GAAP Rule Change (2018)

Core Definition

In 2018, a new Generally Accepted Accounting Principles (GAAP) rule—specifically ASU 2016-01—went into effect. It required companies holding equity securities to include the unrealized gains and losses of those investment portfolios in their "bottom-line" net income every quarter.

Buffett's Critique

In the 2018 Letter, Warren Buffett fiercely criticized this new rule. Because Berkshire Hathaway holds a massive equity portfolio (worth nearly $173 billion at the end of 2018), this rule change caused Berkshire's quarterly net income to swing wildly by tens of billions of dollars based purely on the stock market's daily fluctuations.

For example, in 2018:

• First quarter: $1.1 billion GAAP loss
• Second quarter: $12 billion GAAP profit
• Third quarter: $18.5 billion GAAP profit
• Fourth quarter: $25.4 billion GAAP loss

Buffett argued that these "yo-yo" swings in the bottom line are "totally capricious" and make the net income figure almost entirely useless for analyzing Berkshire's actual operating performance.

Strategic Application

To counteract this accounting distortion, Buffett urged shareholders to focus on Berkshire's operating earnings (which exclude these unrealized capital gains and losses) to understand the true performance of the underlying businesses. He warned that commentators who simply report the bottom-line GAAP figure without explaining this distortion are doing a massive disservice to investors.

🔗 Connections

• Related Concepts: Accounting Earnings vs Economic Earnings, Owner Earnings, Look-Through Earnings, Forest vs Trees
• Sources: 2018 Letter, 2018 Meeting