Estimating Overhead Expenses in Damages Calculations
Whether the case involves compensatory damages for lost profits or remedies in the form of actual profits to be disgorged, the calculation of relevant overhead expenses is often a matter of much dispute. To estimate the amount of overhead expenses in a damages claim, it is often necessary to distinguish between fixed and variable expenses. See below for a summary of how the amount of overhead expenses is accurately estimated in calculating profits as damages.
“We regularly estimate overhead expenses in damages claims by relying upon generally accepted cost accounting techniques,” says Ryan Clark, Member of Hoffman Clark. “But often it is ultimately the specific circumstance of the case that governs how we calculate the applicable overhead expenses.”
The type of case is a factor that can determine how overhead expenses are treated. For example, the calculation of overhead expenses will likely require different cost accounting techniques for cases involving construction delay claims, breach of business acquisition earn-out contract claims, and lost profits claims in a variety of breach of contract, tort, and business interruption cases.
Overhead expense allocations and incremental determinations typically involve cost accounting techniques that can precisely and accurately estimate overhead expenses. Since some overhead expenses are affected by increases in volume and others are not, an incremental cost analysis involves estimating fixed and variable costs. There are four generally accepted cost accounting techniques that may be applicable to estimating incremental overhead expenses.
The simplest cost estimation method is to interview knowledgeable company personnel concerning their opinion of the variable and fixed nature of expense categories. Used alone, this is the least reliable method.
Account Analysis Method:
Overhead expenses can be analyzed over time by conducting an accounting line-item-by-line-item analysis to make observations about cost behaviors to form estimates about the variable and fixed nature of cost categories.
The high/low method (a/k/a incremental cost method) can be used to algebraically estimate fixed and variable costs by comparing accounting periods with the highest and lowest volumes over a given time period.
Regression Analysis Method:
A statistical model can predict costs and provide a formula describing observed cost behaviors. The model may be a simple regression with one variable or a multiple regression with several variables. The regression results also provide statistical correlations that indicate the reliability of the cost predictions.
“We are currently involved in several damages cases where we are using all of the available cost accounting techniques,” notes Clark.