Attaining Reasonable Certainty in Economic Damages (Part II of III)

The purpose of this article—the second of three on this topic—is to provide the reader with an understanding of Chapter 2 (Costs) of the 2018 Practice Aid as well as certain other publications containing a body of knowledge on the best practices for developing “avoided or saved costs,” sometimes referred to by the courts as incremental costs. A prior article dealt with Chapter 1 (Revenue and Growth Rates) and part three will cover Chapter 3 (What Constitutes Best Evidence) of the 2018 Practice Aid and related topics.

In 2015, the American Institute of CPAs (AICPA) Forensic and Valuation Services (FVS) issued a practice aid entitled, “Attaining Reasonable Certainty in Economic Damages Calculations”. That publication added to the body of knowledge available to experts calculating lost profits and other forms of economic damages.

In November 2018, the AICPA FVS updated the practice aid, also entitled, “Attaining Reasonable Certainty in Economic Damages Calculations” (hereafter, the 2018 Practice Aid) further adding to the body of knowledge. The 2018 Practice Aid was updated after the AICPA decided that case law research may yield additional topics worth presenting.

The purpose of this article—the second of three on this topic—is to provide the reader with an understanding of Chapter 2 (Costs) of the 2018 Practice Aid as well as certain other publications containing a body of knowledge on the best practices for developing “avoided or saved costs,” sometimes referred to by the courts as incremental costs^[1]. A prior article dealt with Chapter 1 (Revenue and Growth Rates) and part three will cover Chapter 3 (What Constitutes Best Evidence) of the 2018 Practice Aid and related topics.

AICPA FVS practice aids are prepared by AICPA staff and volunteers and do not reflect AICPA positions, nor establish standards or preferred practices. The AICPA’s position is the practice aids provide illustrative information on the subject matter. The author is both an AICPA and NACVA member and notes in certain of his expert reports, where applicable, that the work performed was guided by the AICPA Standards and Practice Aids; the Litigation Services Handbook, The Role of the Financial Expert, Sixth Edition, Roman L. Weil, Daniel G. Lentz, and David P. Hoffman (the Weil Text); and the Comprehensive Guide to Lost Profits and Other Commercial Damages, Fifth Edition, Nancy J. Fannon and Jonathan M. Dunitz (the Fannon Text).

The 2018 Practice Aid noted that “[as] with any lost profits calculation, the cases dealing with costs … often turn on specific facts and analyses, as well as the particular action and law under which the case was brought.”^[2] The 2018 Practice Aid referred to principles articulated by the Court of Appeals of Texas in Holmes v. Jetall Cos. where the Court wrote the following: “The common thread running through each of the cases we have summarized is that a party seeking to prove lost profits must provide a model showing how the amount of lost profits can be determined, support that model with facts and assumptions, and demonstrate how the assumptions in the model are reasonable.”^[3]

Determining lost profits involves analyzing a counterfactual world, a world that will never exist allegedly as a result of the defendant’s action to be proved at trial (along with liability and causation). For the lost profits calculation to restore the plaintiff back to the position that it would have been in but for the alleged damaging events, the counterfactual world recreates, through (hopefully) reasonable assumptions, the difference between what plaintiff would have made in profits versus what plaintiff made in profits (if any).

The 2018 Practice Aid noted that “Courts have enunciated that such an analysis seeks to measure lost net profits rather than lost gross profits, as the “measure of damages is just compensation for the loss or damage actually sustained.”^[4] Simply put, as a general proposition (and there may be exceptions), economic damages experts calculate and testify as to lost net profits, not lost sales or lost gross profits.

Chapter 2 of the 2018 Practice Aid discussed courts’ treatment of the identification of the appropriate avoided costs to include in a lost profits analysis and concluded there was no one checklist that can address the unique facts and circumstances of each case.^[5] “What these cases demonstrate is that courts are focused on the extent to which the practitioner has analyzed and calculated the avoided costs necessary to estimate the lost net profits of the injured party. Courts have been receptive to a practitioner’s identification of avoided costs when the record indicates that the practitioner has investigated the nature of such costs and engaged in a reasoned analysis for deducting, or failing to deduct, these from a lost profits calculation.”^[6]

Chapter 2 of the 2018 Practice Aid analyzes approximately a dozen instances when courts have addressed the issue of properly...

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Michael D. Pakter CPA, CFF, CGMA, CFE, CVA, MAFF, CA, CIRA, CDBV, has more than 40 years of experience in accounting and forensic accounting, business economics and investigations in numerous industries and diverse engagements, including more than 20 years of experience in economic damages and business valuations. He has submitted expert reports in several jurisdictions and testified in arbitrations, regulatory proceedings and litigated disputes. State, Federal and Bankruptcy Courts, as well as arbitral bodies, have recognized him as an expert in accounting, financial analysis, forensic accounting, economic damages, business valuation and business economics.

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