The Association ofCertified Fraud Examiners (ACFE) explains that, “forensicaccounting is the use of professional accounting skills in mattersinvolving potential or actual civil litigation.” The word“forensic” is defined by Black’s Law Dictionary as “usedin or suitable to courts of law or public debate.”

In the insurance claims world, a forensic accountant is typically engaged by an adjuster, or anattorney, to provide an understanding of an insured’s books andrecords, and to determine through an analysis of those books andrecords whether the policyholder has sustained a loss, as definedin the insurance policy.

The Forensic Accountant’s Role
Depending on the size and complexity of the policyholder’s businessoperation and claim, a team of adjusters and consultants may beassembled to analyze many of the issues that arise during theclaims process, including (but not limited to): building andconstruction, production, sales and marketing, advertising, andaccounting. Both the policyholder and the insurer will assemble a“team”to support their respective position. The insurer’s “team” mayinclude a field adjuster, claims manager, underwriting department,in-house legal staff, and other experts such as engineers, salvors,outside legal resources, and forensic accountants. Thepolicyholder’s “team” may include a public adjuster, in-houseaccounting department, external CPA/accounting firm, productionmanagers, sales and marketing departments, and in-house legaldepartment. It may also employ outside consultants, includingengineers, salvors, outside legal counsel, and forensicaccountants.

Many adjusters do not have the time or expertise to bothproperly and expeditiously evaluate a business interruption (BI) claim, especially in a catastrophicenvironment. A competent forensic accountant will provide anadjuster, policyholder, or legal counsel with his or her knowledgeand experience in matters including (but not limited to): technicalaspects of accounting rules and procedures and other related data;and, the ability to translate accounting data to conform toinsurance policy coverage language. (Please note, a forensicaccountant does not provide coverage interpretation, as this is theresponsibility of an adjuster and or legal counsel.)

A Look At Loss Occurrence
Once engaged, a forensic accountant will review the applicableBI coverage, and familiarize himself/herself with both macroand micro-economic trends of the insured’s industry. The forensicaccountant will then contact the appropriate representative todiscuss the loss occurrence and how the damage affected businessoperations, business/accounting records maintained in the normalcourse of business, and may possibly suggest integrating additionalaccounting procedures to expedite the claim process.

In medium- to large-sized businesses, theremay be a person or persons that have expertise in accounting—forexample, the CFO or controller. However, in many smallerbusinesses, the owner of the business, who may have no formalaccounting training, is also the “accountant.” Be it a small “momand pop” operation or a large complex business, a forensicaccountant will expedite the claims process by having the abilityto translate the policyholder’s operating results, as reflected inits financial records, to its BI coverage.

The Time Element Component
One of the critical factors in determining the value of a BI lossis the “time element,” or duration of time the BI loss will bemeasured over. A claims adjuster may make a determination of themeasurement period by melding his or her knowledge of BI coveragewith assistance from knowledgeable consultants (construction,electrical, engineering, legal, and so forth).

Once the time element is established, it is then forwarded tothe forensic accountant to include in his/her computation. The timeelement is typically referred to as the Period of Restoration, andmay include an Extended Period of Indemnity. ISO coverage form CP0032 04 02 - Business Income (Without Extra Expense) Cover Form,defines the Period of Restoration as the period of time that: (a)Begins 72 hours after the direct physical loss or damage caused byor resulting from a Covered Cause of Loss at the describedpremises; and (b) Ends on the earlier of: (1) The date when theproperty at the described premises should be repaired, rebuilt orreplaced with reasonable speed and similar quality; or (2) The datewhen business is resumed at a new permanent location…” The extendedperiod of indemnity is defined as: (1a.) Begins on the dateproperty (except finished stock) is actually repaired rebuilt orreplaced and “operations” are resumed; and (1b.) Ended on theearlier of: The date operations could be restored with reasonablespeed to the level which would generate the business income amountthat would have existed if no direct loss or damage had occurred;or (ii) 30 days after the date determined in (1a.) above. Even withthis succinct measurement period language, the time elementcomponent of the claim calculation is one of the most disputedareas of business interruption claims.

BI Claim Calculation
A BI loss can be calculated using two separate methods, as theywill end up with the same value: net income plus continuing expenseor gross earnings less non-continuing expenses.

Once the loss measurement period is determined and coverage isconfirmed, a forensic accountant will prepare a list of relevantfinancial and other related documents needed to calculate theactual loss sustained, if any, during the measurement period. Thedocuments requested may include but are not limited to: income taxreturns, income statements (profit & loss statements), budgetto actual variance reports, sales tax returns, equipment and officeleases, general ledgers, and payroll ledgers.

Under both methods of calculating the BIvalue, analyses of sales, costs, and expenses are necessary.Regarding sales, a forensic accountant will project what the saleslevel should have been during the loss measurement period “but for”the loss incident. Some potential factors to consider whenprojecting sales are outlined in the sidebar.

Expenses and costs can be segregated into general categories:fixed, variable, and a combination of fixed and variable. Fixedcosts are considered continuing expenses in the businessinterruption calculation. Examples of fixed/continuing expensesinclude: rent (unless the rent is abated in accordance with theinsured’s lease terms), insurance, property taxes, interestexpense, and other contractual obligations. Variable costs areconsidered non-continuing expenses. Variable/non-continuingexpenses include: bad debt, sales discounts, merchant credit cardfees, shipping and freight, raw materials, ordinary payroll expenseand supplies. An example of an expense that has both a fixed andvariable component is a telephone expense, where there is abase/fixed monthly charge with additional charges based onusage.

Once the period of restoration is determined, the sales trendestablished, and pre- and post-loss costs and expenses analyzed, abusiness interruption calculation is prepared. In a simplescenario, the difference between the insured’s expected revenue andexpenses and its actual revenue earned and expenses incurred duringthe measurement period, results in the BI loss.

Now What?
A BI calculation is the sum of many components. Some of thecomponents are objective while others are more “grey” in nature.The “grey” components may result in a difference of businessinterruption value between the “teams.” If the differences can beresolved, then the claim will be paid and closed. If not, then aforensic accountant may be engaged to take on a new role as anappraiser in the Appraisal process found in many insurance policies, or as aconsultant or expert witness if the claim ends up inlitigation.