1999: How should goodwill be accounted for?

AUDIENCE MEMBER: I’m Liam O’Connor (PH). I come from County Kerry in Ireland. And I must admit the sun shines a little bit more over here than it does on the other side of the world.

I was wondering, today, if you could shed some light on accounting for goodwill.

You reference in your report, in several aspects, including your principles — owner principles — and as well as the fact — with the current merger of General Re.

It seems to me there are several different methods that are used worldwide, through amortization, to direct write-off.

And the fact, when a merger like this is taken, it kind of skews the balance sheet. And I was wondering, in your view, what would you recommend as a more appropriate method for accounting for goodwill?

And secondly, if I could direct it to Charlie, one of the ideas — why not tie goodwill to the share price and have an intangible and a tangible part of shareholder’s equity, the intangible piece being the difference between the book value and the share value of a company?

WARREN BUFFETT: OK, I’ll take the first part. And it’s a good question about goodwill and the treatment of goodwill for accounting purposes.

I actually wrote on that subject. I think it was in 1983 in the annual report. And if you click onto to the berkshirehathaway.com you can look at the older letters. And you will see a discussion of what I think should be the way goodwill is handled. And then we’ve discussed it at various other times in the Owner’s Manual.

To give it to you briefly, in the U.K., for example, goodwill is written off instantly so it never appears in book value. And there’s no subsequent charge for it.

If I were setting the accounting rules, I would treat all acquisitions as purchases — which is what we’ve done, virtually, without exception at Berkshire — I would treat all acquisitions as purchases.

I would set up the economic goodwill, because we are paying for goodwill when we buy a General Re. I mean, we are playing billions and billions of dollars for it. Or when we buy a GEICO or when we buy an Executive Jet. That is what we are buying, is economic — what I call economic goodwill.

I believe it should stay on the balance sheet as reflective of the money you’ve laid out to buy it. But I don’t think it should be amortized. I think in cases where it is permanently impaired and clear that it’s lost its value, it should be charged off at that time.

But generally speaking — in our own case, the economic goodwill that we now have far exceeds the amount that we put on the books originally. And therefore, even by a great amount, exceeds the amount that remains on the books after amortization.

I do not think an amortization charge is inappropriate — is appropriate — at Berkshire for the goodwill that we have attached to the — our businesses. Most of those businesses have increased their economic goodwill — in some cases, by dramatic amounts — since we’ve purchased them.

But I think the cost ought to be on the balance sheet. It’s what we — it shows what we paid for them. I think it should be recorded there.

I don’t think that the coming change in accounting is likely to be along the lines that I’ve suggested here. But I do think it’s the most rational way to approach the problem.

And I think that because there is this great difference between purchase and pooling accounting, that some really stupid things are done in the corporate world.

And I have talked to managers who deplored the fact that they were using their stock in a deal and going through some — various maneuvers to get pooling accounting because they thought it was economically a dumb thing to do.

But they did it, rather than record amortization charges that would result from purchase accounting. And, you know, they’re very frank about that in private. They don’t say as much as about it in public.

Charlie?

CHARLIE MUNGER: Yeah, generally speaking, I think that what Warren argues for would be the best system.

Namely, set up the goodwill as an asset and don’t amortize it in the ordinary case.

Or there would be plenty of cases when — the cases wouldn’t be ordinary cases when amortization would be rational and, in fact, should be required.

So, I don’t think there is any one easy answer to this one. And there’s a lot of crazy distortion in corporate practice because of all the changes.

I mean, Australia has cowboy accounting. And Europe has this write-it-all-off-immediately accounting, which is — what would you call it? — half-cowboy accounting. And maybe mining promoter accounting.

We think the system should be better than that.