Forensic Accounting: Is it Really Lost Income? (Part 3)

Article, California LawyerJune 2017

Legal

In California Lawyer, Mary Furst and James McCurley discuss how forensic accountants can assist counsel to dig deep when preparing—and contesting—claims of economic loss.

As appeared in California Lawyer, June 8, 2017.

By: Mary Furst and James McCurley

The first two articles of this three-part series explained ways in which a forensic accountant can assist counsel in analyzing and uncovering non-loss related elements in a damage claim in a construction defect case. Now, in this final installment, we’ll see how the portion of the claim pertaining to lost income unfolds.

As discussed previously, our hypothetical situation involves a university that has filed a claim for alleged defects in two on-campus housing buildings. To correct the defects, the university’s repair plan spanned two school years with one building taken out of use each year.

In Part 1 of this series, we discussed claimed costs associated with building reconfigurations. In Part 2, we addressed associated claims for in-house costs allocated to the repairs.

Now it’s time to address claims for the lost income associated with taking student housing units out of circulation along with losses associated with increased density in the remaining units.

REVENUE LOSSES?

The “lost revenue” component of the claim includes asserted gross room revenue losses associated with the net number of beds lost when each building was taken off line for repairs. The repairs lasted a full school year for each building. To accommodate displaced students and to mitigate overall losses, select rooms in other dormitories were reconfigured to increase students per room.

The room reconfigurations resulted in substantial mitigation of the potential room revenue losses but still resulted in a net loss of beds available. It also created more density which resulted in beds of less value throughout campus. (The room charge for a student in a single bedroom is greater than that charged for a double occupancy which in turn is greater than that charged for a triple occupancy.)

ANALYSIS

The forensic accountants were asked to analyze the component pertaining to lost room income. The initial analysis involved verifying the occupancy history of the campus including a review of the trends in room configurations and density. This analysis confirmed the net loss of rooms available for rental during the repair period. It also confirmed the reduction in the net revenue per bed associated with the accelerated room reconfigurations and higher than projected densities.

The question then turned to valuing the lost room revenue associated with the number of lost beds and the number of beds in higher density rooms. The claim was based on the “list” price for the affected beds. If a double room was lost, then two beds at the double occupancy annual rate were deemed lost. For reconfigurations, if a double occupancy room was converted to a triple occupancy room, the “list” price per bed charged by the university was reduced.

The claim for the lost “list” price for each bed was based in part on internal accounting charges within the university system. The housing department budget was based on the “list” price of the beds available to the student population without regard to the actual price paid by each student. The housing department therefore loses the “list” price for each lost or reconfigured bed. This “loss” became the basis for the claim.

The forensic accountant’s investigation revealed that in reality the university rarely receives the “list” price charged for tuition, room and board from the student population. Education financing is made up of a combination of funding sources, including Expected Family Contribution (EFC) from the student or family, Work Study, Federal loans and Gift Aid. Gift Aid comes from federal and state grant programs along with Institutional Aid (i.e., money from various programs within the university system. These internal sources typically include endowment monies, alumni or university groups.

The forensic accountant concluded that the loss of room revenue was more properly valued as the difference between each bed’s “list” price and the amount that would have been offset internally by Institutional Aid. The financial impact to the university in this case would be net revenue, not gross revenue.

The use of a forensic accountant with experience in calculating economic damages can lead to the discovery of offsets not contemplated in the original lost income claim. The review here revealed a claim overstatement because it was based on the potential gross revenue loss, not the net revenue that would have been generated.

As this extended discussion shows, a good forensic accountant can be a valuable addition to the legal team that analyzes and presents (or challenges) a complex construction claim. Not only can the expert spot issues that might otherwise be overlooked, but the presentation, if properly developed, will be able to withstand attack from the other side.

As with any dispute, when the experts are in place early, key foundational steps can be taken that will lead to efficiency in the detailed work to follow. And that early work may also make it easier to resolve the matter before trial or arbitration.

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