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Thread: I hate GAAP.

  1. #1

    Default I hate GAAP.

    Recording unrealized gains on long-term derivatives, lolz

    Reading this man's biography has made me interested in this company he runs, but I hate GAAP. Because it's dumb and often misleading due to depreciation and cash flow and stuff. It's a screwy system where declining cash balances can result in substantial paper-profits, which are then horrible next quarter becaus you can't move any of your garbage.

    Kind of unrelated to Berkshire, but they have to report their derivatives gains and losses which is misleading to a lot of people and obfuscates the true profitability of the company. ACCOUNTANTS AND OTHER COOL PEOPLE SOUND OFF.

    Everyone else, maybe not.

  2. #2

    Default

    In all fairness to GAAP, US, UK and otherwise, it was never really designed to deal with the rediculous complexity of financial instruments like derivatives. The IFRS made a reasonable stab at it in IAS39, but it all hinges on measuring the fair value of these instruments, which is impossible unless you can measure their risk. And as we have seen in recent years, when they are as widely traded as they are, gaining a full measure of counterparty risk exposure requires a Nobel Prize in mathematics. I'm of the view that many derivatives shouldn't be regulated - they should just be wholesale banned. I'm a little surprised that Buffet is trafficking in them - did he not once declare derivatives to be "financial weapons of mass destruction"?

  3. #3

    Default



    Quote Originally Posted by Akastus View Post
    In all fairness to GAAP, US, UK and otherwise, it was never really designed to deal with the rediculous complexity of financial instruments like derivatives. The IFRS made a reasonable stab at it in IAS39, but it all hinges on measuring the fair value of these instruments, which is impossible unless you can measure their risk. And as we have seen in recent years, when they are as widely traded as they are, gaining a full measure of counterparty risk exposure requires a Nobel Prize in mathematics. I'm of the view that many derivatives shouldn't be regulated - they should just be wholesale banned. I'm a little surprised that Buffet is trafficking in them - did he not once declare derivatives to be "financial weapons of mass destruction"?
    Yeah, but Berkshire's derivatives aren't the same type that helped blow up the world economy over the past few years. They're basically just very-long-term LEAP calls on the world's major stock indices. Your point is a valid one, but does not address the impact of inaccurate depreciation schedules, substantial inventory build-up which is then slow to be written down when it can't be sold and other such items that can cause substantial disparities between a company's "earnings" and cash flow. Sometimes, I think we'd be better off ditching accrual accounting altogether in favor of a cash basis method. Why have accrual accounting at all when it's often more inaccurate, despite its best efforts?
    Last edited by KTH; 27-Feb-2011 at 18:07. Reason: Indices, not exchanges.

  4. #4

    Default

    Because cash accounting is equally inaccurate, if not more so. Cash accounting provides no basis for assessing financial performance or position at all. It elevates the bank balance to the be all and end all of accounting. If you invalidate the concept of depreciation, then you end up having such massive swings between years, due to capital investment/disposal, that you cannot evaluate long-term trends.

  5. #5

    Default

    Yeah, but what does a business run on? It's cash, not whatever paper profits they're reporting. Take a look at homebuilders in the United States over the past couple of years; they've reported massive losses, but (in most cases) have generated enough cash to stay alive. Why'd they generate losses? Because their inventory wasn't worth what was said on the books, but the sales still generated cash flow.

    Is cash accounting inaccurate? Sure, but I'd argue it's a hell of a lot harder to play games with the income statement with that method, and results would even out over the course of a year or two. Earnings would be a lot lumpier, though, obviously.

    I wouldn't advocate going from accrual accounting to cash accounting - notice the "sometimes" in my prior post. But I am fed up with accrual accounting's inaccuracy in general, and thank God that in the U.S., companies are now required to publish their cash flow statements; believe it or not, they weren't forced to until 1987 (and often didn't).

  6. #6

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    The practical reality is that in order to gain a true picture of any company, you need far more information than it is practical to publish. And trying to distill the activities of an an ongoing entity into single-year snapshots is inherently flawed. There will always be ways to game the system, which is why I have always favoured a principles-based approach to accounting, rather than a prescriptive code.

  7. #7

    Default



    Quote Originally Posted by Akastus View Post
    The practical reality is that in order to gain a true picture of any company, you need far more information than it is practical to publish. And trying to distill the activities of an an ongoing entity into single-year snapshots is inherently flawed. There will always be ways to game the system, which is why I have always favoured a principles-based approach to accounting, rather than a prescriptive code.
    Well, yeah, obviously you need more than just the financial statements to evaluate a company. I have to wonder, though, aren't you concerned that principles-based accounting makes it more difficult to compare companies for investors? That's a pretty big concern, in my opinion.

  8. #8

    Default

    Given that different companies have differing abilities and inclinations to exploit the loopholes in rule-based accounting systems, I don't really see that it makes a great deal of difference. In practise, you can get just as much consistency in a principles-based system, if you enforce it. And I don't believe that facilitating investment decisions is the primary purpose of financial accounting. I hold that is to allow those who have already made a long-term investment decision to assess the performance of their investment. I make no secret of the fact that I have little patience with short-term investors.

  9. #9

    Default



    Quote Originally Posted by Akastus View Post
    Given that different companies have differing abilities and inclinations to exploit the loopholes in rule-based accounting systems, I don't really see that it makes a great deal of difference. In practise, you can get just as much consistency in a principles-based system, if you enforce it. And I don't believe that facilitating investment decisions is the primary purpose of financial accounting. I hold that is to allow those who have already made a long-term investment decision to assess the performance of their investment. I make no secret of the fact that I have little patience with short-term investors.
    I'll have to disagree with you, there. How could a person know whether they wanted to make an investment in a company or not without adequate information and the ability to compare a company to its competitors? Even long-term investors usually want to liquidate their investment at some point, and prospective investors need to be able to understand the company just as well as current investors do. Even if you discount the value of an investor being able to sell her stake, to not have that be the case would be to impair a company's ability to raise additional capital for a new plant, equipment, warehouse, capacity expansion, or whatever, because investors would be less willing to invest their money due to being in a situation where they were at a substantial informational disadvantage.

  10. #10

    Default

    By examining the company very closely before making a decision? I should probably be more specific. I have little patience with the entire concept of a public limited company. I do not approve of publically traded shares that can be exchanged at a moments notice. To me, an investment is a a very long-term committment, rewarded through dividends, not capital appreciation. An investment that can be so easily liquidated isn't an investment at all. A company that has a genuinely strong business model shouldn't need to issue shares left, right and centre, to find investors. I wouldn't object to a little (or a lot) more caution in investment decisions. It would make for less volatility, in my mind. I dispute the assumption that it should be easy to raise capital.

    While I believe passionately in free markets, I am not a fan of modern capitalism. Personally, I think that the whole concept of limited liability is the biggest moral hazard ever created.

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