Advanced Accounting: Consolidated Financial Statements and Outside Ownership

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This is a class discussion subject

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,
raising 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
additional 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 treatment of reporting additional investments in
subsidiaries when control has previously been established?

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