{title} icon

Articles From Brisbane Consulting Group

How to Calculate Damages in Fraud Cases

When courts order restitution from fraud, it may be difficult to determine how much the company has actually lost. Forensic accounting experts can help fraud victims calculate damages in accordance with state laws and prepare presentations that convince judges to accept their conclusions.

Evaluating Case Specifics

Calculating restitution seems easy, right? If an employee steals inventory worth $20,000, he or she should repay that amount, perhaps with interest. However, the calculations get more complicated when a business’s profits are lost because of the fraud.

The calculation varies from state to state, and even from case to case, but forensic accountants typically determine damages using either:

  1. The “benefit of the bargain” method, or
  2. The “out of pocket” method.

What’s appropriate depends to some degree on the location and nature of the fraud. For example, a hypothetical company decides to buy and race a thoroughbred horse for promotional purposes. A horse dealer locates a suitable animal valued at $950,000, but offered at $800,000 because the current owner is retiring.

In truth, however, the owner is selling the horse because it hasn’t lived up to expectations. The horse is actually worth only about $700,000 — information the dealer has known for several weeks. Putting aside the buyer’s failure to perform proper due diligence, how much should it be able to expect in restitution?

Under the out-of-pocket method, the company would be awarded $150,000 in damages, or the difference between the horse’s real value and the amount paid for it. Using the benefit-of-the-bargain method, damages would be calculated at $250,000 — the difference between the dealer’s misrepresented value and the animal’s true worth.

Applying the Benefit-of-the-Bargain Method

Fraud victims usually prefer the benefit-of-the-bargain method. It allows them to recover not only their actual losses and fraud-related expenses, but also the lost profits on their investments.

There are several approaches accountants may use to calculate lost profits when the benefit-of-the-bargain rule applies, including:

Yardstick approach. Here, the company’s profits are compared to those of a similar company that wasn’t defrauded.

Hypothetical approach. After gathering marketing evidence that demonstrates potential lost sales, the expert subtracts costs that would have been associated with the lost sales to arrive at lost profits.

Before-and-after approach.  Under this method, damages are based on the difference between 1) the company’s profits before and after the fraud, and 2) the company’s profits while the fraud was being committed.

The appropriate method for calculating damages will vary according to the specifics of each case. Experts must work with attorneys to determine what’s appropriate.

Beware: Net income rarely is the basis for assessing lost profits. Lost-profit awards are taxable, which means they’re calculated on a pretax basis, making net income invalid for computational purposes.

Pursuing Civil Remedies

Establishing damages for restitution is one thing. Collecting them may be more difficult. In many criminal cases, perpetrators aren’t required to begin paying restitution until they’re released from prison. In addition, victims who aren’t named in indictments handed up against the fraudster aren’t eligible to receive restitution. And, in many cases, the perpetrator already has spent the proceeds of the fraud — or hidden them in other people’s names or offshore bank accounts or trusts.

For these and other reasons, many victims seek both civil judgments and criminal convictions against fraud perpetrators. Civil actions can force crooks to sell or forfeit assets to help pay restitution. Also, while criminal orders affect only property of the defendant, civil forfeitures can include assets taken by family members or friends of the perpetrator. Filing a civil action has no effect on criminal proceedings, and victims may receive restitution orders from either or both.

Getting it Right

Companies that have been struck by fraud understandably want to receive the highest restitution award available. A fraud expert can help evaluate the facts of the cases and select the most appropriate method to calculate damages.

How to Calculate Damages in Fraud Cases

for more information

As a Senior Analyst, Ben’s responsibilities include the valuation of businesses, business interests, and intangible assets for purposes of financial reporting, transaction advisory, and tax planning and compliance. Additionally, Ben’s role includes the performance of various forensic accounting procedures, as agreed upon with clients. Ben’s prior experience includes performing assurance services for publicly traded companies within the aerospace and manufacturing industries, as well as large private companies and the gaming industry. He also has experience in testing and evaluating internal controls over financial reporting.


How Can We Help?