Opinion ID: 1798085
Heading Depth: 1
Heading Rank: 2

Heading: method of computing lost earnings resulting from lost sales

Text: In computing lost earnings resulting from lost sales, the following major assumptions were made: (1) Each business should be viewed as a going concern which would have continued in business until the present (12/31/72) without a boycott. (2) Lost sales as computed by Dr. Oliver are the basis for computing lost earnings. (3) If recovery of sales is made above the trend line in any of the years subsequent to the initial period of loss, total recovery is assumed to have been made. Therefore, any losses of sales subsequent to such recovery are not used in determining lost earnings. In computing lost earnings resulting from lost sales, the accountants added the gross sales for the base period, 1960-65, and divided this into the total net earnings for the base period resulting in a percentage representing net earnings. The projected sales with inflation were multiplied by the percentage of net earnings for the base period, the result being projected earnings. Actual earnings for each year, where applicable, were deducted from the projected earnings leaving the earnings lost. This method did not take into consideration any change in the pricing structure or mark-up of goods for sale. We note that gross profit, which is sales less cost of goods sold, decreased in some of the businesses for the period 1966-1972, which leads us to the conclusion that pricing structure of some of the businesses must have changed. When gross profits are reduced net earnings are affected. In order for the computation of lost earnings to be accurate, pricing policies of the businesses involved must be taken into consideration. The conversion of lost sales into lost earnings was based on Dr. Oliver's calculations of projected sales with inflation. Dr. Oliver was furnished gross sales for each of the businesses for the base period and from this date projected sales with an inflation factor added. Dr. Oliver candidly admitted that he made no study of all facts relevant to management of the businesses to determine what caused deviations in the base period. He said his study showed that something happened to all 12 businesses almost simultaneously, and if he were to make a study to discover all facts relevant to the fluctuation in gross sales he would consider population growth, disasters, and other things of like nature. He stated he would have included a number of factors other than gross sales and specifically listed: managerial skills, a change in amounts spent on advertising, increases in fixed costs of employees and decline in the availability of money to spend. He said the only factor communicated to him was the boycott and that there might well be other factors. He assumed the impact on sales was caused by the boycott and concluded the boycott, as an economic sanction, had a very dramatic impact, which was its goal. He testified that there was a recession in 1970 and he would not exclude this factor from the trend sales line but did not show that the effect of the recession was included. He stated the recession would have had a dramatic effect on the business of Claiborne Hardware. One of the problems with the projected sales as calculated by Dr. Oliver is that his calculations failed to take into consideration other facts which we feel would affect the estimate of future sales. (1) Would additional inventory be required to increase sales? (2) Would the individual complainants have the capital necessary to increase the inventory, if necessary? (3) What would the additional capital cost? (4) Would the physical plant of each business be large enough to house an increased inventory or would additions be necessary? (5) Was there any change in management or employees that would affect the volume of sales? We are of the opinion that these factors, together with the factors mentioned by Dr. Oliver, should be taken into consideration in making an estimate of future sales and that inclusion of all of these factors, or their exclusion with an explanation, if not applicable, is necessary for one attempting to prove lost earnings. Another problem with the projected sales with inflation is that the gross sales furnished Dr. Oliver for the base period are not consistent. In some gross sales included sales taxes, in other sales taxes were excluded, and in some the inclusion or exclusion of sales tax varied from year to year. We recognize that these variations might have a minimal effect on the projections, but since this case is being reversed for retrial on the issue of damages, the gross sales for the base period should be stated accurately and consistently. The chancellor also allowed some of the complainants damages for the loss of good will. Good will was defined in the transmittal letter as follows: ... Goodwill is an intangible asset which exists when the actual or expected earnings produced by the assets of a business, exclusive of goodwill, are in excess of a normal return. Goodwill is generated by any causes of attractive earnings results, such as satisfactory customer relations, location, good employee relations, or know-how. The measurement of goodwill is most commonly necessitated when a business is purchased in order to determine a suitable purchase price for the entire business entity and is, therefore, often determined by sheer bargaining. When a business was sold by a willing buyer to a willing seller, good will is the amount of the purchase price in excess of the tangible assets of the business. The accountants also explained, in their letter of transmittal, their method of arriving at good will. (3) Capitalization of Excess Earnings  a percentage return on the average annual value of the tangible assets of a business is determined, using a period of years immediately prior to the valuation date. The amount of the percentage return on tangible assets, thus determined, is deducted from the average earnings of the business for such period and the remainder is considered to be the amount of the average annual earnings from the intangible assets (goodwill) of the business. This amount capitalized at an applicable percentage is the value of the goodwill. The Capitalization of Excess Earnings Method is considered the most theoretically sound approach by standard accounting texts and is established by the Internal Revenue Service as its accepted guideline in Revenue Ruling 68-609. (Revenue Ruling 68-609 is cited in its entirety in Appendix A of this report). We have, therefore, used this method as the basis for our computation of lost goodwill. A brief summary of our computation follows. For a more technical explanation of our application of this method, see Note 4 on page 8. Our computation is made as of December 31, 1972, and is based on the earnings of the most recent year. We have basically considered the loss of the asset, goodwill, to the business as of that date as if a valuation were made for the sale of each concern. The reason we have used the most recent year's results rather than an average of prior years, is that in this particular case, a potential purchaser would evaluate the current degree of recovery from prior losses. The use of 3 to 5 years prior earnings average would tend to overstate the amount of goodwill lost and would also result in a loss of goodwill for many businesses which have fully recovered per Dr. Oliver's computations. Recovery from the boycott impact, according to Dr. Oliver, is evidenced by the crossing of the actual sales line above the trend line in any year after the initial boycott impact in 1966. For example, in the case of Hudson on page 34, actual sales exceed trend line sales for the year 1972. Therefore, according to Dr. Oliver, Hudson has recovered from the boycott impact, and no loss of goodwill can be determined in his case (See page 39). Since earnings lost in the year 1972 resulted from unfavorable external events, they were, therefore, a loss of return on the intangible asset of goodwill, (i.e., satisfactory customer relations, etc.). We have, therefore, capitalized the amount of earnings lost in 1972 at 15%, the rate of expected return from intangible assets as set forth in Revenue Ruling 68-609 for businesses with a relatively small risk factor and stable earnings. The resulting amount is the lost goodwill as measured at 12/31/72. (See the computation for McDaniel on page 30). As we understand the exhibits and testimony of the accountants they did not employ the method set forth in their transmittal letter. We fail to find that the accountants computed the percentage return on the tangible assets of the businesses involved in this case and deducted this amount from net earnings. We also note that Revenue Ruling 68-609 requires sole proprietorships or partnerships to deduct from earnings a reasonable amount for services performed by the owners or partners engaged in the business. This was not done. Failure to compute good will properly resulted in an overvaluation of good will. For example, Barbara B. Ellis and Norman N. Ellis, doing business as Ellis Variety Store, were awarded $96,633 for loss of good will. The income tax returns for these complainants show a beginning inventory for the years 1960-68 as follows: 1960 $7,058.27 1961 4,774.15 1962 3,174.08 1963 4,595.96 1964 6,146.34 1965 7,659.26 1966 8,479.32 1967 6,794.19 1968 9,998.93 The tax return for 1968 also showed other tangible assets used in the business amounted to $3,000. Adding these tangible assets to the beginning inventory for 1968 makes a total of $12,998.93 of tangible assets used in the business. An allowance of $96,633 damages for loss of good will is a gross overvaluation of good will. We reverse the allowance for loss of good will to each complainant and remand for further evidence on loss of good will. On retrial the court should determine whether a business should be permitted to recover profits on lost sales plus loss of good will. It appears to us there is a strong probability that allowing recovery of profits on lost sales plus loss of good will would pyramid damages and amount to double recovery. We express no opinion on this question but expert testimony should deal with the question on retrial. We are satisfied that complainants suffered some damages resulting from the boycott but are of the opinion that the amount allowed was excessive under the evidence presented. We hold the chancellor erred in failing to reduce the award of damages to complainants McDaniel, Norman N. Ellis and Barbara B. Ellis for the amount earned by them while they were out of business. Southern Christian Leadership Conference, Inc. v. A.G. Corp., 241 So.2d 619 (Miss. 1970). Complainants were under a duty to mitigate damages and any award made to complainants shall be reduced by their earnings. AFFIRMED IN PART AND REVERSED AND RENDERED IN PART ON LIABILITY; REVERSED AND RENDERED IN PART ON DAMAGES; REVERSED AND REMANDED IN PART ON DAMAGES. PATTERSON, C.J., SMITH and ROBERTSON, P. JJ., and SUGG, WALKER, BROOM, LEE and BOWLING, JJ., concur.