Law and Accounting

• Author: Vern Krishna
• Pages: 235-270

Chapter XI: Law and Accounting 235

Chapter XI: Law and Accounting

A. GENERAL COMMENTS

Accounting deals with measurement and summarization of -

nancial transactions according to generally accepted accounting

principles and concepts. Finance is essentially corporate law that

concerns the creation and valuation of nancial instruments, such

as stocks, bonds, and derivatives. us, both accounting and nance

become important for lawyers whenever they deal with nancial

transactions and instruments. Lawyers incorporate accounting and

nance concepts in commercial agreements.

B. BUSINESS CONTRACTS

e most common scenario where lawyers encounter accounting

and nance issues is in litigation over agreements where the par-

ties interpret them dierently. In such cases, lawyers must either

negotiate a settlement of the dispute or have a court adjudicate if

negotiations are unsuccessful.

Legal disputes involving accounting oen centre on basic con-

cepts and terminology, such as “book value,” “net prots,” and “in-

come.” In some cases, the courts defer to GAAP and rely upon the

accounting profession’s understanding of these terms. In others,

however, the courts reject GAAP and insert their own interpreta-

tion of the meaning of the words. As the cases that follow show,

236 Understanding Financial Statements

contractual problems involving interpretation of accounting ter-

minology oen arise in corporate agreements involving buyout

clauses and in incentive compensation agreements for key employ-

ees. Most of the problems can be resolved at the draing stage by

using conventional terminology and dening the meaning of terms

in the contract.

An example in the United States, Piedmont Publishing Company

v Rogers, provides insight into the formulation and resolution of a

contractual dispute involving Mary Pickford Rogers (star of silent

pictures) and Piedmont. e parties were rival applicants for a li-

cence from the Federal Communications Commission for a tele-

vision station in Winston-Salem, North Carolina, where Piedmont

also owned and published two newspapers and a radio broadcasting

station. Piedmont and Ms. Pickford decided to pool their interests

and organized a new company, Triangle Broadcasting Corporation

(Triangle) in North Carolina to apply for the licence. e parties

knew that only one licence would be granted, and that a contest for

it might take so long that a television station already licensed in

Winston-Salem might capture the television audience. Triangle was

awarded the licence and an exclusive local contract with National

Broadcasting Company (NBC).

e parties signed an agreement in New York on  May 

under which Piedmont subscribed for , shares of Triangle’s

stock, for ,. Ms. Pickford subscribed for  shares, for

which she paid ,. us, Piedmont owned two-thirds and

Ms. Pickford one-third of Triangle’s stock.

e contract contained a buyout clause, which gave Piedmont

an option to purchase Ms. Pickford’s stock at the end of any of Tri-

angle’s scal years in , , , and . e formula to be

used by Triangle’s “regularly employed independent certied public

accountants” to determine the purchase price for the stock was as

follows:

  Cal App d ,  Cal Rptr  (District Court of Appeal, d District,

Division , California ).

 e facts of the case are outlined in the decision of Justice Drapeau.

Chapter XI: Law and Accounting 237

An amount per share of stock equal to the sum of the two fol-

lowing items, divided by the number of outstanding shares of the

corporation:

. an amount equal to the total book value at the beginning of

any such period of Triangle’s common stock adjusted to re-

ect an annual depreciation and obsolescence charge of not

over % against such tangible assets as have been depreci-

ated on the books of Triangle at a higher rate; and

. an amount determined by multiplying the average net an-

nual prots of Triangle by ve.

e multiplier declined over the four years. e multiplier for 

was ve. If the option had been exercised in , it would have

been four; in , three; and in , two.

Piedmont exercised its option on  July . e indepen-

dent public accountants valued Triangle at ,,, which made

the Pickfords’ one-third interest worth ,. e option price

was approximately ,. e market value of Triangle did not

include goodwill in “total book value” in the formula.

Goodwill would be the fair market value of the telecasting li-

cence, the fair market value of the television station, as its listening

audience grew in numbers, the value of its advertising contracts, and

the fair market value of contracts with National Broadcasting Com-

pany. Pickford rejected the oer and the parties ended up in court.

e court concluded that by adding the word “total” to “book

value,” the parties meant to include the value of Triangle’s intan-

gible assets — including the goodwill (licence to telecast, the adver-

tising value of the station and Triangle’s contract with NBC). e

court interpreted “total book value” to mean “fair value”:

We do not believe that gentlemen in control of Piedmont’s poli-

cies, with their standing in their community and state, meant to

use an accounting method that would cut down the fair value

of Ms. Pickford’s stock, if they exercise their option. We think,

rather, they intended to pay her a fair price for her participation

in securing the television license and in making the television

station an outstanding success.