In his 1988 Berkshire Hathaway Annual Letter, Warren Buffett argues that some companies view Generally Accepted Accounting Principles (GAAP) as guidelines to be creatively interpreted, rather than strict rules. This can lead to misleading financial statements and even fraud. Investors and creditors who rely on GAAP figures are vulnerable to such manipulation. Buffett has observed many large accounting scandals with little punishment for the perpetrators. Here’s an excerpt from the letter:
Further complicating the problem is the fact that many managements view GAAP not as a standard to be met, but as an obstacle to overcome.
Too often their accountants willingly assist them. (“How much,” says the client, “is two plus two?” Replies the cooperative accountant, “What number did you have in mind?”) Even honest and well-intentioned managements sometimes stretch GAAP a bit in order to present figures they think will more appropriately describe their performance.
Both the smoothing of earnings and the “big bath” quarter are “white lie” techniques employed by otherwise upright managements.
Then there are managers who actively use GAAP to deceive and defraud. They know that many investors and creditors accept GAAP results as gospel. So these charlatans interpret the rules “imaginatively” and record business transactions in ways that technically comply with GAAP but actually display an economic illusion to the world.
As long as investors—including supposedly sophisticated institutions—place fancy valuations on reported “earnings” that march steadily upward, you can be sure that some managers and promoters will exploit GAAP to produce such numbers, no matter what the truth may be.
Over the years, Charlie and I have observed many accounting-based frauds of staggering size. Few of the perpetrators have been punished; many have not even been censured. It has been far safer to steal large sums with a pen than small sums with a gun.
You can read the entire letter here:
Berkshire Hathaway 1988 Annual Letter
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