New Law Journal – 9 November 2018
Users of expert accountants’ reports need to subject them to critical scrutiny. George Sim explains how and why.
In Brief
- Report contents – does the report do what it sets out to do?
- Limitations on the quality of information relied upon.
Expert accountants’ reports vary considerably. Some are brief and consist largely of sets of calculations, whereas reports on large commercial cases may be lengthy and complex, with several appendices showing the detail of the expert’s calculations and providing background information.
The Civil Procedure Rules, the Criminal Procedure Rules and the Family Procedure Rules and relevant practice directions set out basic requirements for expert reports such as the requirement to provide details of experts’ qualifications. Nevertheless, solicitors and barristers will often need to assess the value of expert accountants’ reports by reference to more detailed criteria. This article identifies issues which may be important to an evaluation of an expert accountant’s report.
General Points
Does the report cover the expert’s instructions?
Expert accountants generally summarise their instructions in the body of their reports or include a copy of the relevant letter from the instructing solicitors as an appendix to the report. Therefore, it is normally easy to establish the matters on which the expert accountants were instructed to report and to assess the extent to which the report addresses each issue. If a report addresses a number of issues, it may be that one is covered in detail but less attention is given to the others. In some areas in which there is limited information it may not be possible to express firm views. The experts may state in their report that they cannot form any meaningful conclusions or they may prepare a report based very largely on assumptions which will need to be stated in the report and which may be subject to change if more information becomes available.
Does the report express views on matters outside the expert’s competence?
Accountants, perhaps because of their general business knowledge, may express opinions in expert reports on matters which are outside their areas of expertise such as property values. Clearly any such opinions are of limited value and cannot be used by the ‘other side’ as a substitute for opinions based on relevant professional expertise.
Does the report state the assumptions on which the expert’s computations are based?
An expert accountant’s report will often contain assumptions about variables such as the future growth of turnover of a business or its gross profit percentage. The assumptions and the expert’s justification for adopting them should be stated clearly in the report. This may, for example, be the past experience of the business, e.g. a consistent gross profit percentage in the previous five years, industry background information, or the approach adopted by the Courts in specific types of case, e.g. dependency ratios used in the computation of loss of dependency in fatal accident cases.
Assumptions made by expert accountants in their reports may not always be reasonable. For example, a report in a personal injury case may assume that a self-employed trader’s pension would have been 50% of her pre-retirement earnings, despite the absence of evidence of her having made any significant pension contributions before her accident and despite the fact that it would in any case be extremely unusual for pension benefits to equate to 50% of pre-retirement earnings.
Are the assumptions consistent?
If an expert accountant’s report assumes an increase in a business’s turnover, it should also consider whether there will be any costs associated with the increased income. For example, a business may need to rent larger premises and/or to take on additional staff to deal with a projected increase in sales. Other costs such as travel expenses may also increase.
Has the expert included copies of the principal documents relied upon?
Copies of evidential documents relied upon in the report should be attached as appendices or provided under a separate cover.
Is the background information set out in the report accurate and adequate?
Background information about a case is a matter of fact. A report may include information of which the ‘other side’ was not previously aware. There may also be errors such as a reference to outdated particulars of claim. A report may use basic background information selectively to support its conclusions by omitting information or by failing to mention significant developments, such as the loss of an important customer or the departure of a key director or employee. It may also mix fact with comment which it is not possible to substantiate such as: ‘this shows that Mr Smith was determined to develop his business into a leading concern in the area from the outset’.
Does the report explain the expert’s conclusions?
The report should develop the expert’s argument by reference to the information relied upon and the assumptions made by the expert. There may be several stages to the computations set out in a report, and these will need to be explained clearly so that the reader can see, step by step, how the figures are derived.
Are the appendices consistent with the body of the report?
Simple errors may occur. A common source of inconsistencies is the situation in which calculations set out in the appendices are altered at a late stage, but the changes are not reflected in the body of the report, or vice versa.
Do the conclusions of the report appear reasonable?
An obvious example of a conclusion which is not reasonable would be a projection of annual earnings for an individual in a personal injury or loss of profits case of, for example, £200,000 when earnings over the previous ten years averaged £20,000 per annum.
Does the report deal with matters which may undermine the expert’s opinion?
The credibility of an expert accountant’s report will be enhanced if it acknowledges and addresses facts and issues which do not ‘fit’ the argument which is being advanced, as opposed to ignoring such facts and issues or attempting to play down their significance.
Accounting and Financial Issues
Does the report rely on final rather than draft financial statements?
The financial statements of one or more businesses are often the most important documents which forensic accountants rely upon in forming their opinions. It is important to establish whether the financial statements on which the expert report relies are ‘final’ rather than ‘draft’ as significant adjustments can be made to draft financial statements at a late stage.
Does the report rely on signed financial statements?
Similarly, reliance should be placed on financial statements which have been signed by one of the directors on behalf of the board rather than on those which appear to be final but which have not been signed – adjustments may have been made before the financial statements are signed.
Does the report take account of recent developments?
Even if a company files its financial statements within the statutory time limits, its most recent financial statements may not provide useful information about its current financial position. For example, a private company whose year end is 31 March will have until 31 December 2018 to file its financial statements for the year ended 31 March 2018. It is possible, therefore, that the most recent publicly available financial statements for such a company at present will be those for the year ended 31 March 2017. In such circumstances, it will be necessary to ask for financial statements for the following year, if these have been prepared, and management accounts for as many periods as possible since 31 March 2018. It is often useful in any case to take account of updated developments by referring to management accounts even if the latest available financial statements relate to a recent year end.
Does the report state whether the financial statements have been accepted by HM Revenue and Customs?
The financial statements of most smaller companies are not audited. There is therefore no independent source of assurance as to whether such a company’s financial statements show a true and fair view of its results and financial position. This is also a consideration which applies to unincorporated businesses. Experts can however review exchanges of correspondence with HM Revenue and Customs to establish whether they have raised any issues in relation to, for example, allowable expenditure e.g. whether private expenses of the owners have been ‘put through the business’ or the level of turnover and/or gross profit.
Does the report state whether the expert has examined relevant audit or accounting working papers?
Given the limitations of financial statements as noted above, it is often useful for expert accountants to review the working papers prepared by the external accountants of a business or of its auditors, if the business is subject to audit. These can highlight contentious issues and show how such issues were dealt with.
Does the report contain any factual or arithmetical errors?
Basic errors such as references to an incorrect trial date or year end, inaccurate page or paragraph references or arithmetical errors indicate that a report has not been checked carefully before being signed and can reduce its credibility and that of the expert witness. Computational errors and mistakes relating to such matters as tax rates or accounting standards are particularly damaging to the credibility of expert accountants.
Conclusions
The questions above focus on some common weaknesses. However, they do not cover all potential deficiencies, and it may often be worthwhile for legal advisers to ask a forensic accountant to review a report prepared on behalf of the ‘other side’.
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This article was first published by New Law Journal on 09/11/18, and is reproduced by kind permission.
The information contained in our Articles is provided as general information only. It does not constitute professional advice and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances. In addition, since the Articles were published in recent years, the information contained in them may not be applicable at the current time.