Berkshire Hathaway 2003 Annual Meeting Audience Question # 35

Conservative accounting protects Berkshire’s business decision-making as well as financial integrity

Warren Buffett:

Number 10.

Audience Member:

Phil McCaw, Warren, from Connecticut.

Could you comment on Gen Re and goodwill impairment charges since you purchased it, and how it’s evolved in your thinking, and if it even became a part of your thinking?

Warren Buffett:

Sure. The question is… relates to the fact that, if you buy a business at a price over tangible assets, that you set up a goodwill account.

And if at any time in the future that that goodwill becomes impaired, you should, and must, if the accounting is proper, run a charge to reduce that goodwill item. You run a charge through the income account.

We have a large goodwill item for Gen Re, because it was the biggest acquisition we ever made. We paid substantially more than book. And the question is whether that goodwill is impaired.

And certainly, if the operations of Gen Re of the last couple of years… not including this year… but of the years ’98 through 2001, more or less, were representative of the future, you would say that there has to be a big goodwill charge there, and I would agree with you.

I think that as Gen Re is operating now, and had the capacity to operate… and it’s being realized now, thanks to a couple of great managers we’ve got there… I think that… I personally think that Gen Re is worth more now today than at the time we bought it.

And I think you will… its float has increased substantially, and I think that you will see the float turn out to be cost-free over time.

One thing I should have mentioned, actually, is… and I looked at a draft of our 10-Q. We have to… I think we should put this in there. We… Gen Re, up until this year, was discounting worker’s comp reserves at 4 1/2 percent, which was not conservative.

That… we inherited that situation.

But we have changed that to discounting comp reserves going forward at 1 percent. So the accounting is more conservative going forward now… 2003… by a fair margin, than it was in prior years and in a method we inherited.

So that the figures you see would be somewhat better if we had continued the old discounting at 4 1/2, rather than go to the new discount rate. And in the draft I saw, the 10-Q, that wasn’t in there. I think we should get that in there, Marc, while I think of this.


Charlie Munger:

Yeah. That accounting issue is of a type that is very common within Berkshire. We are so horrified by the terrible business decisions we see made all around us by people who are relying on over-optimistic accounting, that we tend to almost reach for opportunities to make our accounting very conservative. Way more than other people.

We think it protects our business decision-making, as well as our financial integrity.

I don’t know why we ever got into this business of trying to get the accounting result as close to the chalk as we could possibly get it. What is wrong with the world when everything is a little bit under-reported? I mean…

Warren Buffett:

Yeah, generally people think that reporting, you know, and transparency and all that, has improved over the years. And I felt much better working with the financial statements in 1960 than I feel working with financial statements in 2000.

And, frankly, in many ways I thought they taught me more about what the company was really about than the current ones do, even though there was far less detail.

And what we really deplore is solving operating problems by accounting maneuvers.

And, you know, Gen Re had some problems in the mid-’80s, when everybody did, and they went to discounting their worker’s comp reserves. And they… you know, it was a quick fix, but it’s like heroin. And you get on it and it’s not easy to get off.

And we… Charlie and I have seen that time and time again. People that think, you know, trade loading, whatever it may have been, they think they’re going to solve something by paying accounting games.

And they’re encouraged by their CFOs sometimes and frequently they were encouraged by their big-name auditors, in one way or another, to really play with the numbers.

And it catches up with you. You might as well face reality immediately, and take whatever operating steps are necessary to solve problems. Or, if you can’t solve them, just give up on them.

But whatever you do, playing with the numbers, it never works, although I guess if you’re 64 1/2 and you’re going to retire at 65, it might get kind of tempting.

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!