Berkshire Hathaway Essay

ISSUES warren heel counter invoked the substance- everyplace- diversity conception to disembarrass forecasting for the GEICO and full general Foods exertions as dividends distributions cullably than bar stumbles agreements of personal credit line. Do you bind with blow that the substance of separately of the symmetrical salvations was a dividend and non a sales event of computer memory?In deciding how to name for an unusual or unique doing for fiscal answer foring purposes, should one mean the task daintinessment applied to the achievement?Did Peat Marwick have a right to deviate its position on the proper give out treatment for the wrinkle salvations? What factor or factors whitethorn have been responsible for Peat Marwicks decision to change its position regarding these minutes?FACTSIn 1983, GEICO announced plans to purchase some(prenominal) million sh atomic number 18s of its outstanding common pullulate for $60 per sh atomic number 18. Among G EICOs largest beginningholders was Berkshire Hatha trend, Inc., an investment go with. Executives of the deuce companies decided that Berkshire would tender or so 350,000 if its GEICO sh ars in the birth repurchase plan, which would allow Berkshire to treat the relations as a per capita redemption. In a per capita redemption, the division equity reside of on federation in a second family is maintained at the level that existed instantly in the beginning the transaction. For federal taxation purposes, the getting even received by the investor club in a proportionate redemption are taxed as dividends by applying the effective intercorporate dividend tax rate. In 1983, that tax rate was approximately 6.9 percent.Berkshire also chose to treat the proceeds from the redemption of the GEICO stock as dividend income in its 1983 fiscal statements. Berkshires analyse slopped, Marwick, Mitchell & Company, approved that history treatment. In 1984, an opposite association i n which Berkshire had a significant equity interest, world-wide Foods, announced a stock buyback plan. Again, Berkshire structured the sale of stock to pla kaleary Foods so that the transaction competent as a proportionate redemption. Berkshire also opted to report the proceeds received from planetary Foods as dividend income in its 1984 monetary statements.In easy 1984, representatives of Peat Marwick told Berkshire executives that the proceeds of the superior general Foods stock redemption should non be flip overed dividend income for pecuniary describe purposes. Instead, Peat Marwick maintained that the transaction should be enter as a sale of stock with the difference between the selling footing and cost account as a corking gain on Berkshires income statement. This treatment of the transaction was less lucky for financial reporting purposes that the option preferred by Berkshire since it did non allow the numerate proceeds received from General Foods to be rep orted as revenue. Peat Marwicks tribute annoyed Berkshires executives. The score securelys next decision annoyed those executives even more. Marwick insisted that Berkshire restate its 1983 financial statements to contemplate the GECICO stock redemption as a sale of stock rather than as a dividend distribution.Warren buffet, Berkshires CEO, discussed the GEICO and General Foods stock redemption at space in his conjunctions 1984 yearly report. Buffet disputed Peat Marwicks controversy that the proceeding should be hardened as sales of stock and not as dividend distributions. He then explained why he eventually agree to accept the audit firms position by saying to avoid a qualified attendants opinion, we have take Peat Marwicks 1984 view and re verbalise 1983 accordingly. Buffet as confirmed that Marwicks decision had no effect on Berkshires credit line with GEICO or General Foods, their cash, taxes, and market apprize and tax basis of our holdings all delay the same. However, treating the General Foods transaction as a sale of stock reduced Berkshires 1984 net income by 8 percent. Applying that accountancy treatment to the 1983 GEICO transaction reduced Berkshires previously reported net income for 1983 by 1 percent.The Wall Street ledger reported the disagreement between Berkshireexecutives and Peat Marwick that evolved from the proportionate redemption transactions. When asked to comment on Buffets criticism of Peat Marwick in his companionships 1984 annual report, a Peat Marwick render simply noted, Its the clients right to disagree. Our report speaks for itself. Another prerogative of an audit client is to change auditors. In 1985, Berkshire retained Touche Ross & Company to audit its financial statements. As required by the Securities and convince Commission, Berkshire filed an 8-K statement with that federal agency to get out the change in auditors. In that statement, Berkshire reported it was dissatisfy with Peat Marwicks in unani mity regarding the proper invoice treatment for stock redemptions. assurance/ANALYSISThe substance over form story concept means that the scotch substance of transactions and events must be recorded in the financial statements rather than just their legal form in order to present a line up and fair view of the affairs of the entity. Preparers of the financial statements should use their judgment when employing the substance over form concept, which helps to derive the strain maven from the transactions and events and to present them in a manner that best hypothesizes their true essence. In some instances the legal aspects of transactions and events whitethorn have to be disregarded in order to provide more effectual and relevant information to the users of financial statements. The concept of substance over form is unconditional to the representation and reliability of information contained in the financial statements.A proportionate stock redemption is a transaction in wh ich ownership interests are redeemed proportionate to the total shares outstanding. As a result, to separately one shareholder owns the same parting of the company after the redemption as before. Buffet was justified in enter each of the proportionate redemptions as a dividend and not as a sale of stock, because although GEICO and General Foods repurchased their stocks, Berkshire still maintained the same percentage of equity interest as it did before the transaction. Also, Buffet followed federal taxation purposes, which declaredthat the proceeds received by the investor company in a proportionate redemption are taxed as dividends therefore the transaction was recorded as dividends not sale of stock.By placing the responsibility on the preparers of the financial statements to actively consider the economic humanity of transactions and events to be reflected in the financial statements, it will be more ticklish for the preparers to justify the score of transactions in a manne r that does fairly reflect the substance of the situation.According to the PCAOBs AU Section 316.66, the auditor may endure aware of significant transactions that are outside the normal course of business for the entity, or that otherwise appear to be unusual given the auditors intellectual of the entity and its environment. The auditor should gain an disposition of the business rationale for such transactions and whether that rational (or the lack thereof) suggests that the transactions may have been entered into to engage in ambidextrous financial reporting or check misappropriation of assets. (PCAOB, 2002) AU Section 314.21 states that the auditors understanding of the entity and its environment consists of an understanding of several aspects, including industry, regulatory, and other external factors (PCAOB, 2002).Taxation would be an standard of the regulatory aspect therefore, one should consider the tax treatment when deciding how to account for unusual transactions. I n the case of Berkshire Hathaway, Inc., since the IRS considers proportionate redemptions to be equivalent to dividend distributions, and the proceeds from the repurchasing of stock are taxed as dividends to realise consistency, the transaction should have been recorded as dividends.The PCAOB states that the auditor should recognize an adjustment to correct a misstatement in previously issued financial statements to ensure the companys financial statements live consistent in the auditors report, especially if the matter has a significant effect on the financial statements (PCAOB, AU 508.16, 2004). Since Peat Marwick was the auditing firm, it had the right to change its position on the proper report treatment for the stock redemptions, and since Berkshire wanted to preserve the unqualifiedopinion, the company complied with the auditors.In order for Peat Marwick to maintain its reputation as professional auditors and providing quality audits, the firm decided it was in their best interest to record the GEICO and General Foods transactions as sales of stock by Berkshire, rather than as the receipt of dividends. Under this history barbel, a portion of the cost of the Berkshires investment in the stock of each company would be charged against the redemption payment and any gain would be reported as a heavy(p) gain, not as dividend income. This is an accounting approach only, having no bearing on taxes although, Peat Marwick agreed that the transactions were dividends for IRS purposes. Since the change in accounting treatment reduced Berkshires net income by 1% and 8% in 1983 and 1984, respectively, Peat Marwick might have deemed this as material and thought it was necessary to correct the way the transactions were recorded.According to the PCAOB, in evaluating consistency of financial statements, the auditor should evaluate a change in accounting linguistic rule to determine whether the newly adopted accounting principle under GAAP, the method of accounti ng for the effect of the change is in abidance with GAAP, the disclosures related to the accounting change are adequate, and the company has justified that the alternative accounting principle is preferable (PCAOB, AU 508.17A, 2004). whatsoever of these factors may have been responsible for Peat Marwicks decision to change its position regarding these transactions.Although preserve the stock redemption as a dividend complied with taxation rules under the IRS, it may not have been in accordance with GAAP. Berkshire may not have justified that recording the stock redemption as a dividend was preferable. Although it was preferable to Berkshire, because total proceeds from General Foods would have been reported as revenue, change magnitude Berkshires net income it may not have been preferable to all the users of Berkshires financial statements, because net income would have been over stated.Lastly, in Berkshires letter to its shareholders, it stated that the GEICO and General Foods t ransactions were virtually identical, chuck outthat General Foods repurchased its stock over a period of time in the coarse market, whereas GEICO had made a one-shot tender offer. In the General Foods case we sold to the company, on each day that it repurchased shares, but left hand Berkshires ownership percentage unchanged. mayhap this difference triggered Peat Marwick to look back into the stock redemption, where they found discrepancies with the accounting treatments and recommended that Berkshire make adjustments to report the transactions appropriately.RECOMMENDATIONS/CONCLUSIONSAfter Berkshires 1984 audit, the company released Peat, Marwick, Mitchell & Company as its auditing firm. Berkshire reported that it was dissatisfied with Peat Marwicks inconsistency regarding the proper accounting treatment for stock redemption. Corporate non-liquidating distributions to shareholders are usually treated as dividends income however, distributions that delimitate as stock redemptions are treated the same as a sale of stock by the investor to the investee. Therefore, capital gain treatment normally results.Corporate shareholders prefer stock redemptions to be treated as dividend income, because corporate shareholders received the benefits of the dividends, which are allowable and in most cases escape taxation. answer stock redemption results in capital gains that are fully taxable at the corporations highest marginal rate. Warren Buffet employed the substance over form concept while accounting for Berkshires stock redemption transactions. Since the IRS considers proportionate redemptions to be equivalent to dividend distributions and are taxed accordingly, Buffet justified the accounting treatment use to record these truncations.Referenceshttp//www.accountax.us/Taxation-%20Corporations%20Lecture%20V.pdfhttp//www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00314.pdfhttp//pcaobus.org/standards/auditing/pages/au508.aspxhttp//www.berkshirehat haway.com/letters/1984.htmlhttp//pcaobus.org/standards/auditing/pages/au316.aspxau_316.52