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Berkshire Hathaway, Inc.

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Table of Contents

Issues............................................................................................................................3

Facts..............................................................................................................................4

Analysis........................................................................................................................5

Conclusions/Recommendations....................................................................................8

Issues:

1.        Warrren Buffet invoked the substance over from concept to justify accounting for the GEICO and General Foods transactions as dividend distributions rather than as sale of stock.  Buffet pointed out that Berkshire’s proportionate interest in those companies’ undistributed earnings since it purchased their stock far exceeded the amount of funds Berkshire received in the stock redemptions.  Buffet also observed that the IRS considers proportionate redemptions to be equivalent to dividend distributions. Do you agree with Buffet that the substance of each of the proportionate redemptions was a dividend and not a sale of stock? Defend your answer.

2.        In deciding how to account for an unusual or unique transaction for financial reporting purposes, should one consider the tax treatment applied to the transaction? Explain.

3.        In 1983, Peat Marwick accepted Berkshires decision to account for the GEICO transaction as a dividend distribution, but then decided the following year that both the GEICO an General Foods transactions should be treated as sales of stock. Did Peat Marwick have a right to change its position on the proper accounting treatment for the stock redemptions? What factor or factors may have been responsible for Peat Marwick’s decision to change its position regarding these transactions?

Facts:

Berkshire Hathaway is a holding company, owning many large and small subsidiaries that do business in a broad range of industries. Among the subsidiaries Berkshire Hathaway owns is the large, well-known insurance company, GEICO. In 1983, GEICO announced plans to purchase several millions shares of its outstanding common stock at a price of $60 per share. Since Berkshire Hathaway is on of GEICO’s largest stockholders, the executives of both companies agree that Berkshire would tender approximately 350,000 of its GEICO shares in the stock buyback plan. This would allow Berkshire to treat the transaction as a proportionate redemption. By treating the transaction as a proportionate redemption, Berkshire would be able to report the proceeds received from the transaction as dividends for federal tax purposes and would be taxed at the effective intercorporate dividend tax rate, which was 6.9% in that taxable year. However, Berkshire also chose to report the proceeds received from the transition as dividend income on its financial statements.

        In 1983 and 1984, Berkshire Hathaway had retained Peat, Marwick, Mitchell & Company as their audit firm. In 1983, Peat Marwick approved Berkshire’s treatment of GEICO transactions proceeds as dividend income on their financials. In 1984, when another company in which Berkshire had significant equity interest in, General Foods, announced a stock buyback plan, Berkshire again structured the sale as a proportionate redemption and decided to report the proceeds as dividend income on its 1984 financial statements. However, in late 1984, the auditors from Peat Marwick told Berkshire executives that the transaction of the General Foods stock redemption should have been reported as sale of stock with the difference between the selling price and the cost reported as capital gains income instead of dividend income. The Peat Marwick auditors also insisted that Berkshire restate its 1983 financials to reflect the 1983 GEICO stock redemption as a sale of stock rather than as dividend income. These changes greatly irritated the Berkshire executives because the new treatment of these transactions was less favorable for financial reporting purposes than the option preferred by Berkshire since it did not allow the proceeds to be reported as income. Treating the transactions as a sale of stock ended up reducing Berkshire Hathaway’s net income by a total of 9% for both years; 1% for the GIECO transaction in 1983 and 8% for the General Foods transaction in 1984.

        In 1984’s annual report, Berkshire’s CEO, Warren Buffet, discussed the GEICO and General Foods stock redemptions at length and disputed Peat Marwick’s contention that the transactions should be treated as sale of stock and not as dividend distribution. However, the stated that he eventually agreed to accept Peat Marwick’s position to avoid having the auditors issue his company a qualified opinion. Due to the disagreements, Berkshire Hathaway dropped Peat Marwick as its auditor and retained Touche & Ross in 1985 to audit their financial statements.

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