Stocks A to Z / Stocks B / Berkshire Hathaway (BRK.A) ❤
No. of Recommendations: 0
IIRC Munger made a stink about including unrealized gains and losses in GAAP earnings. Was that because Berkshire would have to pay taxes on them? Or is it still OK from tax law viewpoint, and he just hated giving a more accurate picture to the shareholders?
No. of Recommendations: 33
My understanding is that accountants prepare accounts in accordance with GAAP. Tax computations take the GAAP numbers as a starting data point and then adjust back to tax law. For example accountants will post a depreciation journal. The tax professional will reverse this depreciation journal and create a capital allowance, based on tax law.
Reporting unrealised gains/losses in the P&L account would not effect tax. Again, the tax professional would reverse out such accounting entries and apply the tax laws, which provide that tax is only paid when investments are actually sold.
I would imagine Charlie Munger's beef with the accounting profession and their standards, is that they often have accounting treatments that are just plain stupid. For example, when Berkshire owns Coca-Cola since 1998 and never sells. If the stock market says, it is worth $20 billion as at 31 Dec 2022 and then $40 billion as at 31 Dec 2023, then a $20 gain (less deferred tax) is added to net profit. That is simply crazy, as the intrinsic value is unlikely to have changed that much in 12 months. It causes the reported earning to be overstated in some years and understated in others. It introduces unnecessary distortions and confusion. It's just not helpful to users of accounts in understanding the performance of the business and its investments.
Charlie Munger was also irritated by the auditors at Daily Journal. I am not sure exactly what his beef was there but I know Charlie said Daily Journal's accounts do not in any way reflect the economic reality of the business. I know, for example, Daily Journal expenses the Journal Technology development costs, as they are incurred and only recognises income when implementations have gone live and the customer is happy to pay for the development. That lacking of 'matching' income and expenditure, probably caused a problem for the auditors. Charlie Munger would probably have argued that his way was the best way, as it is 'prudent'. He might have argued that there is no guarantee that the customer would be happy with the development and may never pay anything. He would have preferred to have pleasant surprises for his shareholders, rather than potential disappointments. He would be of a strong view that accounting should be prudent and conservative, which is perhaps not always conventional thinking, for CEO's and CFO's, with incentives to promote stock prices to realsie personal share option harvesting.
I appreciate this is accounting 101 and apologies if it's incorrect, or patronising. Let me know if you think I can learn something...
No. of Recommendations: 2
great post. A recommendation was not sufficient
No. of Recommendations: 8
Was that because Berkshire would have to pay taxes on them?
No, it wasn't a tax issue. Had you listened closely, you would have understood that it was absurd to report unrealized gains and losses in GAAP because it is so volatile. What if the last day of the quarter happens to have seen a broad 5% decline in markets, only to see the 5% recovered in the first week of the next quarter? It's absurd to have GAAP move rapidly up and down due to market vagaries. It makes GAAP mostly useless for such companies.
and he just hated giving a more accurate picture to the shareholders?
And this is just plain ridiculous. Berkshire has always given an accurate accounting of the value of all holdings regardless of what is required to be accounted for in GAAP. In their annual letters, over all the decades they've existed, they literally compare their value to common benchmarks.
No. of Recommendations: 1
"Or is it still OK from tax law viewpoint, and he just hated giving a more accurate picture to the shareholders?"
Actually, it's the opposite. Having to report "earnings" on stock gains that aren't actually sold distorts the shareholders ability to analyze bottom line earnings. That's why Warren and Charlie said if you're looking for a snapshot of how the company's doing look at the operating earnings.
No. of Recommendations: 4
I know, for example, Daily Journal expenses the Journal Technology development costs, as they are incurred and only recognises income when implementations have gone live and the customer is happy to pay for the development.
At one place I worked, I had multiple arguments with the CFO about this exact topic. My point was we would be doing software development, maintenance and administration for as long as the company was in business. And expensing the development costs each year was much more realistic than claiming they were longer term and could be amortized over multiple years. But the bottom line of his point was that doing so made the current years numbers look better. Seemed dishonest to me.
No. of Recommendations: 9
At one place I worked, I had multiple arguments with the CFO about this exact topic. My point was we would be doing software development, maintenance and administration for as long as the company was in business. And expensing the development costs each year was much more realistic than claiming they were longer term and could be amortized over multiple years. But the bottom line of his point was that doing so made the current years numbers look better. Seemed dishonest to me.
I've been in the exact same boat, and had that same discussion, with the same push back.
After many years of pondering the discussion, I concluded that the most realistic way do to it (not that we ever did it that way) was to expense maybe 1/2 to 3/4 of the ongoing "R&D" department expenses, but then to capitalize and depreciate the rest slowly over a VERY long lifetime. Some of the code I wrote was still making money 20-30 years later...but only a tiny fraction of it. Some had a little earning power after 2-3 bankruptcies of the company owning it at any given time.
Jim
