By Ron J.  Anfuso, CPA, ABV, CFF, CDFA, FABFA*

The valuation and distribution of marital property is typically one of the most difficult and arguable issues to be dealt with in a divorce proceeding. The process can become considerably more complicated and expensive when the marital community owns an interest in a business. In such cases, a Forensic Accountant is often hired by the attorney to prepare a list of documents needed to perform a business valuation and then to conduct the valuation. The problem is that to perform an accurate assessment of the value of a business, the Forensic Accountant will need to review a considerable number of documents. When the list of documents is presented to the attorney, the attorney’s reaction may be to request minimizing the number of reports due to the size of the case or the costs involved. Thus, it is imperative for the Forensic Accountant to be able to explain why the requested documents are essential to attain an accurate valuation. In this article, I concisely clarify the reasons why Forensic Accountants make these requests.

Documents Forensic Accountants Require

Financial Statements: A good starting point is to review the business’s financial statements to visualize the financial condition of the company based on its assets and income. Financial statements assist to form a standard for comparison to industry information and help indicate the amount of additional analysis that will be required. Forensic Accountants will be able to compute business ratios for profitability, leverage and liquidity. In addition, financial statements can help establish prior-to-marriage property tracing requirements. Careful review may also uncover discrepancies that could red flag the legitimacy of the financial statements.

Tax Returns: Reviewing tax returns are invaluable because they are filed under the penalty of perjury. Studying returns also benefits the task because the Forensic Accountant can compare what was reported with what was stated on the financial statements. The Forensic Accountant will then be able to assess whether an aggressive tax position was taken. This can suggest the likelihood of perquisites, which may not only influence business valuation, but spousal support calculations, as well.

It is customary to have experts review five years of returns. Forensic Accountants consider this adequate enough to thoroughly analyze business cycles.

General Ledgers and Journals: These are essential because they provide thorough information behind the broad picture that financial statements and tax returns present. General ledgers and journals provide the details concerning all disbursements. Thus, the Forensic Accountant can inspect who and what was paid, as well as the dollar amount of all transactions.

Paid Bills: Paid bills assist in determining whether disbursements were made for the business, or for the owner (or shareholder). Because paid bills show whether disbursements were made for the business or for other expenditures, such as divorce legal fees, they are useful in determining the existence and amount of perquisites.

Bank Statements, Canceled Checks and Brokerage Statements: In some instances, bank statements and canceled checks can reveal what general ledgers and journals do not disclose. Together, these test the reliability of the records and books provided, as they can reconcile deposits and income. In some instances, bank and brokerage statements and canceled checks will also uncover previously undisclosed bank accounts.

Income Tax Audits: Federal and state agency audits may disclose unreported income and sales, and deductions of personal expenses. In addition, audits may reveal business entities or locations that were not previously known to exist. Reviewing the audit reports often save time and effort in establishing a business’s actual earnings.

Stockholder and Director Minutes: Corporate minutes often discuss company plans, such as the purchase of new buildings or acquisitions. In addition, minutes may disclose salary information, authorizations for dividends, reasons for debt existence or appropriation of retained earnings. In some cases, the content of the minutes may include information that expose attempts to mislead the other party.

Salary, bonus and personal expense records (perquisites) paid for by the business: These documents help evaluate whether the community was sufficiently funded during the period of the marriage, and assist in establishing the income available for spousal and child support.

Insurance policies: In some instances, studying insurance policies may reveal assets not on the books, such as boats, rental properties, vacation homes or RVs. Additionally, if the owner claims business volume is low when the company is paying premiums for a high volume of business, it usually justifies further investigation of the business’s financial records. Insurance policies occasionally also uncover assets being insured that the spouse was unaware existed and may also help determine the value of perquisites.

Accounts receivable: Receivable records help ascertain the amount of collectibles that should be included in a valuation. An aging analysis can determine the collectibility of accounts, thus establishing their value. Studying accounts receivable can also determine whether all income has been recorded and whether any income may have been deposited into undisclosed bank accounts. In addition, studying receivables allows Forensic Accountants to uncover situations whereby a business owner may have collaborated with devoted clients to write off balances during the year of the divorce and mutually agree for these clients to pay the remainders owed later off the books.

Accounts payable: This is a place where business owners can overstate items. For example, when a business owner uses business credit lines to pay personal credit card balances, it overstates debt and downplays the value of the business.

Profit sharing and pensions: In some cases, profit sharing agreements and pensions disclose marital assets that aid in establishing portions that are separate and community. These also help establish the value of the benefits received by the individual.

Company websites, brochures and advertisements: The company’s promotion may provide a history of the business, and reveal changes in products or services made over time. Marketing materials may indicate places of business that were never disclosed, as well as reveal their competitive position in the marketplace. In addition, promotion may uncover products or services that were previously unknown, or indicate that a business has purposely dropped prices to reduce profits during the year of the divorce.

The business’s direct competitors: Evaluating the degree of risk is a key factor in determining the value of a business. For example, Forensic Accountants can ascertain the degree of strength of a business’s rivals and whether some are generating significant risk. Likewise, the Forensic Accountant can assess whether the competitive environment is weak and if there lies an opportunity for substantial growth. Factored into this also is an assessment of the potential of entry of new competitors and how these players might impact the business’s future.

Work in progress: Careful evaluation of the financial worth of a business must also include the value of work in progress, as this may appreciably influence the profitability of the business. In addition, this analysis may lead to the discovery of hidden assets.

Documents Needed for Incorporated Businesses

There are specific documents concerning corporations that Forensic Accountants frequently request to review in a dissolution matter. Typical ones include articles of incorporation, by-laws, corporate minutes, stock certificate books, stock ownership lists, organograms and job descriptions of key officers.

Articles of incorporation: Forensic Accountants want to know when the company was established and the authority of the laws by which the corporation operates. Identifying whether the corporation was established before or during the marriage may play significantly in assessing the value of the parties’ assets.

By-laws: Through by-laws, accountants discover the names of the board of directors and high-ranking executives, and whether there are any conflicting interests that could effect the case.

Corporate minutes: In some instances, minutes may reveal plans for expansion or acquisitions, which can have a significant impact on the value of a party’s assets. In some instances, we may find that corporate minutes had been altered to mislead the other party, such as withholding of earnings, to attempt to hide the actual value of the corporation.

Stock certificate books: These records provide the history and changes that have taken place in ownership. They may assist in determining the value of shares as the result of ownership transformations.

Stock Ownership lists: These disclose who the current and past owners of the company are.

Organization Charts: Organization charts divulge the level of responsibility and authority of executives, which may prove important in determining the value of assets.

Job descriptions of key officers: When combined with other corporate information gathered, this may help uncover arguments for inadequate or replacement compensation.

Other Documents Frequently Required

Among the additional valuable documents we have yet to mention include the following:

Accountant’s paperwork: Workpapers that accountants use to prepare business and personal tax returns, and financial statements can help uncover the basis for determining certain calculations, as well as clarifying the nature of particular transactions.

Loan agreements: Loan documents impact the determination of the value of a business, as they establish financial commitments, and set ratios and restrictions on salaries.

Operating budgets: Budgets reveal the needs for working capital and affect the computation of the value of a business.

Lease agreements: Evaluating leases can assist in determining the expectations for the future viability of the business. For example, if a party claims his business is struggling and having difficulty meeting its rent obligations, and no attempt has been made to rent out a portion of the space, it could indicate an anticipation for recovery.

Sales tax records: Reports of sales taxes provide an accurate record of sales, as it is subject to audit and stringent penalties by state agencies. A Forensic Accountant can reconcile reported sales taxes to the sales data provided by the company.

Joint venture agreements: Agreements regarding joint ventures can reveal whether company money has been placed into other companies or investments, and can assist in understanding cash and income restrictions on investments. In addition, these help establish whether investments of the business are operating.

Work in progress reports: These reports can uncover undisclosed assets. The Forensic Accountant should be able to analyze the value of the work in progress and, as a result, help determine the sales, profitability and worth of the business.

Should you have questions concerning any of the above documents, I welcome you to call me or place a question here on our blog.