The short definition of fraud is theft by deception. Someone misrepresented pertinent facts, orally as an assurance or within the four corners of a contract, so that the other party to the deal got something other than what he bargained for. Blatant fraud could draw the attention of a zealous prosecutor and wind up in criminal court, but most alleged business fraud winds up in civil court. Either way, if the court determines a defendant committed fraud, restitution is at least part of the remedy. The fraudster must pay the innocent party for the losses suffered due to the fraud. But what is the best measure of those losses? At first glance, you might say, just have him pay the full amount he stole. But the answer is not always that simple.

Fraud damages is an area where accountants who are well-versed in fraud can offer litigation support. At Breon & Associates, we help attorneys calculate damages for fraud cases using different methods, such as:

• Out of pocket — This is the simplest method of calculation. Damages equal the difference between the amount the purchaser paid and the true value of the transaction.
• Benefit of the bargain — This method factors in incentives that induced the victim to enter into the agreement. Damages here are equal to the difference between the value the purchaser was led to anticipate and the true value of the transaction. This method generally results in greater restitution for a victim.

Here’s a hypothetical that explains how the two methods might work.

Suppose you own a garage and you want to sponsor a Classic Car Rally. Someone offers to sell you a 1968 Mustang GT just like the one Steve McQueen drove in Bullitt. They say it’s worth $80,000, because it’s in cherry condition with all original factory parts. Unfortunately, the owner passed away and the car has to be sold to settle the estate, so they’re willing to sell for $60,000. You buy the car, thinking this is going to be centerpiece of your rally. But after you by the car — as is — you put it up on the lift and find the engine’s been rebuilt with several cheap parts, and it’s only worth about $25,000.

According to the out-of-pocket formulation, your damages are what you paid ($60K) minus what it’s worth ($25K), which amounts to $35K. But, part of the reason you bought the car was because you were getting a bargain. Under the benefit of the bargain formulation, your damages are what the seller said the car was worth ($80K) minus what it’s really worth ($25K) or $55K.

However, the best outcome for this scenario might be to void the sale and get our $60K back.

There are other methods that can be used to in business when fraud has caused a company to lose profits. Lost profits can be calculated a number of ways:

• Benchmark — This approach compares the victim’s corporate profits to the profits of another, similar company that wasn’t defrauded.
• Hypothetical — If your company doesn’t have much of a track record, this method relies on marketing data that demonstrates potential lost sales. From the amount of lost sales, you can arrive at a sum that accurately represents lost profits.
• Before-and-after — When a business has a history, forensic accountants look at the company’s profits before and after the fraud and compare those numbers to the profits made during the time the fraud was being committed.