Warren Buffet invoked the substance-over-form construct to warrant accounting for the GEICO and General Foods minutess as dividends distributions instead than gross revenues of stock. Make you hold with Buffet that the substance of each of the proportionate salvations was a dividend and non a sale of stock?

In make up one’s minding how to account for an unusual or alone dealing for fiscal coverage intents. should one see the revenue enhancement intervention applied to the dealing?

Did Peat Marwick have a right to alter its place on the proper accounting intervention for the stock salvations? What factor or factors may hold been responsible for Peat Marwick’s determination to alter its place sing these minutess?

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In 1983. GEICO announced programs to buy several million portions of its outstanding common stock for $ 60 per portion. Among GEICO’s largest shareholders was Berkshire Hathaway. Inc. . an investing company. Executives of the two companies decided that Berkshire would tender about 350. 000 if its GEICO portions in the stock redemption program. which would let Berkshire to handle the dealing as a proportionate salvation. In a proportionate salvation. the per centum equity involvement of on company in a 2nd company is maintained at the degree that existed instantly before the dealing. For federal revenue enhancement intents. the returns received by the investor company in a proportionate salvation are taxed as dividends by using the effectual intercorporate dividend revenue enhancement rate. In 1983. that revenue enhancement rate was about 6. 9 per centum.

Berkshire besides chose to handle the returns from the salvation of the GEICO stock as dividend income in its 1983 fiscal statements. Berkshire’s audit house. Marwick. Mitchell & A ; Company. approved that accounting intervention. In 1984. another company in which Berkshire had a important equity involvement. General Foods. announced a stock redemption program. Again. Berkshire structured the sale of stock to General Foods so that the dealing qualified as a proportionate salvation. Berkshire besides opted to describe the returns received from General Foods as dividend income in its 1984 fiscal statements.

In late 1984. representatives of Peat Marwick told Berkshire executives that the returns of the General Foods stock salvation should non be considered dividend income for fiscal coverage intents. Alternatively. Peat Marwick maintained that the dealing should be recorded as a sale of stock with the difference between the merchandising monetary value and cost reported as a capital addition on Berkshire’s income statement. This intervention of the dealing was less favourable for fiscal coverage intents that the option preferred by Berkshire since it did non let the entire returns received from General Foods to be reported as gross. Peat Marwick’s recommendation annoyed Berkshire’s executives. The accounting firm’s following determination irritated those executives even more. Marwick insisted that Berkshire repeat its 1983 fiscal statements to reflect the GECICO stock salvation as a sale of stock instead than as a dividend distribution.

Warren Buffet. Berkshire’s CEO. discussed the GEICO and General Foods stock salvation at length in his company’s 1984 one-year study. Buffet disputed Peat Marwick’s contention that the minutess should be treated as gross revenues of stock and non as dividend distributions. He so explained why he finally agreed to accept the audit firm’s place by stating “…to avoid a qualified auditor’s sentiment. we have adopted Peat Marwick’s 1984 position and restated 1983 consequently. ” Buffet as confirmed that Marwick’s determination had no consequence on Berkshire’s concern with GEICO or General Foods. their hard currency. revenue enhancements. and market value and revenue enhancement footing of our retentions all remain the same. However. handling the General Foods dealing as a sale of stock reduced Berkshire’s 1984 net income by 8 per centum. Using that accounting intervention to the 1983 GEICO dealing reduced Berkshire’s antecedently reported net income for 1983 by 1 per centum.

The Wall Street Journal reported the dissension between Berkshire executives and Peat Marwick that evolved from the proportionate salvation minutess. When asked to notice on Buffet’s unfavorable judgment of Peat Marwick in his company’s 1984 one-year study. a Peat Marwick spouse merely noted. “It’s the client’s privilege to differ. Our study speaks for itself. ” Another privilege of an audit client is to alter hearers. In 1985. Berkshire retained Touche Ross & A ; Company to scrutinize its fiscal statements. As required by the Securities and Exchange Commission. Berkshire filed an 8-K statement with that federal bureau to unwrap the alteration in hearers. In that statement. Berkshire reported it was “dissatisfied” with Peat Marwick’s incompatibility sing the proper accounting intervention for stock salvations.


The substance over form accounting construct means that the economic substance of minutess and events must be recorded in the fiscal statements instead than merely their legal signifier in order to show a true and just position of the personal businesss of the entity. Preparers of the fiscal statements should utilize their judgement when using the substance over signifier construct. which helps to deduce the concern sense from the minutess and events and to show them in a mode that best reflects their true kernel. In some cases the legal facets of minutess and events may hold to be disregarded in order to supply more utile and relevant information to the users of fiscal statements. The construct of substance over signifier is imperative to the representation and dependability of information contained in the fiscal statements.

A proportionate stock salvation is a dealing in which ownership involvements are redeemed proportionate to the entire portions outstanding. As a consequence. each stockholder owns the same per centum of the company after the salvation as earlier. Buffet was justified in entering each of the proportionate salvations as a dividend and non as a sale of stock. because although GEICO and General Foods repurchased their stocks. Berkshire still maintained the same per centum of equity involvement as it did before the dealing. Besides. Buffet followed federal revenue enhancement intents. which stated that the returns received by the investor company in a proportionate salvation are taxed as dividends ; hence the dealing was recorded as dividends non sale of stock.

By puting the duty on the preparers of the fiscal statements to actively see the economic world of minutess and events to be reflected in the fiscal statements. it will be more hard for the preparers to warrant the accounting of minutess in a mode that does reasonably reflect the substance of the state of affairs.

Harmonizing to the PCAOB’s AU Section 316. 66. “…the hearer may go cognizant of important minutess that are outside the normal class of concern for the entity. or that otherwise look to be unusual given the auditor’s apprehension of the entity and its environment. The hearer should derive an apprehension of the concern principle for such minutess and whether that rational ( or the deficiency thereof ) suggests that the minutess may hold been entered into to prosecute in deceitful fiscal coverage or conceal embezzlement of assets. ” ( PCAOB. 2002 ) AU Section 314. 21 provinces that the auditors’ apprehension of the entity and its environment consists of an apprehension of several facets. including industry. regulative. and other external factors ( PCAOB. 2002 ) .

Tax would be an illustration of the regulative facet ; hence. one should see the revenue enhancement intervention when make up one’s minding how to account for unusual minutess. In the instance of Berkshire Hathaway. Inc. . since the IRS considers proportionate salvations to be tantamount to dividend distributions. and the returns from the repurchasing of stock are taxed as dividends ; to guarantee consistence. the dealing should hold been recorded as dividends.

The PCAOB provinces that the hearer should acknowledge an accommodation to rectify a misstatement in antecedently issued fiscal statements to guarantee the company’s fiscal statements remain consistent in the auditor’s study. particularly if the affair has a material consequence on the fiscal statements ( PCAOB. AU 508. 16. 2004 ) . Since Peat Marwick was the auditing house. it had the right to alter its place on the proper accounting intervention for the stock salvations. and since Berkshire wanted to continue the unqualified sentiment. the company complied with the hearers.

In order for Peat Marwick to keep its repute as professional hearers and supplying quality audits. the house decided it was in their best involvement to enter the GEICO and General Foods minutess as gross revenues of stock by Berkshire. instead than as the reception of dividends. Under this accounting attack. a part of the cost of the Berkshire’s investing in the stock of each company would be charged against the salvation payment and any addition would be reported as a capital addition. non as dividend income. This is an accounting attack merely. holding no bearing on revenue enhancements ; although. Peat Marwick agreed that the minutess were dividends for IRS intents. Since the alteration in accounting intervention reduced Berkshire’s net income by 1 % and 8 % in 1983 and 1984. severally. Peat Marwick might hold deemed this as stuff and thought it was necessary to rectify the manner the minutess were recorded.

Harmonizing to the PCAOB. in measuring consistence of fiscal statements. the hearer should measure a alteration in accounting rule to find whether: the freshly adopted accounting rule under GAAP. the method of accounting for the consequence of the alteration is in conformance with GAAP. the revelations related to the accounting alteration are equal. and the company has justified that the alternate accounting rule is preferred ( PCAOB. AU 508. 17A. 2004 ) . Any of these factors may hold been responsible for Peat Marwick’s determination to alter its place sing these minutess.

Although entering the stock salvation as a dividend complied with revenue enhancement regulations under the IRS. it may non hold been in conformity with GAAP. Berkshire may non hold justified that entering the stock salvation as a dividend was preferred. Although it was preferred to Berkshire. because entire returns from General Foods would hold been reported as gross. increasing Berkshire’s net income ; it may non hold been preferred to all the users of Berkshire’s fiscal statements. because net income would hold been over stated.

Last. in Berkshire’s missive to its stockholders. it stated that the GEICO and General Foods minutess were “virtually” indistinguishable. except that General Foods repurchased its stock over a period of clip in the unfastened market. whereas GEICO had made a “one-shot” stamp offer. In the General Foods instance we sold to the company. on each twenty-four hours that it repurchased portions. but left Berkshire’s ownership per centum unchanged. Possibly this difference triggered Peat Marwick to look back into the stock salvation. where they found disagreements with the accounting interventions and recommended that Berkshire make accommodations to describe the minutess suitably.


After Berkshire’s 1984 audit. the company released Peat. Marwick. Mitchell & A ; Company as its auditing house. Berkshire reported that it was “dissatisfied” with Peat Marwick’s incompatibility sing the proper accounting intervention for stock salvation. Corporate non-liquidating distributions to stockholders are normally treated as dividends income ; nevertheless. distributions that qualify as stock salvations are treated the same as a sale of stock by the investor to the investee. Therefore. capital addition intervention usually consequences.

Corporate stockholders prefer stock salvations to be treated as dividend income. because corporate stockholders received the benefits of the dividends. which are deductible and in most instances escape revenue enhancement. Qualifying stock salvation consequences in capital additions that are to the full nonexempt at the corporation’s highest fringy rate. Warren Buffet employed the substance over signifier construct while accounting for Berkshire’s stock salvation minutess. Since the IRS considers proportionate salvations to be tantamount to dividend distributions and are taxed consequently. Buffet justified the accounting intervention used to enter these shortnesss.


hypertext transfer protocol: //www. accountax. us/Taxation- % 20Corporations % 20Lecture % 20V. pdf

hypertext transfer protocol: //www. aicpa. org/Research/Standards/AuditAttest/DownloadableDocuments/AU-00314. pdf

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hypertext transfer protocol: //www. berkshirehathaway. com/letters/1984. hypertext markup language

hypertext transfer protocol: //pcaobus. org/standards/auditing/pages/au316. aspx # au_316. 52


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