Question

In Berkshire Hathaway’s 2012 annual report, Warren Buffett, in discussing the company’s post-control step acquisitions of Marmon Holdings, Inc., observed the following:

Marmon provides an example of a clear and substantial gap existing between book value and intrinsic value. Let me explain the odd origin of this differential.

Last year I told you that we had purchased additional shares in Marmon, raising our ownership to 80% (up from the 64% we acquired in 2008). I also told you that GAAP accounting required us to immediately record the 2011 purchase on our books at far less than what we paid. I’ve now had a year to think about this weird accounting rule, but I’ve yet to find an explanation that makes any sense—nor can Charlie or Marc Hamburg, our CFO, come up with one. My confusion increases when I am told that if we hadn’t already owned 64%, the 16% we purchased in 2011 would have been entered on our books at our cost.

In 2012 (and in early 2013, retroactive to year end 2012) we acquired an additional 10% of Marmon and the same bizarre accounting treatment was required. The $700 million write-off we immediately incurred had no effect on earnings but did reduce book value and, therefore, 2012’s gain in net worth.

The cost of our recent 10% purchase implies a $12.6 billion value for the 90% of Marmon we now own. Our balance-sheet carrying value for the 90%, however, is $8 billion. Charlie and I believe our current purchase represents excellent value. If we are correct, our Marmon holding is worth at least $4.6 billion more than its carrying value.

How would you explain the accounting valuations for the post -control step acquisitions to the Berkshire Hathaway executives? Do you agree or disagree with the GAAP treatment of reporting additional investments in subsidiaries when control has previously been established?

Answer 1

Answer :

According to the given data : In Bershire Hathway's 2012 annual report ,warren buffet is discussing the company's

1. Accounting valuations for the post control stock acquisitions as per GAAP is to report the same on the fair value of the stock rather than the cost incurres to acquire such stocks
2. As rightly stated by warren Buffet this rule is quite absurd and due to that rule the parent company's EBITDA as well as other important ratios are effected negatively.

There is a way around this rule,if another subsidiary is created by the parent company for this special purpose

As entity acquired the stock of the subsidiary where parent company has control already ,then this particular SPE can report the carrying amount based on the cost of the purchase

I won't agree with the GAAP treatment ,hence I suggested a aroud the same