Source: https://www.pcblawfirm.com/articles/forensic-accountants-as-experts-in-missouri-dissolution-of-marriage-cases/
Timestamp: 2019-04-19 10:19:11+00:00

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The era of the divorce case dominated by “who did what to whom” has been largely replaced by “what is this worth” and “where did that money go?” As assets and income in dissolution of marriage cases become more and more complex, attorneys and courts turn more frequently to forensic accounting to illuminate the issues and to aid in the ultimate resolution of the case. Forensic accounting is, broadly, the use of accounting and auditing skills to assist in legal matters.1 Forensic accountants are used, generally, in two ways: 1) in litigation support with the accountant in the role of expert consultant, and 2) as investigators whose accounting skills are used to form opinions to which they may testify as expert witnesses.
Forensic accounting in divorce cases most commonly involves an analysis of one or more of the following: 1) valuation of a closely held business; 2) investigation of a spouse who may be hiding income or hiding assets; and 3) a tax consequence and cash flow analysis for the purpose of helping to determine appropriate amounts of child support and maintenance.
Although there are legitimate uses for forensic accounting without contemplation of testimony by the accountant, this article will focus on the use of forensic accountants as experts who may testify as expert witnesses. Generally, in a divorce case, when the attorney retains a forensic accountant, he or she contemplates that accountant may have to testify in deposition or at trial, if the case goes that far. The equitable distribution of property and debt, awards of child support, awards of maintenance, and awards of attorneys fees are governed, respectively, by Mo.Rev.Stat. §§ 452.330, 452.340, 452.335, and 452.355. The testimony of the forensic accountant can have a critical impact on the court’s analysis of the equitable distribution of property and debt, an award of child support, an award of maintenance, or an award of attorneys fees.
A witness who possesses specialized knowledge or experience may testify to facts which can only be observed or understood by persons who possess that specialized knowledge or experience. A witness who possesses this specialized knowledge or experience who uses his expertise to make observations relevant to a case does not automatically become an expert witness. Such a witness is still a fact witness.2 For example, the regular auditor or accountant used by a company who testifies about the financial condition of a company, based on work performed not in contemplation of litigation, is a fact witness. Expert testimony is that testimony which takes the form of an expert’s opinion or interpretation.3 The admissibility of expert opinion testimony is governed by Mo. Rev. Stat. §490.065.
Disclosure of the expert and of the expert’s opinions is governed by Rule 56.01.b(4), Mo.R.Civ.Pro., which requires the disclosure through interrogatories, of the identity, contact information, qualifications to give an opinion and the general nature of the matters upon which the expert will testify and further provides that the facts and opinions to which he may testify may be discovered by deposition.
Perhaps the most common use of forensic accounting in divorce cases occurs when one or both spouses have an ownership interest in a closely-held corporation, L.L.C., partnership or other business entity. Unless the value of that ownership interest is de minimis, then the value is an important issue in the divorce. Unlike other investment assets or accounts whose values can be readily determined, the value of ownership interest in a business that is not publicly traded may be an issue of great controversy between the parties. Although the owner of a closely-held business can probably testify as to his or her opinion of its value8, the credibility of such testimony is minimal. Therefore, valuing a closely held business generally requires the help of an expert.
Most fair market value appraisals of a business interest require the appraiser to assume that the business is a “going concern.” That means the business is a viable, operating entity having a trained, qualified workforce and the necessary systems in place to continue operating.
The primary tools used by the forensic account in evaluating the value of a business are the financial statements and tax returns of the business entity. Virtually every business, even very small businesses, produce periodic financial statements, such as “income” or “profit and loss” statements, as well as “balance sheets”. Forensic accountants frequently begin with a review of the most recent five years of these documents, along with the tax returns. Income (Profit and Loss) Statements identify net income in the form of revenues, direct costs to produce those revenues, and the expenses, direct and indirect, necessary to support the operation. The Income Statement will identify these revenues and expenses over a specific period of time, such a one month, one quarter or one year. The “balance sheet” is a statement of assets, liabilities and owner equity as of a certain date. The balance sheet is a “snapshot in time.” There are many other relevant records the competent forensic accountant will need to review to perform a full and accurate evaluation. The attorney using a forensic accountant as an expert should use that expertise to create and request a comprehensive checklist of supporting documents from the business. The types of records will vary depending on the business, but a careful forensic accountant will want to delve into the records behind the financial statements (such as aged accounts receivable, inventory lists, depreciation schedules, lists of prepaid expenses, equipment lists, aged accounts payables, leases, contracts, budgets, among others) to obtain a more detailed, complete picture of the financial operation of the company.
In some circumstances, both spouses are equal owners of the business, but one spouse is the operator of the business. In other circumstances, only one spouse has a direct ownership interest in the business (although the interest may be marital property). In either event, it is frequently appropriate for the forensic accountant to make an on-site visit to the business operation and interview the owner (operator) spouse about the operation of the business. Of course, the owner-operator spouse will tend to diminish the success of the business operation and predict doom and gloom for the future. It is up to the forensic accountant to ask the right questions, to obtain the relevant factual information from the owner-operator spouse which will allow the accountant to accurately assess the financial picture of the business.
Although the accountant will generally begin by looking at five years worth of records, depending on the business, review of a longer period of time may be appropriate. If a business is cyclical, the accountant will want to view the records of the business for a long enough period of time to identify longer-term cycles. In addition, if a business is being valued in the midst of a broad economic downturn, such as the condition in which we currently find ourselves, the forensic accountant may want to look at a 10-year period of business records, so that the court can see the business has survived downturns before and has recovered to remain profitable.
Attorneys who are dealing with forensic accountants and the valuation of a privately held business interest should be familiar with some basic concepts that are likely to be used by the expert. There are numerous methodologies and terms used by forensic accountants to determine the value of a business. However, the following few concepts are extremely common to valuation issues in dissolution of marriage cases and may be critical to understanding the work of the forensic accountant who is valuing a business interest.
(1) Income (Income-Based) Approach: a general way of determining a value indication of a business, business ownership interest, security or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount.
(2) Capitalization of Earnings: a method within the income approach whereby economic benefits for a representative single period are converted to value through division by a capitalization rate.
(3) Capitalization Rate: any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period into value.
(4) Minority Discount: A discount for lack of control applicable to a minority interest.
The income-based approach, and the capitalization of earnings method which is part of that approach, is the most common method used by forensic accountants in Missouri dissolution of marriage cases to value business interests that are viable, going concerns. Generally, this approach is used when the future operations of a business are not expected to change significantly from its historical operations. This approach involves taking a historical net income figures and applying a capitalization rate to those historical income figures to determine a current fair market value. The expert will make certain adjustments to the historical figures based upon factors which are individual to each case (such as the excess or inadequate compensation the owner may pay to himself or herself). In addition, the expert will apply certain discounts, if applicable, to adjust the ultimate number-the current fair market value. For example, with regard to a minority discount, how much control does a minority owner have over a business? If the shareholder cannot unilaterally direct corporate action, select management, decide upon distributions, and, most important, cannot decide whether to liquidate, merge or sell assets, then a discount may be appropriate. The less control a spouse has in a business entity, the greater the discount will be from its total fair market value. For example, if a spouse owns 20% of a company, does he or she have any ability to sell the interest in the company. The lack of marketability discount deals with the extent to which circumstances preclude a spouse from converting his or her interest to cash.
The application of these concepts all involve applying the opinion of the expert to the facts of the case. They illustrate the degree of discretion that the forensic accountant has in reaching the ultimate conclusion of the value of the spouse’s ownership interest in the business entity. As a result, the proper use of a forensic accountant for the purpose of business valuation requires thorough study and careful preparation.
b) examining who is in control of cash flow. How does the money come in and who receives it? Are payments made out to individuals instead of the business? How much of the business revenue is cash?
e) making statistical comparisons between the subject business and other similar businesses in the industry. There are statistics available in many industries which indicate, for example, what gross profit margins should be, in addition to other valuable information. If the cost of each good sold in the industry is $1.00, but the cost of each good sold in the spouse’s business, in this industry, is $2,00, why is that?
g) analyzing the cash flow when the owner of the closely-held business owns the real estate on which the business operates and leases the real estate to the business. This is a common mechanism for the owner to draw funds from the business which are not reported as income, while the owner depreciates the real estate.
In each of these examples, the intervention of a forensic accountant could uncover hidden or unreported income that might not otherwise be discovered. Hidden or unreported income can have a direct relationship to the determination of maintenance or child support of a spouse.
If hidden or unreported income is not spent, then it becomes a hidden asset. If assets are successfully hidden, they will not be subject to distribution by the court, pursuant to Mo.Rev.Stat §452.330. Hiding assets means that property is transferred to an unknown account or location not disclosed to the other party. This is easier for a spouse to accomplish when the spouse owns or controls a business. Sometimes, assets are transferred to a relative, friend or paramour. Sometimes, a spouse will overpay an employee, particularly if the employee is a family member, with the understanding that the employee will hold the excess income for the spouse. A spouse may be able to defer receipt of a bonus or other compensation until after a divorce judgment is rendered.
The forensic accountant may use a number of tools to discover hidden assets, if there is a reason to believe such assets exist. The accountant could compare total personal expenditures to reported income. Once all explainable sources of cash flow have been covered (such as loans or credit card advances), then remaining expenditures may be the result of unreported income. Another tool the accountant may use is to compare the family’s net worth at the beginning and the end of a period in order to attempt to reconcile the amount of the increase to the family’s reported income for that same period. If there is an unaccounted for decrease in net worth, that may be an indicator of hidden assets.
While it may be difficult for an attorney, not trained or experienced in forensic accounting, to uncover hidden income or assets, the forensic accountant will recognize clues not obvious to the untrained eye. The forensic accountant will be qualified to testify and reconstruct the analysis at trial.
Forensic accountants are also commonly used to testify as to the tax consequences and cash flow results, from income property and all sources, for each spouse. Although the court is, technically, an expert in the tax code, judges are more than happy to have accountants testify as to the tax consequences and resulting cash flow given various maintenance and child support scenarios. A picture may be worth a thousand words, and an exhibit, explained by the forensic accountant, will illustrate, using certain assumptions relevant to the tax code, what percentage of the total family cash flow each party will have given different maintenance and child support scenarios.
Attorneys and courts are relying on forensic accounting with increasing frequency in dissolution of marriage cases. The analysis an attorney must make, in determining whether and how to use a forensic accountant as an expert witness, is whether or not it will aid the attorney in telling the story that needs to be told. In some cases, such as those in which the attorney must prove the fair market value of a business controlled by the other spouse, the forensic accountant is indispensable. In other appropriate cases, the forensic accountant’s testimony will illuminate the financial issues for the court in a manner that could not be done without the skills acquired from that discipline.
1 806 The CPA Journal, p. 68 August, 2006.
2 Whelan v. Missouri Public Service, Energy One, 163 S.W.3d 459, 462 (Mo. App. 2005).
4 James v. James, 108 S.W.3d 1, 5 (Mo.Ct.App. 2002); Faintich v. Faintich, 861 S.W.2d 277 (Mo.Ct.App. 1993).
5 Byers v. Cheng, 238 S.W.3d 717, 729 (Mo.Ct.App. 2007).
7 Vehleweld v. Vehleweld, 853 S.W.2d 944 (Mo.Ct.App. 1993).
8 Binder v. Thorne-Binder, 186 S.W.3d 864, 869 (Mo.Ct.App. 2006).
9 Id.; Thill v. Thill, 26 S.W.3d 199, 203 (Mo.Ct.App. 2000); Craig-Garner v. Garner, 77 S.W.3d 34, 37 (Mo.Ct.App. 2002).
10 Thill, supra at 203; Craig-Garner, supra at 37.
11 Binder, supra at 869; Thill, supra at 203; Tarneja v. Tarneja, 164 S.W.3d 555, 559 (Mo.Ct.App. 2005).
13 Wilhite, 35 Fam.L.Q. 351 (Summ. 2001).
14 738 S.W.2d 429, 433 (Mo. en banc 1987), citing Welsch, Zlatkovich, and Harrison, Intermediate Accounting, 438 (6th ed. 1982).
15 Hansen v. Hansen, 738 S.W.2d 429, 436 (Mo. en banc 1987).
17 Binder, supra; Thill, supra; Craig-Garner, supra; and Tarneja, supra.
18 These five definitions were taken from the Glossary of Business Valuation Terms adopted by the American Society of Appraisers and the American Institute of Certified Public Accountants.
19 Faintich v. Faintich, supra, 861 S.W.2d at 277.

References: §490
 §452
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