Mind the GAAP

“Why not?”

I responded, “Because it’s not required.”

The “GAAP” Trap: Why It’s Not Enough

I understand the logic opposing counsel was making in his line of questioning. He wants to get the expert witness to admit his work didn’t conform to GAAP, then build a foundation the analysis was inferior, and that it doesn’t meet standards. Backed with this, his main point being how could a trier of fact give any weight to this testimony?

Just understanding the words oozes credibility. Generally accepted? Nothing in the legal or accounting world is likely to be “always accepted” – generally accepted is the next best. How can your analysis be worthy of consideration if it is not “generally accepted?” How about the final two words, “accounting principles?” The same applies here, how could your analysis not conform to “accounting principles?” Hence, we have the genesis to ask an expert, “Does your analysis conform to GAAP?”

While GAAP sounds definitive, it isn’t a qualitative metric which is the mistake opposing counsel made in my story. Meaning, whether your financials comply or do not comply with GAAP, it doesn’t make them any less reliable or correct. It just means your financials were either required to follow or not follow GAAP.

Identifying Relevant Accounting Standards

Public companies regulated by the SEC, companies “audited” or “reviewed” by a CPA, or companies with bank loans or loan instruments often are required to present financials in accordance with GAAP. Even public companies that present financials according to GAAP often will denote “pro-forma or non-GAAP adjustments” in their statements to be read along with GAAP financials if the companies believe additional disclosures might help investors understand or compare results to previous key operating metrics. In cases like these, investors and Wall Street analysts often will look to a non-GAAP number or result to understand the performance of the company in quarterly or annual results and ignore the required GAAP number.

Examining Deficiencies and Process

There is a better line of questioning that addresses the issue of accessing and following the appropriate accounting standard that applies in this situation. The expert should be able to identify and describe the types of accounting standards they considered, and whether the financial information they evaluated conformed to those standards. This would likely include whether they were required to, or voluntarily complied with, GAAP, IFRS, or GASB.

Once an expert testifies as to what standards they considered and applied in this situation, then specific questions could be raised as to whether the financial information presented conforms to those standards or perhaps, more importantly, whether there were identifiable deficiencies that made the financials nonconforming. By examining these deficiencies and their effects, opposing counsel could concentrate on whether an expert corrected these deficiencies before arriving at, or drawing a conclusion. If they didn’t correct the financials that conform to the standards, how could you reasonably decide or provide testimony that would assist the trier of fact?

While many non-accountant attorneys will immediately shy away from asking specific, nuanced financial questions to expert witnesses, asking process-oriented questions can often highlight critical thinking lapses or logic errors attorneys may want to explore. By understanding an expert’s process and whether this is something procedurally undertaken before an analysis or conclusion is reached, may impugn the validity of an expert witness’s testimony at trial.