Berkshire Hathaway 1999 Annual Meeting Audience Question # 22

Some major corporations have used questionable accounting practices to make their operations seem more favorable

Warren Buffett:

So let’s go onto zone 9.

Audience Member:

I’m Lola Wells from Florida.

You have been recently quoted in the newspapers as saying that some major corporations have used questionable practices to make their operations seem more favorable. Would you be willing to be more specific about these practices?

Warren Buffett:

Not until I’m on my deathbed. The… no, I have followed a policy of criticizing by practice and praising by name, and we will not…

You know, we do… Charlie and I both find certain practices very deplorable. And they aren’t limited to a single, or a few, large corporations. But it would… we would probably be less effective in arguing for change if we went to a few specific examples.

A, they would not be that much different, probably, than hundreds of other, or at least dozens of other companies. And secondly, those who get critical of the world, find the world gets very critical of them, promptly.

And I think we do more good by, in a sense, hating the sin and loving the sinner. So, we will continue to point out the sin. But we will not name the sinners.

Charlie?

Charlie Munger:

Warren, I think she wants you to name the practices.

Warren Buffett:

Oh, the practices?

Charlie Munger:

Not the miscreants.

Warren Buffett:

Oh, well, the practices are some… the practices are some of the things of the things we’ve said.

They relate to accounting charges that are designed to throw, into a given period, a whole lot of things that should’ve been covered in subsequent periods in the earnings account. Or to smooth out or to inflate earnings in future accounts.

There’s a lot of that being done. There’s a lot that’s been done. The SEC, under Arthur Levitt, who I admire enormously for his efforts on this, is making a concerted attempt to get corporate America to clean up its act on that.

But it’ll only be because somebody hits them over the head. I mean, it has become totally fashionable to play games with the timing of expenses and revenues. And frankly, until the SEC got tougher, in my view, the auditors were not doing enough about it.

I think that, in terms of hiding compensation expense and not recording it, in the case of options and all of that, I think…

Companies now have the option of recording option costs in the income account. But you have not seen any great flood of people doing it.

And actually, the way they show it in the footnotes is quite deceptive, in my view, because they try to make assumptions that minimize what the income account impact would be.

But the cost to the shareholder is what counts. I mean, that is the compensation cost, as far as we’re concerned. And that’s been minimized.

The whole effort to engage in pooling rather than purchase accounting, I’ve seen a lot of… there’s been a lot of deceptive accounting, in that respect. There’s been deceptive accounting on purchase accounting adjustments. So those are the kind of things we’re talking about.

Charlie?

Charlie Munger:

Yeah, it’s the big bath accounting, and the subsequent release back into earnings of taking an overly large bath, that create a lot of the abuse.

Warren Buffett:

We could name names. We won’t. But I mean, we have seen, firsthand, managements who think they are doing… they say they’re doing what everybody else does. The truth is, they are now because everybody else is doing it.

And it takes some outside force, in this case, probably the SEC… it should’ve been the auditors and… to clean up the act.

Because once it becomes prevalent, the fellow who is… who says, “I’m going to do it fair and square,” all of a sudden becomes at a disadvantage in capital markets.

He’s penalized. And he says, “Why should I penalize my shareholders by doing something when, legally I can get away with doing something else?”

Charlie?

Charlie Munger:

Nothing more.

Looking for an offline, PDF copy of all shareholder questions carefully arranged into specific topics such as How to properly evaluate a company for potential investment, Intelligent Investing and Secrets to achieving Success and Happiness? Click on the image below to learn more.

Q&A with Warren Buffett and Charlie Munger: A Compilation of All Shareholder Questions and Answers from The Berkshire Hathaway Annual Shareholder Meetings

Click here to return to the Q&A topic list. Alternatively, you can proceed to the next or go back to the previous question.

Don`t copy text!