discretionary earnings amount as appropriate to use in the methodology.

Pratt’s Stats Discretionary Earnings Base

Year Ending Year Ending Year Ending Year Ending Year Ending
Adjusted 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18
Pretax Income - Pre-adjustment (160,000) 10,000 600,000 582,000 559,861
Lease Expense A 26,000 26,000
Officer Compensation B 50,000 50,000 50,000 50,000 50,000
Other Expenses C 1,000,000 1,400,000 1,000,000
Income Taxes Tax
Adjusted Pretax Income −110,000 60,000 1,650,000 2,058,000 1,635,861
Interest 0 0 0 0 0
Depreciation and Amortization 450,000 940,000 380,000 400,000 450,000
Other Noncash Expenses 0 0 0 0 0
Owners Compensation 190,000 190,000 190,000 190,000 190,000
Additional Adjustment
Discretionary Earnings 530,000 1,190,000 2,220,000 2,648,000 2,275,861
Weight on Discretionary Earnings Base 1 1 1
Ongoing Discretionary Earnings Base 2,381,287
SELECTED ONGOING DISCRETIONARY EARNINGS BASE 2,381,000
Estimate of Net Sales Base

As shown below, I selected the Company’s most recent annual net sales amount as appropriate to use in the methodology.

Pratt’s Stats Net Sales Base

  Year Ending Year Ending Year Ending Year Ending Year Ending
Adjusted 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18
Net Sales
Additional Adjustment
21,820,000 22,110,000 23,470,000 24,722,000 24,587,000
Total 21,820,000 22,110,000 23,470,000 24,722,000 24,587,000
Weight On Net Sales 1
Ongoing Net Sales 24,587,000
SELECTED ONGOING NET SALES BASE 24,587,000

Application of the Pratt’s Stats Data in the Guideline Transactions Method

As shown in the following calculation, I determined that, based on the analysis, both the MVIC to discretionary earnings multiple and the MVIC/net sales multiple to be reasonable indications of value of the Subject Interest; therefore, I assigned equal weight to each multiple.

Pratt’s Stats multiples are net of debt. This means that the multiples are calculated for all the funds a company might utilize to capitalize itself. In order to obtain an equity value, the market value of the debt on the balance sheet needs to be subtracted from the indicated value of the multiple times the base. This debt amounted to $1,326,000.

Pratt’s Stats Indicated Value

  Discretionary
  Net Sales Earnings
  Multiple Multiple
Base 24,587,000 2,381,000
Multiple 0.31 3.50
Subtotal 7,621,970 8,333,500
Weight 1 1
Ongoing Value 7,977,735
Adjusted Balance Sheet Debt 1,326,000
Subtotal 6,651,735
Deduct: 20% Minority Interest Discount −1,330,347
Subtotal 5,321,388
Deduct: 30% Marketability Discount −1,596,416
Operating Value 3,724,972
Excess/Nonoperating Assets
Cash 4,000,000
Land 900,000
Cash Surrender Value of Life Insurance 470,000
Excess/Nonoperating Assets 5,370,000
Apply 20% Minority Interest Discount −1,074,000
Subtotal 4,296,000
Apply 30% Marketability Discount −1,288,800
Adjusted Excess/Nonoperating Assets 3,007,200
Indicated Equity Value 6,732,172
SELECTED EQUITY VALUE 6,732,000
Application of a Discount for Lack of Control (i.e., Minority Interest Discount)

A discount for lack of control is a reduction to the initial indicated value due to a lack of control prerogatives such as declaring dividends, liquidating the company, going public, issuing or buying stock, directing management, setting management’s salaries. As discussed in greater detail later in this report, a discount for lack of control of 20.00% is deemed appropriate to apply in this method.

Application of a Discount for Lack of Marketability

As discussed later in this report, a discount of 30.00% is required for the lack of marketability of the Subject Interest. The discount reflects an expectation for the lack of a secondary market in which to negotiate a quick sale.

Adjustment for Excess/Nonoperating Assets

Excess or nonoperating assets represent the value of resources the company has control of but are not required to operate the business. Examples are excess cash on hand, real estate, or other securities. In the judgment, excess and nonoperating assets that need to be added back and are part of the entity’s value total $5,370,000.

Indicated Value

As calculated and based on this methodology, the indicated fair market value of $6,732,000 and 40% of the equity of the Company is $2,693,000.

Valuation Approaches and Methods Used

Income Approach/Capitalization of Adjusted Net Earnings

The capitalization of adjusted net earnings method under the income approach was used to determine the fair market value of the Subject Interest. This method includes determining the adjusted net earnings available to the equity owners of the Company, developing an appropriate capitalization rate, and implementing the capitalization process.

Determination of Adjusted Net Earnings

The benefit stream to be capitalized is that which an investor would expect the enterprise to realize in the future. The historical weight-adjusted normalized pretax earnings was calculated to be $1,740,630. Estimated ongoing tax adjustments were made resulting in an amount consistent with the after-tax capitalization rate used in the calculation. Cash flow adjustments were then made, $100,000 for working capital and $100,000 for recurring capital expenditures, resulting in an ongoing adjusted net cash flow of $581,500.

Capitalization of Earnings Benefit Stream

  Year Ending Year Ending Year Ending
  31-Dec-16 31-Dec-17 31-Dec-18
Earning Power Based on Net of Debt After Tax Cash Flow
Adjusted Pretax Income 1,236,000 1,497,600 1,258,289
Add Depreciation/Amortization and Other Noncash Expenses 380,000 400,000 450,000
Total 1,616,000 1,897,600 1,708,289
Weight 1 1 1
Ongoing Earning Power 1,740,630
Less Ongoing Depreciation/Amortization 410,000
Before Taxes 1,330,630
Less Taxes 266,126
Subtotal 1,064,504
Depreciation/Amortization 410,000
Adjust for Working Capital Requirements −100,000
Adjust for Capital Expenditure Requirements −100,000
Adjust for Long-Term Debt Requirements 0
Calculated Ongoing Net of Debt After Tax Cash Flow 1,274,504
SELECTED ONGOING NET OF DEBT AFTER TAX CASH FLOW 1,274,500

Determination of the Capitalization Rate—Cost of Equity

The rate used to capitalize the expected economic income is the expected rate of return that a buyer requires in order to make a particular investment. Most of the information for estimating the expected rate of return, or capitalization rate, comes from the investment markets. A build-up method was used to estimate the capitalization rate.

Capitalization of Earnings - Capitalization Rate

BUILD-UP CAPITALIZATION RATE
Risk-Free Rate of Return 2.50%
Equity Risk Premium 6.60%
Small Stock Risk Premium 6.00%
Company-Specific Premium 6.00%
Net Cash Flow Discount Rate 21.10%
Discount Rate 21.10%
Sustainable Growth 2.50%
Capitalization Rate to Apply to Next Year Stream 18.60%
Divide by 1 Plus the 2.5% to Get 1.025%
Capitalization Rate to Apply to Current Year Stream 18.14%
Selected Rate (rounded) 18.10%

Determination of such a rate begins with an estimate of the cost of equity capital (also known as Ke or the “discount rate”). The build-up method is one of several widely used methods to estimate the cost of common equity capital. It is an additive model in which the return on any asset is estimated as the sum of two or more components:

  1. A “risk-free” rate of return
  2. One or more premia for risk

The components used in the build-up method are shown in the following formula:

Ke=Rf+RPm+RPs+RPu

where

  • Ke = Cost of equity
  • Rf = Risk-free rate
  • RPm = Equity risk premium
  • RPs = Risk premium for small size
  • RPu = Company-specific risk premium (i.e., unsystematic risk)

The risk-free rate (Rf) of 2.50 is based on the annual yield of a 20-year United States Treasury Bond as of the valuation date, December 31, 2018, as published by the Federal Reserve in their statistical release.

The equity risk premium (6.6%) and the risk premium for small size (6.0%) are calculated as the average rate of return on common equity securities over the average income return earned on long-term treasury bonds over the same period and are ranked by five different measurements of size as found in the 2018 Ibbotson SBBI Valuation Yearbook. The total ERP plus risk premium used is 12.6% (6.6% + 6.0%).

The company-specific risk premium (RPu) is a subjective measurement of the unsystematic risk associated with the subject Company. This risk premium is based on factors such as industry risk, volatility of returns, leverage, size smaller than the smallest size premium group, and other company-specific factors. Some of the factors influencing the company-specific risk premium include the following:

  • Size. Investments in small companies typically carry a greater expected rate of return.

    Rosewood is on the lower end of the size spectrum.

  • Access to capital markets. Small, closely held firms generally have more difficulty raising money.

    Rosewood has an unused line of credit and no long-term financing.

  • Breadth of customer base. Dependence on specific customers who can easily choose a competitor is a significant risk.

    While no single customer accounts for more than 3% of revenue, Rosewood’s largest 25 customers account for about 40% of 2018 revenue.

  • Geographic location. Certain regions of the county or metropolitan areas underperform.

    The West Virginia economy and Morgantown in particular seem to offer improving economic conditions, though conditions that trails the nation.

  • Key executive dependency. Smaller companies that rely on certain executives, particularly if these executives are older, may be vulnerable.

    The company is dependent on a few key management personnel.

  • Limited product line. Single focus closely held companies are more risky.

    The company has little diversification, earning all revenues from the florist industry that is currently impacted with technological innovation.

  • Litigation/regulating risk. Many profitable, otherwise healthy companies have been significantly affected overnight by lawsuits and legislation.

    No litigation has been identified.

  • Volatility of the industry. Certain industries are subject to cycles or serve competitive pressures.

    The industry is changing due to the impact of technology and trends in florist services.

Rosewood has been operated by experienced leadership and has been financially conservative. There have been no major issues, such as environmental or labor problems, in the Company’s history nor does management foresee any issues arising in the future. Company-specific risk for an entity like this should be relatively low. Based on these factors and our analysis of the financial and operational characteristics of the Company, a company-specific risk premium of 6.0% was considered reasonable.

Company-Specific Risk
Further Size Adjustment
Image described by surrounding text.
Depth of Management
Importance of Key Personnel
Stability of Industry
Diversification of Product Line
Diversification of Customer Base
Diversification/Stability of Suppliers
Geographic Location
Stability of Earnings
Earnings Margins
Financial Structure
Other
Company-Specific Premium

The build-up method resulted in a net cash flow discount rate of 21.1%. From this amount, the estimated long-term sustainable growth rate must be subtracted in order to determine the capitalization rate. The long-term sustainable growth amount of 2.5% was determined based on the forecast for the foreseeable future based on the estimated growth in inflation and revenue opportunities afforded Rosewood through its early transition to digital florist. Subtracting the 2.5% long-term sustainable growth rate from the discount rate of 21.1% resulted in a capitalization rate of 18.6% for next year. In order to determine the appropriate capitalization rate to apply to the historical earnings, the 18.6% was adjusted by dividing it by 1 plus the long-term sustainable growth rate of 2.5%, calculating a capitalization rate of 18.1%, which is appropriate for the historical income benefit stream.

As shown below, this capitalization rate was then applied to the adjusted net cash flows of the Company to estimate the fair market value of the Subject Interest.

Capitalization of Earnings Indicated Value

Net of Debt After Tax Cash Flow 1,274,500
Sustainable Growth Rate 2.50%
Net of Debt After Tax Cash Flow 1,306,363
Capitalization Rate 18.10%
Subtotal 7,217,472
20% Minority Interest Discount −1,443,494
Subtotal 5,773,978
30% Marketability Discount −1,732,193
Subtotal 4,041,785
Excess/Nonoperating Assets
Cash 4,000,000
Land 900,000
Cash Surrender Value of Life Insurance 470,000
Excess/Nonoperating Assets 5,370,000
Apply 20% Minority Interest Discount −1,074,000
Subtotal 4,296,000
Apply 30% Marketability Discount −1,288,800
Adjusted Excess/Nonoperating Assets 3,007,200
Indicated Equity Value 7,048,985
SELECTED EQUITY VALUE (rounded) 7,049,000
Application of a Discount for Lack of Control (i.e., Minority Interest Discount)

A discount for lack of control is a reduction to the initial indicated value due to a lack of control prerogatives such as declaring dividends, liquidating the company, going public, issuing or buying stock, directing management, setting management’s salaries. As discussed in greater detail later in this report, a discount for lack of control of 20.00% is deemed appropriate to apply in this method.

Application of a Discount for Lack of Marketability

As discussed in this report, a discount of 30.00% is required for the lack of marketability of the Subject Interest. The discount reflects an expectation for the lack of a secondary market in which to negotiate a quick sale.

Adjustment for Excess/Nonoperating Assets

Excess or nonoperating assets represent the value of resources the company has control of but are not required to operate the business. Examples are excess cash on hand, real estate, or other securities. In our judgment, excess and nonoperating assets that need to be added back and are part of the entity’s value total $5,370,000.

Indicated Value

As calculated and based on this methodology, the indicated fair market value of $7,049,000 and 40% of the equity of the Company is $2,819,600.

Conclusion of Value

The conclusion of value is rendered in the context of the specific assignment described above and is applicable only for the period noted. The conclusion of value of the fair market value of a 40.0% ownership interest in Rosewood Florist Shop, LLC as of December 31, 2014, on a noncontrolling, nonmarketable basis is as follows:

Conclusion of Value

Valuation Indication by Method Indicated
  Value Weight
Methods Rejected:
Adjusted Book Value Method - Going Concern 6,892,402 0 Considered & Rejected
Market Data Method - Bizcomps 7,346,858 0 Considered & Rejected
Market Data Method - IBA 7,104,115 0 Considered & Rejected
Market Data Method - Pratt’s Stats 6,651,735 0 Considered & Rejected
Methods Used:
Capitalization of Earnings Method 7,217,472 1 Considered & Used
Initial Conclusion of Equity Value 7,217,472
20% Minority Interest Discount −1,443,494
Subtotal 5,773,978
30% Marketability Discount −1,732,193
Subtotal 4,041,785
Excess/Nonoperating Assets
Cash 4,000,000
Land 900,000
Cash Surrender Value of Life Insurance 470,000
Excess/Nonoperating Assets 5,370,000
Apply 20% Minority Interest Discount −1,074,000
Subtotal 4,296,000
Apply 30% Marketability Discount −1,288,800
Adjusted Excess/Nonoperating Assets 3,007,200
Indicated Equity Value 7,048,985
SELECTED CONCLUSION OF EQUITY VALUE (rounded) 7,049,000
Shares Outstanding 50,000
100% Equity Value per Share $141
40% Interest - Number of Shares 20,000
40% Equity Value $2,819,600
40% Equity Value per Share $141

The conclusion of value of the fair market value of a 40% ownership interest in Rosewood Florist Shop, LLC as of December 31, 2018, on a noncontrolling, nonmarketable basis was $2,820,000. The 20,000 shares of stock on a per-share basis have a corresponding fair market value of $141.00 per share.

Notes

Appendix A: Statement of Assumptions and Limiting Conditions

This valuation engagement and summary valuation report is subject to the following assumptions and limiting conditions:

  1. The conclusion of value arrived at herein is valid only for the stated purpose as of the valuation date.
  2. Financial statements and other related information provided by the Company or its representatives, in the course of this engagement, have been accepted without any verification as fully and correctly reflecting the enterprise’s business conditions and operating results for the respective periods, except as specifically noted herein. I have not audited, reviewed, or compiled the financial information provided, and, accordingly, I express no audit opinion or any other form of assurance on this information.
  3. Public information and industry and statistical information, if obtained, has been derived from sources I believe to be reliable. However, I make no representation as to the accuracy or completeness of such information and have performed no procedures to corroborate the information.
  4. The conclusion of value arrived at herein is based on the assumption, unless otherwise noted in the report, that the current level of management expertise and effectiveness would continue to be maintained, and that the character and integrity of the enterprise through any sale, reorganization, exchange, or diminution of the owners’ participation would not be materially or significantly changed.
  5. This report and the conclusion of value arrived at herein are for the exclusive use of my client for the sole and specific purposes as noted herein. They may not be used for any other purpose or by any other party for any purpose. Furthermore, the report and conclusion of value are not intended by the author and should not be construed by the reader to be investment advice in any manner whatsoever. The estimate of value represents the considered opinion of the analyst based on information furnished by the Company and other sources.
  6. Neither all nor any part of the contents of this report (especially the conclusion of value, the identity of any Valuation Analysts, or any reference to any of their professional designations) should be disseminated to the public through advertising media, public relations, news media, sales media, mail, direct transmittal, or any other means of communication without my prior written consent and approval.
  7. Future services regarding the subject matter of this report, including, but not limited to testimony or attendance in court, shall not be required unless previous arrangements have been made in writing.
  8. I am not an environmental consultant and take no responsibility for any actual or potential environmental liabilities. Any person entitled to rely on this report, wishing to know whether such liabilities exist, or the scope and their effect on the value of the property, is encouraged to obtain a professional environmental assessment. I do not conduct or provide environmental assessments and have not performed one for the subject property.
  9. I have not made a specific compliance survey or analysis of the subject property to determine whether it is subject to, or in compliance with, the American with Disabilities Act of 1990, and this valuation does not consider the effect, if any, of noncompliance.
  10. I have not made a specific compliance survey or analysis of the subject property to determine whether it is subject to, or in compliance with, any laws, regulations or any other legislation, code, ordinance, statute or other requirements, and this valuation does not consider the effect, if any, of noncompliance.
  11. No change of any item in this valuation report shall be made by anyone other than the Firm, and I shall have no responsibility for any such unauthorized change.
  12. Unless otherwise stated, no effort has been made to determine the possible effect, if any, on the subject business due to future Federal, state, or local legislation, including any environmental or ecological matters or interpretations thereof.
  13. Unless otherwise informed or determined independently by me, it is assumed that there are no regulations of any government entity to control or restrict the use of the subject business’s underlying assets and that the underlying assets will not operate in violation of any applicable government regulations, codes, ordinances, or statutes. I also assume that, unless otherwise informed or determined independently, the subject business is in compliance with all federal, state, and local laws and regulations, as well as up to date in regard to all filing and reporting requirements.
  14. I have conducted interviews with the Client and/or the current management of the Company concerning the past, present, and prospective operating results of the Company.

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Appendix D Forensic Economics (Personal Injury) Report

NOTES:

  • The analyses to support this report were examined in the prior chapter.
  • This example is not necessarily inclusive of all report elements.
  • Each forensic economic report should be reflective of relevant case attributes and examination outcomes.

Certification

I, Gabriele DiJames, hereby certify as follows:

  • I am a Certified Public Accountant, Certified Valuation Analyst, Certified in Financial Forensics, PhD, among other designations. I am a partner in the accounting firm of DiJames, Froman & Co., LLC. Our firm was retained by Mason and Dixon, LLP to prepare an economic damage analysis.
  • The following is a true copy of the Economic Damages analysis which I prepared.
  • The statements of fact contained in this report are true and correct, subject to the assumptions and conditions stated.
  • The reported analyses, opinions, and conclusions are limited only by the reported assumptions and limiting conditions and are our unbiased and professional analyses, opinions, and conclusions.

Our compensation is not contingent on an action or event resulting from the analyses, opinions, or conclusions in, or the use of, this report.

Contingent and Limiting Conditions

This report is subject to the following contingent and limiting conditions:

  • Information, estimates, and opinions contained in this report are obtained from sources considered reliable; however, DiJames, Froman & Co., LLC has not independently verified such information, and no liability for such sources is assumed.
  • All facts and data set forth in the report are true and accurate to the best of our knowledge and belief. I have not knowingly withheld or omitted anything from our report affecting our conclusion.
  • Possession of this report, or a copy thereof, does not carry with it the right of publication of all or part of it, nor may it be used for any purpose without the previous written consent of DiJames, Froman & Co., LLC.
  • The various estimates of loss presented in this report apply to this report only and may not be used out of the context presented herein. Any other use of this report may lead the user to an incorrect conclusion for which DiJames, Froman & Co., LLC assumes no responsibility.
  • I assume that there are no hidden or unexpected conditions of the parties that would adversely affect loss, other than as indicated in this report.

Exhibit 1 - Economic Damages Assumptions for Alex Jones

  Name of Injured: Alex Jones
  Date of Birth: 5/16/1977
  Sex: Male
  Age/Date of Injury: 40.50 years
  11/16/2017
  Age/Date of Planned Retirement: 62.00 years
  5/16/2039
  Age/Life Expectancy: 78.50 years
  11/16/2055
  Annual Income Base for Projection:
  Projected: $45,000
  Mitigating Income $21,000
  Risk of Unemployment:
  Government 1.80%
  Growth Rate:
  Wages 1.50%
  Household Services 1.50%
Discount Rate (U.S. Treasury website):
  20 Years - Future Loss of Income 2.75%

Economic Damages Report

Background

On November 16, 2017, Jones suffered a personal injury. At the time of injury, Jones was a Maintenance Worker for Mononghia School District.

Jones was born on May 16, 1977. He was approximately 40.5 years old at the time of his injury. Jones is currently married to Deena Jones. They have one child, a son, born on March 14, 2002, currently 16 years of age.

Jones suffered an injury on the job on November 16, 2017. He was unable to work after that date; he was paid through November 16, 2017.

According to the Jones, he would have retired upon reaching 62 years of age, May 16, 2039.

According to Social Security’s Online Actuarial Life Table, Jones’s statistical life expectancy in 2018 is an additional 37 years to age 78.50 (November 16, 2055).

My analysis illustrates economic damages suffered by Jones as a result of injury with mitigating wages. According to the vocational expert’s report, Jones mitigating wages may be assumed to begin on November 17, 2018.

The calculation of lost wages and fringe benefits was based on the following assumptions:

  1. LOSS OF EARNINGS and FRINGE BENEFITS
    1. Projected Gross Wages: Projected gross wages represent wages Jones would have earned in the absence of his injury. Projected gross wages for years 2017 through 5/16/2020 are calculated based on an agreement between the Board of Education Mononghia County School District and Mononghia County School District Custodial and Maintenance Organization. Jones’s future wages from 5/17/2020 through his planned retirement date of 5/16/2039 are projected forward by 1.50%, which is the average annual increase from the 2016–2017 school year to the 2017–2018 school year.
    2. Overtime: As part of Jones’s compensation package, he was offered overtime. His average overtime from 2015 through 2017 was approximately 20% of his salary.
    3. FICA Benefits: As part of Jones’s lost fringe benefits, he would no longer receive employer Medicare nor social security contributions. These lost benefits are added to wages and overtime.
    4. Healthcare: As part of Jones’s compensation package, he was offered healthcare insurance, 100% paid for by his employer; pay stubs indicate that Mr. Jones received this employer-paid benefit. Post injury, Mr. Jones’s most likely source of healthcare benefits is Obamacare. Healthcare.gov was used to estimate the cost of health care for Mr. Jones, his wife and son.
    5. Union Dues: According to Jones’s pay stubs, his annual union dues were $225, or 0.50% of his annual salary. I have decreased projected wages by union dues Jones would have paid had he remained employed as a Maintenance Worker with Mononghia School District.
    6. Required Pension Contribution: Mononghia School District automatically enrolls all employees in a defined benefit pension plan. The lost benefits associated with this plan are considered in a separate section. The District plan requires a 5% contribution by employees. Because the benefit is added to Mr. Jones damages in a separate section, the cost of participation is subtracted from income.
    7. Taxes: Ignored in compliance with West Virginia Supreme Court decisions.2
    8. Risk of Unemployment: I have estimated Jones’s earning reduction rate for possible periods of unemployment to be 1.8%3 of his earnings from November 17, 2017 through May 16, 2039 based on the average unemployment rate for Government Workers as of April 2017.
    9. Mitigating Income: I have reduced my calculation by mitigating wages in accordance with a report from a vocational expert. Dr. Jobs’s vocational expert report states that if Jones is successfully rehabilitated, his future earnings potential is approximately $21,000 per year with full employment.4 Jobs states that Jones would be limited to entry-level positions and minimum wage rates. I have projected the aforementioned forward by 1.50%,5 which is the 5-year average national growth rate for all occupations from the period of 2013–2017. I have started mitigating wages on November 17, 2018 as suggested by Dr. Jobs in his report date June 6, 2018.
    10. Economic Income Benefit: The total loss of income subsequent to Jones’s Loss of Income Date (11/16/2017) through his planned retirement date (5/16/2039) before discount.
    11. Number Alive: Derived from the National Vital Statistics Reports, Vol. 66, No. 4, August 14, 2017, Table 14. The amount represent the number of persons from 100,000 who survived to the age. The first number is 95,641, for a non-Hispanic white male, age 41–42.
    12. Probability of Surviving: The National Vital Statistics Reports provide the basis to estimate the probability that a person will be alive up through 100 years of age. Using (k) as a base, the probability of survival is estimated.
    13. Discount Factor: Total lost income is discounted to present value, to provide a lump sum representing the future loss. Generally, the discount rate represents the rate at which a person can invest a lump sum with no risk of loss. Interest-bearing United States Treasury investments are commonly referred to as risk-free investments. The most recent yield available to date on United States 20-year Treasury Note (approximate time from the future value to present value date of 5/16/19, which is on or around our report date) is 2.75%.6
    14. The column represented the total lost income after considering the probability of survival and discounting to the present value.

    Calculation of loss of earnings and fringe benefits subsequent to Jones’s Loss of Income Date (11/16/2017) to his planned retirement date (5/16/2039) is summarized in the following schedule:

    Exhibit 2 - Alex Jones’ Loss of Income

      DOB (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)
      5/16/1977 1.50% 20% 7.65% 4.00% 1.50% 5.00% 0.00% 1.80% 1.80%
    Year End % Year Age Projected Hourly Wages Overtime Loss FICA Lost Healthcare Union Dues Required Pension Taxes Risk of Unemployment Mitigating Income Loss before P(Survival) and Discounting
    11/16/2017 Injury 40.50 $45,000 $9,000 $8,844 ($225) −21000
    11/16/2018 1.00 41.50 $45,675 $9,135 $4,193 $9,198 ($228) (2,741) - (329) $0 $64,903
    5/16/2019 0.50 42.00 $23,180 $4,636 $2,128 $4,783 ($116) (1,391) - (167) ($10,881) $22,172
    Past Loss of Income (Based on Date of Report)
    11/16/2019 0.50 42.50 $23,180 $4,636 $2,128 $4,783 ($116) (1,391) - (167) ($10,881) $22,172
    11/16/2020 1.00 43.51 $47,056 $9,411 $4,320 $9,948 ($235) (2,823) - (339) ($22,155) $45,183
    11/16/2021 1.00 44.50 $47,761 $9,552 $4,384 $10,346 ($239) (2,866) - (344) ($22,553) $46,043
    11/16/2022 1.00 45.50 $48,478 $9,696 $4,450 $10,760 ($242) (2,909) - (349) ($22,959) $46,924
    11/16/2023 1.00 46.50 $49,205 $9,841 $4,517 $11,190 ($246) (2,952) - (354) ($23,373) $47,828
    11/15/2024 1.00 47.50 $49,943 $9,989 $4,585 $11,638 ($250) (2,997) - (360) ($23,793) $48,755
    11/16/2025 1.00 48.50 $50,692 $10,138 $4,654 $12,104 ($253) (3,042) - (365) ($24,222) $49,706
    11/16/2026 1.00 49.50 $51,453 $10,291 $4,723 $12,588 ($257) (3,087) - (370) ($24,658) $50,682
    11/16/2027 1.00 50.50 $52,224 $10,445 $4,794 $13,091 ($261) (3,133) - (376) ($25,101) $51,683
    11/15/2028 1.00 51.50 $53,008 $10,602 $4,866 $13,615 ($265) (3,180) - (382) ($25,553) $52,710
    11/16/2029 1.00 52.50 $53,803 $10,761 $4,939 $14,160 ($269) (3,228) - (387) ($26,013) $53,764
    11/16/2030 1.00 53.50 $54,610 $10,922 $5,013 $14,726 ($273) (3,277) - (393) ($26,481) $54,847
    11/16/2031 1.00 54.50 $55,429 $11,086 $5,088 $15,315 ($277) (3,326) - (399) ($26,958) $55,958
    11/16/2032 1.00 55.51 $56,260 $11,252 $5,165 $15,928 ($281) (3,376) - (405) ($27,443) $57,100
    11/16/2033 1.00 56.50 $57,104 $11,421 $5,242 $16,565 ($286) (3,426) - (411) ($27,937) $58,272
    11/16/2034 1.00 57.50 $57,961 $11,592 $5,321 $17,227 ($290) (3,478) - (417) ($28,440) $59,476
    11/16/2035 1.00 58.50 $58,830 $11,766 $5,401 $17,916 ($294) (3,530) - (424) ($28,952) $60,714
    11/16/2036 1.00 59.51 $59,713 $11,943 $5,482 $18,633 ($299) (3,583) - (430) ($29,473) $61,985
    11/16/2037 1.00 60.50 $60,608 $12,122 $5,564 $19,378 ($303) (3,637) - (436) ($30,004) $63,293
    11/16/2038 1.00 61.50 $61,518 $12,304 $5,647 $20,153 ($308) (3,691) (443) ($30,544) $64,637
    5/16/2039 0.50 62.00 $31,220 $6,244 $2,866 $20,960 ($156) (1,873) - (225) ($15,547) $43,489
    Present Value of Future Loss of Income
    Total Projected Loss of Income

    Exhibit 2 - Alex Jones’ Loss of Income - Part 2

      DOB (k) (l) (m) (n)
      5/16/1977 2.75%
    Year End % Year Age Number Alive, Vital Stats P (Survival) Discount Factor P.V. Income Loss
    11/16/2017 Injury 40.50
    11/16/2018 1.00 41.50 1.00 1.0000 $64,903
    5/16/2019 0.50 42.00 95,641 1.00 1.0000 $22,172
    Past Loss of Income (Based on Date of Report) $87,075
    11/16/2019 0.50 42.50 95,414 0.99762654 0.9865 $21,820
    11/16/2020 1.00 43.51 95,173 0.9951067 0.9600 $43,162
    11/16/2021 1.00 44.50 94,914 0.99239866 0.9344 $42,693
    11/16/2022 1.00 45.50 94,635 0.9894815 0.9094 $42,222
    11/16/2023 1.00 46.50 94,333 0.98632386 0.8850 $41,750
    11/15/2024 1.00 47.50 94,005 0.98289437 0.8613 $41,276
    11/16/2025 1.00 48.50 93,646 0.97914075 0.8383 $40,798
    11/16/2026 1.00 49.50 93,250 0.97500026 0.8158 $40,314
    11/16/2027 1.00 50.50 92,813 0.97043109 0.7940 $39,823
    11/15/2028 1.00 51.50 92,337 0.96545415 0.7728 $39,325
    11/16/2029 1.00 52.50 91,823 0.96007988 0.7521 $38,820
    11/16/2030 1.00 53.50 91,268 0.95427693 0.7319 $38,309
    11/16/2031 1.00 54.50 90,667 0.94799302 0.7124 $37,789
    11/16/2032 1.00 55.51 90,017 0.94119677 0.6932 $37,256
    11/16/2033 1.00 56.50 89,314 0.93384636 0.6747 $36,717
    11/16/2034 1.00 57.50 88,559 0.92595226 0.6567 $36,164
    11/16/2035 1.00 58.50 87,753 0.91752491 0.6391 $35,602
    11/16/2036 1.00 59.51 86,897 0.90857477 0.6219 $35,027
    11/16/2037 1.00 60.50 85,992 0.89911231 0.6053 $34,449
    11/16/2038 1.00 61.50 85,034 0.88909568 0.5891 $33,857
    5/16/2039 0.50 62.00 84,528 0.88379983 0.5813 $22,342
    Present Value of Future Loss of Income $779,515
    Total Projected Loss of Income $866,590
  2. LOSS OF RETIREMENT BENEFIT

    According to Jones, he plans on retiring at age 62 with 30 years of service to the Mononghia School District. Under the Defined Benefit Retirement System, members vest with 5 or more years of service. Bylaws require members to contribute 5% of wages from any and all sources: wages and overtime. Plan members may retire at any age with 5 or more years of service. Maximum Annual Pension is calculated as follows:

    36-month Average Annual Compensation×Pension Percentage×Years of Service=Pension Benefit
                                                    

    Pension Percentage is as follows: less than 20 years of service, the retiree receives 2.00% per year for all years of service, and for 30 or more years of service, retirees receive 2.50% for all years of service.

    Final Average Salary is based on the highest average wages earned during any three consecutive years (36 months), inclusive of overtime.

    Exhibit 3 - Alex Jones - Pension Loss

    Panel A: Projected Final Average Salary
    Wages Overtime Gross Months Totals
    2039 $31,220 $6,244 $37,464 6 $37,464
    2038 $61,518 $12,304 $73,821 12 $73,821
    2037 $60,608 $12,122 $72,730 12 $72,730
    2036 $59,713 $11,943 $71,655 6 $35,828
    36 $219,843
    Average Per Month $6,106.76
    Average Annual times 12 $73,281
    Pension Percent 2.50% $1,832
    Service Factor 30 $54,961
    Panel B: Mitigating Final Average Salary
    Wages Overtime Gross Months Totals
    2017 $45,000 $9,000 $54,000 12 $54,000
    2016 $44,325 $8,865 $53,190 12 $53,190
    2015 $43,660 $8,732 $52,392 12 $52,392
    36 $159,582
    Average Per Month $4,432.84
    Average Annual times 12 $53,194
    Pension Percent 2.00% $1,064
    Service Factor 8 $8,511

    The retirement benefit is subject to an annual COLA (cost of living adjustment). The COLA over the 5-year period 2013–2017 averaged 1.50%.

    Mitigating wages and projected pension benefits are summarized in the following:

    Exhibit 4 - Alex Jones - Projected Pension Loss

    P(a) P(b) P(c) P(d) P(e) P(f) P(g)
    5/16/2019 42.00 1.50% 1.50% 95,641 2.75%
    Age Age Projected Pension Mitigating Pension Loss before P(Survival) and Discounting Number Alive, Vital Stats P (Survival) Discount Factor P.V. Pension Loss
    5/16/2040 63.00 $54,961 ($8,511) $46,450 84,021 0.878504 0.5657 $23,083
    5/17/2041 64.00 $55,785 ($8,639) $47,146 82,950 0.99 0.5505 $25,622
    5/17/2042 65.00 $56,622 ($8,768) $47,854 81,825 0.9864376 0.5357 $25,290
    5/17/2043 66.00 $57,471 ($8,900) $48,571 80,645 0.9722122 0.5214 $24,622
    5/16/2044 67.00 $58,333 ($9,033) $49,300 79,412 0.9573478 0.5075 $23,952
    5/17/2045 68.00 $59,208 ($9,169) $50,040 78,118 0.941748 0.4939 $23,274
    5/17/2046 69.00 $60,097 ($9,306) $50,790 76,757 0.9253406 0.4807 $22,590
    5/17/2047 70.00 $60,998 ($9,446) $51,552 75,314 0.9079445 0.4678 $21,896
    5/16/2048 71.00 $61,913 ($9,588) $52,325 73,772 0.889355 0.4553 $21,188
    5/17/2049 72.00 $62,842 ($9,731) $53,110 72,113 0.869355 0.4431 $20,458
    5/17/2050 73.00 $63,784 ($9,877) $53,907 70,330 0.8478602 0.4312 $19,709
    5/17/2051 74.00 $64,741 ($10,026) $54,715 68,421 0.8248463 0.4197 $18,941
    5/16/2052 75.00 $65,712 ($10,176) $55,536 66,388 0.8003376 0.4085 $18,156
    5/17/2053 76.00 $66,698 ($10,329) $56,369 64,237 0.7744063 0.3975 $17,353
    5/17/2054 77.00 $67,698 ($10,484) $57,215 61,996 0.74739 0.3869 $16,544
    5/17/2055 78.00 $68,714 ($10,641) $58,073 59,564 0.7180711 0.3765 $15,701
    5/16/2056 79.00 $69,744 ($10,800) $58,944 57,014 0.6873297 0.3665 $14,847
    5/17/2057 80.00 $70,791 ($10,962) $59,828 54,321 0.6548644 0.3566 $13,973
    5/17/2058 81.00 $71,852 ($11,127) $60,726 51,478 0.6205907 0.3471 $13,081
    5/17/2059 82.00 $72,930 ($11,294) $61,637 48,489 0.584557 0.3378 $12,171
    5/16/2060 83.00 $74,024 ($11,463) $62,561 45,376 0.5470283 0.3288 $11,252
    5/17/2061 84.00 $75,135 ($11,635) $63,499 42,154 0.5081857 0.3200 $10,325
    5/17/2062 85.00 $76,262 ($11,810) $64,452 38,818 0.4679687 0.3114 $9,392
    5/17/2063 86.00 $77,406 ($11,987) $65,419 35,414 0.4269319 0.3031 $8,465
    5/16/2064 87.00 $78,567 ($12,167) $66,400 32,016 0.3859675 0.2950 $7,560
    5/17/2065 88.00 $79,745 ($12,349) $67,396 28,573 0.3444605 0.2871 $6,664
    5/17/2066 89.00 $80,941 ($12,534) $68,407 25,139 0.3030621 0.2794 $5,792
    5/17/2067 90.00 $82,155 ($12,722) $69,433 21,770 0.2624473 0.2719 $4,955
    5/16/2068 91.00 $83,388 ($12,913) $70,475 18,527 0.2233514 0.2646 $4,166
    5/17/2069 92.00 $84,639 ($13,107) $71,532 15,469 0.1864858 0.2575 $3,436
    5/17/2070 93.00 $85,908 ($13,303) $72,605 12,649 0.1524895 0.2507 $2,775
    5/17/2071 94.00 $87,197 ($13,503) $73,694 10,111 0.1218927 0.2439 $2,191
    5/16/2072 95.00 $88,505 ($13,706) $74,799 7,888 0.0950934 0.2374 $1,689
    5/17/2073 96.00 $89,832 ($13,911) $75,921 5,993 0.0722483 0.2311 $1,267
    5/17/2074 97.00 $91,180 ($14,120) $77,060 4,428 0.0533816 0.2249 $925
    5/17/2075 98.00 $92,547 ($14,332) $78,216 3,176 0.0382881 0.2189 $655
    5/16/2076 99.00 $93,936 ($14,547) $79,389 2,208 0.0266184 0.2130 $450
    5/17/2077 100.00 $95,345 ($14,765) $80,580 1,486 0.0179144 0.2073 $299
    5/17/2078 101.00 $96,775 ($14,986) $81,789 966 0.0116456 0.2018 $192
      $474,903
  3. LOSS OF HOUSEHOLD SERVICES

    According to the “Household Services Checklist” completed by Jones, prior to the injury Jones was responsible for performing specific household services: inside housework, household maintenance, pet care, lawn and outside maintenance, and automobile maintenance. The estimated weekly hours appear to be reasonable based on a review of the American Time Use Survey of household activities. These services and the estimated percentage that Jones indicates that he will be able to perform post injury are summarized in Exhibit 5. The value of household services that Jones is no longer able to perform is based the median wage for such services from the BLS occupational employment statistics for the appropriate job code.

    The calculation of the annual cost to replace household services that can no longer be performed due to the injury sustained by Jones is as follows:

    Exhibit 5 - Alex Jones - Loss of Household Services

      Percent After Injury Weekly Hours Yearly Hours National Median Wage OES - Occupation Code Annual Cost Cost After Injury
    Inside Housework 50% 2.00 104.00 $10.99 37-2012 $1,142.96 $571.48
    household Maintenance 20% 2.00 104.00 $18.11 49-9071 $1,883.44 $1,506.75
    Pet care 100% 5.00 260.00 $11.13 39-2021 $2,893.80 $0.00
    Lawncare & Outside Maintenance 20% 2.00 104.00 $11.03 37-3011 $1,147.12 $917.70
    Auto Maintenance 0% 1.00 52.00 $19.02 49-3023 $989.04 $989.04
      $8,056.36 $3,984.97

    I calculated the replacement value of household services for Jones from the date of injury to his expected end of his life. The 2017 annual household service amount is projected forward by 1.50%,7 the estimated 5-year average annual wage growth rate for all occupations. The past loss is from the date of injury 11/16/2017 through 5/16/2019 (on or around the date of our report). The future loss is from 5/17/2019 through life expectancy. The future loss is discounted by 2.75% to present value,8 and calculation is summarized in Exhibit 6:

    Exhibit 6 - Alex Jones Projected Household Service Loss

      HH(a) HH(b) HH(c) HH(d) HH(e)
    5/16/2019 42.00 1.50% 95,641 2.75%
    Date Age Loss before P(Survival) and Discounting Number Alive, Vital Stats P (Survival) Discount Factor P.V. Household Services Loss
    11/16/2017 40.50 $3,985
    5/16/2018 41.00 0.50 $1,992 0 1 1.0000 $1,992
    5/16/2019 42.00 1.00 $4,045 95,641 1 1.0000 $4,045
    Past Loss $6,037
    5/16/2020 43.00 1.00 $4,105 95,414 0.99763 0.9732 $3,986
    5/16/2021 44.00 1.00 $4,167 95,173 0.99511 0.9471 $3,927
    5/16/2022 45.00 1.00 $4,229 94,914 0.99240 0.9218 $3,869
    5/16/2023 46.00 1.00 $4,293 94,635 0.98948 0.8971 $3,811
    5/16/2024 47.00 1.00 $4,357 94,333 0.98632 0.8731 $3,752
    5/16/2025 48.00 1.00 $4,423 94,005 0.98289 0.8497 $3,694
    5/16/2026 49.00 1.00 $4,489 93,646 0.97914 0.8270 $3,635
    5/16/2027 50.00 1.00 $4,556 93,250 0.97500 0.8049 $3,576
    5/16/2028 51.00 1.00 $4,625 92,813 0.97043 0.7833 $3,516
    5/16/2029 52.00 1.00 $4,694 92,337 0.96545 0.7624 $3,455
    5/16/2030 53.00 1.00 $4,765 91,823 0.96008 0.7420 $3,394
    5/16/2031 54.00 1.00 $4,836 91,268 0.95428 0.7221 $3,332
    5/16/2032 55.00 1.00 $4,909 90,667 0.94799 0.7028 $3,270
    5/16/2033 56.00 1.00 $4,982 90,017 0.94120 0.6840 $3,207
    5/16/2034 57.00 1.00 $5,057 89,314 0.93385 0.6657 $3,143
    5/16/2035 58.00 1.00 $5,133 88,559 0.92595 0.6478 $3,079
    5/16/2036 59.00 1.00 $5,210 87,753 0.91752 0.6305 $3,014
    5/16/2037 60.00 1.00 $5,288 86,897 0.90857 0.6136 $2,948
    5/16/2038 61.00 1.00 $5,367 85,992 0.89911 0.5972 $2,882
    5/16/2039 62.00 1.00 $5,448 85,034 0.88910 0.5812 $2,815
    5/16/2040 63.00 1.00 $5,529 84,021 0.87850 0.5657 $2,748
    5/17/2041 64.00 1.00 $5,612 82,950 0.86731 0.5505 $2,680
    5/17/2042 65.00 1.00 $5,697 81,825 0.85554 0.5357 $2,611
    5/17/2043 66.00 1.00 $5,782 80,645 0.84321 0.5214 $2,542
    5/16/2044 67.00 1.00 $5,869 79,412 0.83031 0.5075 $2,473
    5/17/2045 68.00 1.00 $5,957 78,118 0.81678 0.4939 $2,403
    5/17/2046 69.00 1.00 $6,046 76,757 0.80255 0.4807 $2,332
    5/17/2047 70.00 1.00 $6,137 75,314 0.78747 0.4678 $2,261
    5/16/2048 71.00 1.00 $6,229 73,772 0.77134 0.4553 $2,188
    5/17/2049 72.00 1.00 $6,322 72,113 0.75400 0.4431 $2,112
    5/17/2050 73.00 1.00 $6,417 70,330 0.73535 0.4312 $2,035
    5/17/2051 74.00 1.00 $6,513 68,421 0.71539 0.4197 $1,956
    5/16/2052 75.00 1.00 $6,611 66,388 0.69414 0.4085 $1,875
    5/17/2053 76.00 1.00 $6,710 64,237 0.67165 0.3975 $1,792
    5/17/2054 77.00 1.00 $6,811 61,996 0.64822 0.3869 $1,708
    5/17/2055 78.00 1.00 $6,913 59,564 0.62279 0.3765 $1,621
    5/16/2056 79.00 1.00 $7,017 57,014 0.59613 0.3665 $1,533
    5/17/2057 80.00 1.00 $7,122 54,321 0.56797 0.3566 $1,443
    5/17/2058 81.00 1.00 $7,229 51,478 0.53824 0.3471 $1,351
    5/17/2059 82.00 1.00 $7,337 48,489 0.50699 0.3378 $1,257
    5/16/2060 83.00 1.00 $7,447 45,376 0.47444 0.3288 $1,162
    5/17/2061 84.00 1.00 $7,559 42,154 0.44075 0.3200 $1,066
    5/17/2062 85.00 1.00 $7,672 38,818 0.40587 0.3114 $970
    5/17/2063 86.00 1.00 $7,787 35,414 0.37028 0.3031 $874
    5/16/2064 87.00 1.00 $7,904 32,016 0.33475 0.2950 $781
    5/17/2065 88.00 1.00 $8,023 28,573 0.29875 0.2871 $688
    5/17/2066 89.00 1.00 $8,143 25,139 0.26285 0.2794 $598
    5/17/2067 90.00 1.00 $8,265 21,770 0.22762 0.2719 $512
    5/16/2068 91.00 1.00 $8,389 18,527 0.19371 0.2646 $430
    5/17/2069 92.00 1.00 $8,515 15,469 0.16174 0.2575 $355
    5/17/2070 93.00 1.00 $8,643 12,649 0.13225 0.2507 $287
    5/17/2071 94.00 1.00 $8,773 10,111 0.10572 0.2439 $226
    5/16/2072 95.00 1.00 $8,904 7,888 0.08248 0.2374 $174
    5/17/2073 96.00 1.00 $9,038 5,993 0.06266 0.2311 $131
    5/17/2074 97.00 1.00 $9,173 4,428 0.04630 0.2249 $96
    5/17/2075 98.00 1.00 $9,311 3,176 0.03321 0.2189 $68
    5/16/2076 99.00 1.00 $9,451 2,208 0.02309 0.2130 $46
    5/17/2077 100.00 1.00 $9,592 1,486 0.01554 0.2073 $31
    5/17/2078 101.00 1.00 $9,736 966 0.01010 0.2018 $20
    Present value of future lost household services $117,735
    Total loss of household services $123,772

Notes

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