Question

BERKSHIRE HATHAWAY'S MANY INVESTMENTS

As of this writing (February 2014), Warren Buffett is the fourth-richest man in the world, worth a staggering $58.5 billion. He is also the chairman, CEO, and primary shareholder of Berkshire Hathaway Inc. Over the past 48 years, Berkshire has grown at an average rate of 19.7 percent annually. Warren Buffett has achieved this success through his unparalleled business sense regarding investments and acquisitions of other companies. Berkshire Hathaway was originally a textile manufacturing company. In 1962, Warren Buffett and his partners began buying large blocks of Berkshire stock. Within five years, Buffett began expanding into the insurance industry, and in 1985 the last of Berkshire's textile operations was shut down. In the late 1970s, Berkshire began acquiring stock in GEICO insurance and in January 1996 bought GEICO outright. While Berkshire has extensive insurance holdings, it has not focused its investment activities solely on insurance. Since Buffett took the helm in the 1960s, Berkshire has made many acquisitions. Look at the list of selected Berkshire holdings as of the end of 2013 (on the next page). Do you recognize any of these companies? Each item in Berkshire's portfolio has to be accounted for individually. For example, Comdisco Holdings and Graham Holdings Company are accounted for as equity method investments, while Walmart and American Express are classified as available-for-sale investments. Berkshire consolidates the fully owned companies such as Wesco Financial and See's Candies. In addition, companies like GEICO have many subsidiaries of their own. As you can imagine, accounting for investments at Berkshire can be very complex.

Case Questions

A. What three accounting rules guide the external reporting of intercompany investments? (briefly)

B. What are your thoughts on consolidation challenges Berkshire-Hathaway faces in accounting for these complex ownership structures?

Answer 1

a.

Investments in Financial Assets
At acquisition, the assets (investment in investee) are recorded on the investing firm's (investor) balance sheet at fair value. As time passes and the fair value of the assets changes, the accounting treatment will be totally based upon the classification of the assets.

The Assets are classified as:

1. Held-to-Maturity
These are debt securities intended to be held till maturity. Long-term securities will be reported at amortized cost in the balance sheet, with interest income being reported on the investee's income statement.

2. Held-for-Trading
Equity and debt securities held with the intention to sell them for a profit within a short time-horizon, typically three months. They are reported on the balance sheet at fair value, with any fair value changes (unrealized and realized) being reported on the income statement, along with any interest or dividend income.

2. Available-for-Sale
These are neither held-to-maturity nor held-for-trading.
Available for sale securities are the default categorization of securities that companies decide to invest in for the purposes of benefiting their financial position. Unlike trading securities, available for sale securities are not bought or sold for the sole purpose of realizing a short-term capital gain. They may be purchased as tools to diversify away some of the risk that a company’s investment portfolio currently carries. For instance, a company may choose to invest in two industries that exhibit negatively correlated returns or invest in lower beta securities in order to hedge against investment risks.

b. 1.

Consolidation is the aggregation of the financial statements of two or more companies under the same ownership into a consolidated financial statement.
Challenges in accounting for Complex ownership structure like Berkshire-Hathaway

1. Identifying the investee’s returns, which involves
identifying its assets and liabilities. This may appear
straightforward but complications arise when the legal
ownership of assets diverges from the accounting depiction
(for example, in financial asset transfers that ‘fail’
de-recognition, and in finance leases). In our view the
assessment of the investee’s assets and returns should
be consistent with the accounting depiction in accordance
with IFRS.

2. It may not always be clear whether contracts and other
arrangements between an investor and an investee
– create rights or exposure to a variable return from the
investee’s performance for the investor; or
– transfer risk or variability from the investor to the investee