The Financial Reporting Council (FRC) has published a statement to confirm that the requirement to present a true and fair view remains of fundamental importance in IFRS and UK GAAP, including the new UK standards FRS 100-103
The statement published by the Financial Reporting Council (FRC) reflects developments in UK GAAP, legal advice on the true and fair requirement obtained and published in October 2013 and feedback from stakeholders seeking clarity as to the primary requirement to present a true and fair view.
In particular, the precedent to the statement was, in October 2013, the confirmation by the Department for Business, Innovation & Skills (BIS) and the FRC that the current legal framework requires the financial statements of companies to present a true and fair view.
The confirmation was issued on the basis of the legal opinion received from Martin Moore QC in response to a divergent legal opinion commissioned earlier in 2013 by a group of major investment funds, who argued that substantial legal flaws in International Financial Reporting Standards (IFRS) result in accounts produced under international standards to be unable to present a true and fair view as required by UK legislation.
BIS and FRC confirmed the legality of IFRS accounts in view of the true and fair requirement in UK legislation, specifically section 393 of Companies Act 2006, as Mr Moore’s opinion confuted the arguments raised by the group of investment funds, and stressed that the overriding objective in preparing financial statements is that of achieving a true and fair view.
A detailed analysis of the issues involved has been published by ACCA.
The new FRC True and Fair document highlights the centrality of the true and fair requirement, and provides guidance on how that is relevant to accounts preparers, those charged with governance and auditors.
Section 393 of the Companies Act 2006 requires that the directors of a company must not approve accounts unless they are satisfied that they give a true and fair view and the FRC clarifies that the introduction of IFRS in the UK did not change such fundamental requirement, even though the routes by which that requirement is embedded may differ slightly.
In particular, concerns were raised on the operation of the true and fair override in IFRS and the absence of the term 'prudence' in the International Accounting Standards Board’s Conceptual Framework.
However, the FRC notes that, while terminology is different under IFRS, the true and fair override requirement still exists in the same substantive form, and the absence of the term 'prudence' in the 2010 Conceptual Framework does not prevent accounts prepared in accordance with IFRS from presenting a true and fair view.
The FRC’s statement points out that the relevance of the true and fair requirement is indicated by the fact that professional judgement should be applied at all stages of accounts preparation, as opposed to mechanically following the accounting standards. For example:
For companies reporting under new UK GAAP, both FRS 102 and company law require that directors make prudent judgements in their consideration of accounts, particularly where there is uncertainty.
For companies applying IFRS, IAS 8 requires that financial statements are prudent and neutral, ie free from bias.
More emphasis is placed under IFRS on neutrality, which is seen as the absence of deliberate manipulation of financial information intended to make its reception by users more or less favourable.
The concern in IFRS is that the use of excessive prudence, resulting in the deliberate understatement of assets or overstatement of liabilities, does not lead to useful information and may be conducive to smoothing of the profits.
However, as part the second phase of its review of the Conceptual Framework, the IASB is now proposing to reintroduce an explicit reference to prudence, though this is not expected to be finalised until 2015.
The FRC statement points out that, in any case, the concept of prudence continues to underlie the preparation of accounts under both UK GAAP and IFRS through, for example, asymmetry in the recognition of profits when compared to losses and the measurement of assets and liabilities where uncertainty exists.
IFRS and new UK GAAP do not contain separate standards that require accounts to reflect the substance of a transaction rather than its legal form where this is different.
However, both frameworks include provisions to report information in accordance with economic substance rather than strictly in adherence with its legal form.
The FRC concludes that it would be difficult for accounts to present a true and fair view if form had overridden substance.
In the majority of cases a true and fair view would be achieved by compliance with the accounting standards as the standards are designed to provide for recognition, measurement, presentation and disclosure for specific aspects of financial reporting in a way that reflects economic reality.
The FRC’s statement, however, clarifies 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 standard. Disagreement with a particular standard does not, on its own, provide grounds for departure from it.
The true and fair override, as noted by the FRC, is enshrined in both FRS 102 and IFRS (specifically IAS 1, Presentation of Financial Statements) which both require departure from the requirements of a specific standard when compliance would conflict with the objective of financial statements.
In response to concerns about the proper operation of the true and fair override under IFRS, the FRC clarifies that, under IAS 1, an accounting policy would conflict with the objective of financial statements 'when it does not represent faithfully the transactions, other events and conditions that it purports to present or could reasonably be expected to represent' and that, where the true and fair override is applied, IAS 1 requires disclosure that the departure from a particular requirement is 'to achieve a fair presentation'.
The FRC therefore concludes that the true and fair override is fully applicable under IFRS and points out that there have been examples of its application under IFRS both inside and outside the UK.
The FRC statement stresses that auditors are legally obliged, under Companies Act 2006, to state, when giving their opinion on a company’s financial statements, whether the accounts, in their opinion, give a true and fair view.
For auditors to discharge their legal and professional responsibilities, It is therefore necessary that they should stand back as they approach finalisation of an audit and consider whether, as a whole and in light of the issues identified during the audit, the accounts do indeed give a true and fair view.
The statement highlights what is expected by the FRC as a result of the clarifications outlined in respect of the true and fair requirement: