Sunday, August 24, 2014

Issue of Whether True and Fair Overrides IFRS May Be Turning into Battle of QCs

The issue of whether IFRS incorporates the concept of a true and fair presentation of a company’s financial statements appears to have taken a turn towards a battle of QC opinions with a U.K., shareholders consortium recently questioning a recent U.K. Financial Reporting Council report reaffirming the opinion that IFRS incorporates the concept of a true and fair presentation of a company’s financial statements. This issue is more than an academic concern in the U.S., which has the fairly presents concept in that financial statements must fairly present the company’s situation. True and fair and fairly presents are both judicially created doctrines: true and fair by Lord Hoffman and Dame Arden and fairly presents by Judge Friendly of the Second Circuit.

U.K. investors and the U.K. Shareholders Association have grave concerns over fault lines in the IFRS used by U.K. listed companies. In their view, the FRC paper fails to respond to whether IFRS delivers a true and fair view as required by U.K. company law. The shareholder and investor consortium urged the government to undertake a robust review of the issue.

In its recent report, the 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 that 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 U.S., the analogous principle is that financial statements must fairly present the company’s financial picture.

In a 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, 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.

Notwithstanding these contributions, the shareholder and investor groups said that the FRC paper failed to provide clarity over what a true and fair view means and, critically, how one knows that it has been achieved. The FRC paper outlines the availability of an IFRS override to achieve a true and fair view, but (in part due to the lack of clarity over the meaning of true and fair) indicates that in practice the override can only be used where accounts fail to comply with the IFRS Framework, rather than Company Law.

Also, the FRC does not mention the opinion of George Bompass, Q.C., despite its significance as a respected legal opinion on the topic. The Bompass opinion states, in part, that it is questionable whether statutory accounts prepared in accord with international accounting standards will always give a true and fair view. Mr. Moore responded to the Bompass opinion, stating that, while he accepts that international accounting standards does not use the direct language that would satisfy Mr. Bompass, there is no reasonable basis for denying the existence of a true and fair account.