Tuesday, June 17, 2014

U.K. Auditor Watchdog Affirms That True and Fair Financial Statement Overrides IFRS and GAAP

The U.K. Financial Reporting Council affirmed that the requirement that audited financial statements give a true and fair account of a company’s operations remains of fundamental importance under both U.K. GAAP and IFRS and the true and fair principle can override the mechanistic application of a particular accounting standard. True and fair is all important, said the FRC, such that where directors and auditors do not believe that following a particular accounting policy will give a true and fair view they are legally required to adopt a more appropriate policy, even if this requires a departure from a particular accounting standard.

In a formal statement, the Council emphasized that in order to properly discharge their legal and professional responsibilities auditors must stand back as they approach finalization of the financial statements and consider whether, viewed as a whole and in view of the issues that they have addressed in the course of the audit, the accounts give a true and fair view. In the US, the analogous principle is that financial statements must fairly present the company’s financial picture.

In the vast majority of cases a true and fair view will be achieved by compliance with accounting standards and by additional disclosure to fully explain an issue, noted the FRC. However, where compliance with an accounting standard would result in accounts being so misleading that they would conflict with the objectives of financial statements, the standard should be overridden.

True and fair is not something that is merely a separate add-on to accounting standards. Rather the whole essence of standards is to provide for recognition, measurement, presentation and disclosure for specific aspects of financial reporting in a way that reflects economic reality and hence that provides a true and fair vision

The FRC noted the concerns of some people that the IFRS requirement that financial statements be useful, coupled with the omission of true and fair in IFRS, means IFRS cannot be overridden in order to present a true and fair view. These concerns are misplaced, said the FRC, because the concepts of usefulness and true and fair are inseparable. For financial statements to be useful, reasoned the FRC, they must present a true and fair view.

The introduction of IFRS in the U.K. did not change the fundamental requirement for accounts to give a true and fair view and the concept remains paramount in the presentation of company financial statements, even though the routes by which that requirement is embedded may differ slightly. 

The true and fair concept has been a part of English law and central to accounting and auditing practice in the U.K. for many decades. There has been no statutory definition of true and fair. The most authoritative statements as to the meaning of true and fair have been legal opinions written by Lord Hoffmann and Dame Mary Arden in 1983 and 1984 and by Dame Mary Arden in 1993.

In a recent report commissioned by the U.K. authorities in light of evolving global standards, Martin Moore Q.C. endorsed the analysis in the opinions of Lord Hoffmann and Dame Arden and confirmed the centrality of the true and fair requirement to the preparation of financial statements in the U.K., whether they are prepared in accordance with international or U.K. accounting standards. In his opinion, Mr. Moore noted that, in relation to the gradual shift over time to more detailed accounting standards, that it does not follow that the preparation of financial statements can now be reduced to a mechanistic process of following the relevant standards without the application of objective professional judgment applied to ensure that those statements give a true and fair view.

Directors must consider whether, taken as a whole, the financial statements that they approve are appropriate. Similarly, auditors are required to exercise professional judgment before expressing an audit opinion. As a result, the Moore Opinion confirms that it will not be sufficient for either directors or auditors to reach such conclusions solely because the financial statements were prepared in accordance with applicable accounting standards.

The Moore Opinion also states that the true and fair view is of an overarching nature. The concept is dynamic, evolving and subject to continuous rebirth. The preparation of financial statements is not a mechanical process where compliance with GAAP or IFRS will automatically ensure that those statements show a true and fair view or a fair presentation of the financial statements. Such compliance may be highly likely to produce such an outcome, but does not guarantee it. Any decision or judgment made by the preparer of financial statements is not made in a vacuum but is made against the requirement to give a true and fair view.