The Association of CertifiedFraud Examiners (ACFE) explains that, “forensic accountingis the use of professional accounting skills in matters involvingpotential or actual civil litigation.” The word “forensic” isdefined by Black’s Law Dictionary as “used in or suitableto 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’sbusiness operation and claim, a team of adjusters and consultantsmay be assembled to analyze many of the issues that arise duringthe claims 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” may include a fieldadjuster, claims manager, underwriting department, in-house legalstaff, and other experts such as engineers, salvors, outside legalresources, and forensic accountants. The policyholder’s “team” mayinclude a public adjuster, in-house accounting department, externalCPA/accounting firm, production managers, sales and marketingdepartments, and in-house legal department. It may also employoutside consultants, including engineers, salvors, outside legalcounsel, and forensic accountants.

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, there may be a person orpersons that have expertise in accounting—for example, the CFO orcontroller. However, in many smaller businesses, the owner of thebusiness, who may have no formal accounting training, is also the“accountant.” Be it a small “mom and pop” operation or a largecomplex business, a forensic accountant will expedite the claimsprocess by having the ability to translate the policyholder’soperating results, as reflected in its financial records, to its BIcoverage.

The Time Element Component

One of the critical factors in determining the value of a BIloss is 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 BI value, analyses ofsales, costs, and expenses are necessary. Regarding sales, aforensic accountant will project what the sales level should havebeen during the loss measurement period “but for” the lossincident. Some potential factors to consider when projecting salesare 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-continuing expenses include: baddebt, sales discounts, merchant credit card fees, shipping andfreight, raw materials, ordinary payroll expense and supplies. Anexample of an expense that has both a fixed and variable componentis a telephone expense, where there is a base/fixed monthly chargewith additional charges based on usage.

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.