Accountants Predicting The Future
During preparation for my appearance in the Supreme Court a fortnight ago, I was struck by the nature of the disagreement between the two accounting experts. It effectively boiled down to who could better foretell the future.
A plaintiff had suffered a business loss for which it held the defendant responsible. The plaintiff’s legal team had engaged an accounting expert who formulated projections of the profits the plaintiff would have earned and prepared a comparison of this to the profits which were actually earned. The difference was a loss claimed from the defendant.
As is not uncommon in these matters, the financial projections of the plaintiff’s expert displayed a steep upward trajectory following the circumstances which were blamed on the defendant. Had the circumstances not occurred, the projections recorded, the previously static financial results of the business would have been replaced by a sharp and sustained increase in turnover and profits.
My role was to assess the reasonableness of these calculations. This is the standard second line of defence by the defendant’s legal team, behind their principal defence that their client had no case to answer.
I had formed the view that the plaintiff’s projections were of little assistance to the Court after uncovering calculation errors, unrealistic assumptions and patterns of growth not previously experienced for any of the plaintiff’s components of income.
My thinking about accountants foretelling the future led me to reflect on the various approaches that they use for financial projections of the future. Some methodologies can have an overly simplistic, overly complex or just a difficult to discern basis. For instance, one methodology to determine future profits of a business is to calculate them as the average of profits for the last three or the last five years. How this approach is valid is rarely explained and I don’t know this outcome occurs in the real world. A variation on this approach is projecting future profits to be an average of past years’ profits but to apply a different weighting to each year. The reason why some years are more reflective than others of future results is also rarely explained.
I concluded that all attempts to foretell the future are guesses but some are better than others. We can’t imply that complex calculations make a guess of lost profits or future financial performance more likely, just because there are calculations involved. The objective should be for the accounting expert to use reasoned professional judgement to make their guess of the future as likely as their relevant data allows. The thinking behind the professional judgement should also be properly explained.
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