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When the Accountant Speaks, We Don't Listen!

Guest post by: Pia Lord

Article Overview: Warren Buffet's very informative and enlightening Annual Report each year includes a list of owner related business principles by which Berkshire Hathaway (Warren Buffett and Charlie Munger)have skippered the ship. Principle # 6 discusses aquisition of portions of businesses or whole companies, the related costs and taxation benefits or drawbacks. Mr. Buffett has successfully led Berkshire Hathaway to the empire it has become through steadfast reliance on money saving, intrinsic value growth and goodwill accrual principles such as these.

When the Accountant Speaks, We Don't Listen!



Warren Buffet Principle #6

“Accounting consequences do not influence our operating and capital-allocation decisions”

This statement in the Berkshire Hathaway Annual Report under # Owner Related Principles seems to me to be rather cavalier at first glance. Buffet goes on to say that they prefer to make purchases of parts of companies who earnings are non-reportable, as allowed under standard accounting principles rather than buy companies whose earnings they are required to report. Money that can be reinvested into the company always is preferable than that having to be paid out in taxes.

Clearly Berkshire Hathaway is looking for ways to acquire companies that earn a great deal of money, have great reputations, but that are not cash hogs or spendthrift or money squanderers.

Who would not want companies like this? It sounds like the ideal investment. To have a large portfolio of companies that make me lots of money, but that I don’t have to pay a lot out for in the tax year reckoning. I could have them all working for me too!

Capital expenditures-also known as investment outlay of money to grow the business, usually in terms of real property, machinery, equipment which is deemed necessary to have the business function at higher sales and profit .

Capital allocation decisions- determining when and where to put the money that you have set aside for growing and reinvesting in your business.

Undistributed earnings- earnings that accrue on paper but that are not actually tangible or real earnings. They do not affect the bottom line in one way or another in terms of actual earnings for the year. This is akin to having a stock that say you buy in January of the year at 20$ per share and by December of the year have skyrocketed to $100 per share. This gives you a gain on your stock books by $80 per share. If you bought 200 shares to begin with, your initial investment would have been $ 4,000 but by December, that stock is now valued at 200 x $ 100= $20,000, a five fold increase in your investment. Since you decided to not take any profit in December, the 200 shares are still on your stock books, sitting pretty and looking good. Of course if you are not careful by March, the winds of change could have swept over and blown your stock price back down to $20 per share or even lower. On the other hand if you were to have taken the profit in one calendar year, you would have to pay short term capital gains taxes on the profits. If you wait and hold on longer than one year and a day, you would only pay long term capital gains tax which is usually a lower percentage.

Mr. Buffet discusses purchasing small portions of companies ( whose earnings are largely not reportable) vs. purchasing the entire company (where you are responsible for the accounting and taxation of reportable earnings).

This is an interesting statement which I do not fully understand. But the assumption seems to be that a company section or portion can be available for a lower purchase price with not reportable earnings. While the whole company purchase would be at a double the per share price, $2 vs. $1, with taxes waiting to be paid, for true earnings, realized at the end of the year.

These monies, Mr Buffet goes on to say, which are not reported for tax purposes, while staying in the business, he expects will be reflected in the growth in the intrinsic value of the business. Here we have this word again, the intrinsic value of the business. The intrinsic value of the business, the basic reputation and good will that the company has acquired through operations, customer service, marketing, and general reputation of products and services, will grow over time. His expectation seems to be that the monies reinvested in a company will go toward long term success of the business as a whole.

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Article Tags: accounting principles, allocation decisions, annual report, berkshire hathaway, bottom line, bough, business function, capital allocation, capital expenditures, cash hogs, first glance, investment outlay, lots of money, machinery equipment, reputations, rsquo, spendthrift, stock books, undistributed earnings, warren buffet
Referred by: http://jaykubassek.com



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