Every number in a financial statement is somebody's opinion — accounting is a language, and languages can be used to obscure as easily as to reveal.
"I think you should… every time you see the word EBITDA, you should substitute the word 'bullshit' earnings."
GAAP leaves genuine judgment calls — depreciation schedules, revenue timing, reserve estimates.
Management leans toward whichever judgment call flatters this quarter's numbers.
The headline figures look fine while the footnotes tell a very different story.
Enron used special purpose entities and mark-to-market accounting to keep debt off its balance sheet and inflate reported earnings. The scheme unraveled in late 2001, leading to bankruptcy and the collapse of its auditor, Arthur Andersen — one of the most studied accounting frauds in modern history.
WorldCom improperly recorded billions of dollars in routine operating expenses as capital expenditures, spreading costs over years instead of recognizing them immediately, artificially inflating reported profit. The fraud, exposed in 2002, remains a textbook case of how a single accounting choice can distort an entire company's earnings.
For years, companies could grant employee stock options without recording the cost as an expense on the income statement. Munger and Buffett were vocal, early advocates for expensing options, arguing this understated real compensation costs, until accounting rules changed under FAS 123R in the mid-2000s.
Read the footnotes before the headline numbers — that's where the real assumptions live.
Compare reported net income to actual cash flow from operations over several years.
Treat "adjusted" or "non-GAAP" earnings as a claim to verify, not a fact to accept.
Look for changes in accounting policy or estimates that conveniently flatter the current period.
Check related-party transactions and off-balance-sheet arrangements for hidden obligations.
Note how management is compensated — it shapes which numbers get emphasized.
Munger's core idea: financial statements are not a photograph of reality — they are a translation of it, and like any translation, something is always lost, exaggerated, or quietly left out.