Forensic accounting is the practice of binding together accounting and auditing with investigative skills to assist in legal matters. It is primarily used in areas such as litigation support, investigation, and dispute resolution.

 

£2 million of the selling price of the hotel was placed in an escrow fund to indemnify the purchaser against any breach of warranties or representations made by the sellers in the sale agreement.

In October 1991, the purchaser claimed that, amongst other things the financial statements of the hotel had not been prepared in accordance with generally accepted accounting principles in that they did not disclose potential redundancy costs of £2.5 million in connection with terminating employees. As a result of this alleged breach of warranty, they demanded and received payment of £750,000 from the escrow agents. The sellers filed suit for return of the funds.

The Forensic Accountant was retained by the Plaintiff to provide an opinion on the specific accounting and financial statement disclosures which the defendant claimed were omitted.

Methodology

The first task was to determine a chronology of events surrounding the sale of the hotel and to consider the extent of the due diligence of the purchaser. The sale agreement was reviewed and it was determined that amongst the accounting records, audited financial statements had been seen. These financial statements showed a business that, whilst having a £20 million turnover, was barely breaking even. The largest single expenses related to payroll costs. It seemed clear that the plaintiffs were attempting to fund the redundancies via the escrow account. An approach based upon an alleged breach of warranty.

During the course of the sale and immediately following, the purchaser made a number of public statements to the effect that no redundancies would take place. In October of 1991, a large number of staff were made redundant.

It was necessary to establish the appropriate accounting treatment for the redundancy costs. The hotel reported under Bermuda and Canada accounting standards - these were considered first. Following this, common practice was considered - this required a detailed review of disclosure in available financial statements in both Bermuda and Canada. Finally, United States' accounting standards were considered and examples of redundancy disclosure were considered.

The key issue relating to the case revolved around the definition of "liability" and "contingent liability" in the accounting literature. Based upon the facts available, it was clear that the potential redundancy costs did not meet the criteria. Accordingly, the seller was correct in not including the amounts or disclosure in their financial statements.

The review of published financial statements supported the theoretical position - no examples of the disclosure alleged as required by the defendant could be found.

Result

The report was completed and published. The Plaintiff did not contest the financial statements disclosure aspects of the claim.