Page 11 - Economic Damage Calculations

Chapter 1

Introduction

Experts evaluate the time value of money in both valuation and economic damages analyses. Courts,
however, have offered little guidance with respect to acceptable methods to identify and implement an
appropriate discount rate to accomplish this objective—particularly in the economic damages context.
Moreover, the published opinions in this area are frequently fact-specific and are not always consistent
(see chapter 7, "Example Case Law," in this practice aid for a case law summary). Consequently, experts
are called upon to interpret and apply the case circumstances using an appropriate methodology. fn 1

Terms in this practice aid that are in italics are defined in the glossary. This practice aid was written with
an expectation that the reader has a basic understanding of the concept of the time value of money.
Building on this knowledge, this practice aid presents the bases for certain general approaches to ac-
count for risk in the development of a damages model. These approaches include the capital markets
approach, which accounts for risk with the use of a risk-adjusted discount rate, and the expected cash
flow approach, which by comparison places a greater emphasis on adjustments for risk directly in the
cash flow model and on the use of a lower discount rate.

With that in mind, an initial review of some of the applicable foundational elements and terminology
provides a basis for further discussion. This initial review focuses on the similarities of an economic
damages analysis to the valuation of business interests and intangible assets. Specifically, a damages
analysis often requires the conversion of values from future time periods to present value, such as when
an award in litigation is intended to compensate a plaintiff for future lost profits. The litigation context
often requires different methods from those used in a valuation of business interests or intangible assets,
depending on the facts of the particular matter. fn 2 This practice aid is not intended to provide an ex-
haustive discussion of the cost of capital or valuation theory. For a list of additional reference materials
and publications, see the appendix, "Resource and Reference List," in this practice aid.

The Concept of Time Value of Money

fn 1 For example, see Michael Crain, Bonnie Goldsmith, and Michael Wagner, "Response to One Man’s Opinion," CPA Expert,
Spring 2004, 4–6, "Case law recognizes that each case has its own set of unique facts and circumstances and requires the expert to
consider these relevant facts and circumstances in calculating damages. Therefore, CPAs should determine the most appropriate meth-
odology to use in the damages calculation under the specific facts and circumstances of the case."

fn 2 Forensic services are defined by the Statement on Standards for Forensic Services (SSFS) No. 1 (FS sec. 100). Practitioners per-
forming economic damages calculations generally meet the definition of forensic services and are subject to SSFS No. 1. In addition,
practitioners performing business valuations should be aware of the standards set forth in Statement on Standards for Valuation Ser-
vices (SSVS) No. 1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset (VS sec. 100). Although
SSVS No. 1 does not cover lost profits calculations, those developmental standards may be applicable to other economic damages,
including loss of business value.

All FS sections can be found in AICPA Professional Standards.

All VS sections can be found in AICPA Professional Standards.

© 2020 Association of International Certified Professional Accountants 9