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For many years now, every February, investors across the world look forward to the letter that Warren Buffett and Charlie Munger send to the shareholders of Berkshire Hathaway. The annual letter contains nuggets of investing wisdom that the duo have gathered over their careers.
Over the last few years, the letters have informed shareholders that Buffett and Munger have developed their own formula to analyse the earnings of Berkshire Hathaway — this formula shows up a different figure from what the audited numbers show.
Operating earnings
In the latest 124-page report, Buffett states that most shareholders would look only at the page which contains net earnings.
For the years ended 2023, 2022 and 2021, Berkshire reported net earnings of $96 billion, ($23 billion) and $90 billion respectively. Buffett explains the 2022 loss by taking a dig at the regulators and auditors.
He states that “you seek guidance and are told that the procedures for calculating these ‘earnings’ are promulgated by a sober and credentialed Financial Accounting Standards Board (FASB), mandated by a dedicated and hard-working Securities and Exchange Commission (SEC) and audited by the world-class professionals at Deloitte & Touche (D&T).”
He goes on to state that the audit report pulls no punches in stating that “In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company and the results of its operations for each of the three years in the period ended December 31, 2023.” So sanctified, this worse-than-useless “net income” figure quickly gets transmitted throughout the world via the internet and media.
Per the formula adopted by Buffett and Munger, operating earnings for the years ended 2023, 2022 and 2021 were $37.4 billion, $30.9 billion and $27.6 billion. The primary difference between the two sets of numbers was that the operating earnings calculated by the duo excluded unrealised capital gains and losses.
On some days, the unrealised capital gains and losses for Berkshire could cross $5 billion a day. The total losses for 2022 were a staggering $67,899 million. In another place in the newsletter, Buffett states that Berkshire looks only at earnings after providing for interest, taxes and amortization and depreciation and that judging entities only on the basis of EBIDTA is banned in the entire Berkshire group.
The accounting standard that prescribes this treatment for capital gains and losses is ASC 320 (Investments-Debt and Equity Securities) which requires that equity securities with readily determinable fair values and all debt securities be measured at fair value with gains and losses included in earnings.
In the past, Buffett has questioned the requirement of accounting standards mandating amortisation of Intangible Assets over its useful life. He made a distinction between accounting goodwill and economic goodwill.
In India, Ind AS accounting standards are similar to the International Financial Reporting Standards (IFRS). IFRS and US GAAP are almost similar but there are some differences.
Till date, no entity in India seems to have differed from some of the concepts of Ind AS accounting standards.
It is possible that, in the future, some entities could take inspiration from Buffett and develop their own formula to analyse Ind AS financial statements.
The writer is a chartered accountant
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