Warren Buffett was unequivocal in his criticism of the Financial Accounting Specifications Board’s ASU 2016-01 — the new accounting for equity securities handed in 2016 and carried out in 2018. In his 2017 letter to shareholders, Buffet pointed out:
“The new rule suggests that the web change in unrealized financial investment gains and losses in shares we hold need to be involved in all web revenue figures we report to you. That prerequisite will produce some definitely wild and capricious swings in our GAAP bottom-line. For analytical purposes, Berkshire’s ‘bottom line’ will be ineffective.”
The crux of Buffett’s argument was that his intent is to hold securities endlessly, and hence quick-term fluctuations have been irrelevant because he sights them as partnerships and periodic market quotations don’t change very long-term worth prospective clients.
Donald Graham, chairman of Graham Holdings, arrived to Buffett’s defense in a November 2018 opinion piece in The Wall Avenue Journal. He explained: “On paper, these [quick term] fluctuations in inventory worth dwarf Berkshire’s true business profits. In fact, they basically report quick-term variations in the prices of shares that may possibly be held for a long time ahead of they are offered.”
For good evaluate, he extra, “Berkshire and all other providers currently report gains and losses on shares at the time of sale. Interim fluctuations should not be authorized to fuzz up claimed earnings.”
In reaction, I pointed out at the time:
“For equity securities for which there is much less than a 20% possession or no significant influence, this new standard additional prominently demonstrates the worth of the securities working with the cost Berkshire would require to exit these positions (e.g. exit cost reasonable worth). Despite the fact that Mr. Buffett considers these corporations relatively than ticker symbols, as pointed out in his remarks, the accounting for such appreciation in web revenue better demonstrates the change in these positions than people more than which Berkshire has greater influence or regulate and can add to the business functions.
“It is additional correct to reflect the change in the worth of these investments in web revenue as it happens relatively than basically when management’s intent variations and the conclusion to promote is produced. Reflecting the understood gains in web revenue at that time inaccurately portrays such earnings as latest period of time events, when in truth, the gains may possibly have gathered more than quite a few yrs. Now additional than ever, the different solutions of accounting for equity securities most precisely depicts Berkshire’s business model.”
That reaction was and continues to be appropriate. Nevertheless, it appeared to have experienced minor influence. Maybe this was because the whole affair experienced the experience of a supreme verdict that rested on the parsing of obtuse ideas. True, Buffett said his intention to hold securities endlessly, experienced primarily demonstrated that in apply, and established a precedent presenting a tenable defense to his ASU 2016-01 interpretation, while my case was rooted in the irrefutable economics of market pricing.
But there was absolutely nothing obtuse in Buffet’s communication at the the latest Berkshire annual meeting that he experienced offered his stakes in the 4 major U.S. airlines: American, Delta, Southwest, and United. By offering the shares he transformed the unrealized losses in the March 31 revenue assertion to understood losses — which traders will see mirrored in Berkshire’s June 30 revenue assertion. In making the sale, Buffet contradicts his and Graham’s previously statements that the investments are held for the very long-term and that the accounting — the bottom line, if you will — is not reflective of the economics.
Further, what he fails to issue out is that when it arrived to his financial investment in airline shares he took the securities market cost or the ticker cost and bought out — presumably because he imagined the very long-term prospective clients have been worse than the latest securities cost. His only “quote” was the market cost of the shares on the trade.
Ultimately, the wisdom of ASU 2016-01 will come down to this: Management intent does not change the worth of an equity protection. If this have been the case, all people asset administrators who acquired equities with the intent they would increase in worth would be insulated from the difficult realities of market pricing. And after Mr. Buffett, the most devout pupil of very long-term investing, is pressured to confront how market prices influence the worth of a portfolio and web revenue, should not all traders have to confront the same fact when they search at an revenue assertion?
Sandra Peters is head of economical reporting coverage at CFA Institute, where by she leads a world-wide staff analyzing and developing coverage positions related to significant economical reporting, accounting, and auditing troubles around the globe. Prior to this, she was vice president and corporate controller at insurance coverage service provider MetLife.