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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Warren Buffett and "look-through" earnings

Berkshire Hathaway, the investment holding company of Warren Buffett, reports its “less than 20% ownership" investments according to generally accepted accounting principles. However, it also provides additional disclosures that it terms “look-through" earnings.

Warren Buffett states,

Many of these companies (in the less than 20%-owned category) pay out relatively small proportions of their earnings in dividends. This means that only a small proportion of their earning power is recorded in our own current operating earnings. But, while our reported operating earnings reflect only the dividends received from such companies, our economic well-being is determined by their earnings, not their dividends.

The value to Berkshire Hathaway of retained earnings (of our investees) is not determined by whether we own 100%, 50%, 20%,or 1% of the businesses in which they reside.... Our perspective on such “forgotten-but-not-gone” earnings is simple, the way they are accounted for is of no importance, but their ownership and subsequent utilization is all-important. We care not whether the auditors hear a tree fall in the forest; we do care who owns the tree and what's next done with it.

I believe the best way to think about our earnings is in terms of “look-through” results, calculated as follows. Take $250 million, which is roughly our share of the operating earnings retained by our investees (<20% ownership holdings); subtract... incremental taxes we would hove owed had that $250 million been paid to us in dividends then add the remainder, $220 million, to our reported earnings of $371 million. Thus, our “look-through” earnings were about $590 million. Source: Warren Buffett. The Essays of Warren Buffett lessons for Corporate America, edited by Lawrence A. Cunningham, pp. 180-183 (excerpted)

Write a brief memo to your instructor, explaining look through-earnings and why Mr. Buffet favors look-through earnings.

To determine

Equity investment: Equity investments are stock instruments which claim ownership in the investee company and pay a dividend revenue to the investor company.

Cost method: Cost method is the accounting method used for accounting equity investments which claim less than 20% of the outstanding stock of the investee company.

To draft: A memo explaining the ‘look-through’ earnings, and the reasons why these earnings are favored by Mr. WB

Explanation

Draft a memo explaining the ‘look-through’ earnings, and the reasons why these earnings are favored by Mr. WB.

MEMO

Date:    January 23, 2018

To:    Ms V, Instructor

From:    Ms J

Subject:  Favoring the ‘look-through’ earnings

According to the concept coined and created by Mr. WB, ‘look-through’ earnings are the total profits earned by the investees through the less than 20% ownership investment. These companies pay a part of those profits earned as dividends to the investors and the remaining is plowed back as retained earnings. The look through earnings metric is created by Mr...

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