The treatment of unrealised gains and losses under a recent update to the U.S Accounting Standards could lead to erratic results for companies operating under Generally Accepted Accounting Principles (GAAP), according to A.M. Best.
Accounting Standards Update 2016-01, issued by the Financial Accounting Standards Board (FASB) in January 2016, requires companies to record net unrealised capital gains and losses on equity holdings directly within the statement of income for results after December 15, 2017.
This requirement is regardless of holding intent (e.g. for trading or available-for-sale) and represents a shift away from the previous treatment of recording unrealised results for available-for-sale equites as part of Accumulated Other Comprehensive Income (AOCI) within the equity section of the balance sheet.
Whilst this development does not affect the actual economic reality of companies, the higher profile of unrealised gains and losses may result in seemingly erratic income statements, affecting items such as loan covenants, compensation, and general investor awareness.
A.M. Best said that this volatility was reflected, for example, in the 2018 results of Berkshire Hathaway, whose Chairman, Warren Buffett, has referred to the new accounting treatment as a “nightmare” that would produce “truly wild and capricious swings.”
Without the impact of ASU 2016-01 Berkshire would have recorded net earnings of $6.6 billion for the first quarter of 2018, but due to a $7.7 billion net unrealised loss on equity holdings, the company posted a net loss of $1.1 billion.
In contrast, Berkshire’s results ‘seesawed’ at Q2 when a $5.6 billion unrealised gain on equity securities almost doubled its net income, A.M. Best noted.
