DOES GAAP UNDERVALUE POST-CONTROL STOCK ACQUISITIONS? In Berkshire Hathaway’s 20
ID: 3119328 • Letter: D
Question
DOES GAAP UNDERVALUE POST-CONTROL STOCK ACQUISITIONS? 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, rais- ing 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 addi- tional 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 treat- ment of reporting additional investments in subsidiaries when control has previously been established?
Please read the discussion question "Does GAAP undervalue post-control stock acquisitions" on page 175 of chapter 4 in the eText. You can find this in the end of chapter materials in Required Resources. 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?
Support your answers with cited references in APA style.
Explanation / Answer
The situtation described above is correct as in GAAP post control acquisition has to be mandatory on fair value rather than book value and in that fair value calculation deffered revenue which company has prior to the acquisition is reduced substantially. And it happens mostly with technology and software companies which charge their revenue in advance as deferred revenue and then convert them to revenue as and when services arwe delivered. This is a major gap in GAAP rules and this might affect EBITDA and Intrest coverage ratios post acquisition. So every company has to consider these differences in accounting of GAAP prior to acquisition.
Yes GAAP undervalue post control acquisition.In this case the undervaluation is due to the typical accounting rule and the value lost cannot be regained again. I know it is difficult to digest but according to this absurd rule it has to be this way. No I don't agree with this rule as this leads to a dramatic impact on earnings and valuation inspite of no actual effect on earnings.
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