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The Meaning Of ‘True and Fair’
The expression ‘true and fair’ is one of the most common expressions used in
the financial industry today. It is used to describe the required standard of financial
reporting but equally to justify decisions, which require a certain amount of arbitrary
judgement making. It is the principle that is used in guidelines ranging from auditing
and financial standards to the company law acts.
The term originated …
The aim of the financial statements is to report to the shareholders on the
financial position at the year-end, and the performance of the company over the year.
They are also important for tax computations, for management decisions and
quotations from lending institutions. Thus, it can clearly be seen why independence
and objectivity are important in the statements. Thus, some kind of measure is needed.
A true and fair view is one of the bedrock principles of preparing financial
information. This can be linked back to the four basic concepts on presenting this
information: going concern, accruals (matching), consistency, and prudence. As
stated in Financial Accounting (Arnold, Hope, Southworth and Kirkham; 1994, p56):
…without some form of standardised accounting treatment of financial transactions, it
would be very difficult for a user of accounts to compare the performance of an
organisation either through time or with the performance of other organisations.
This is very similar to The Statement Of Principles for Financial Reporting (SOP,
1999) and Chapter 3, which details The Qualitative Characteristics Of Financial
Information: relevance, reliable, comparability, understandable.
But how can the accountant be sure that the statements show a true and fair
view, especially when there is no precise definition. There are many definitions and
explanations in the Statement of Principles, but they are qualitative rather than
specific measurements. Elliot & Elliot (1997, p189) offer the following explanation:
‘true and fair is a legal concept and can only be authoritatively decided by a court’.
They do give some specific attributes: Authority: all transactions are official and above board.
Accurate: all information provided is accurate, e.g. sales invoices give full details of
vat, discount, and amounts payable
Complete: there should be no missing dockets in the accounting system.
If the accounts hold the above qualities, they are likely to give a true picture.
However, there has to be some inherent risk in financial reporting. It is not possible
to be one hundred percent certain that the above qualities are complete, only a certain
amount of sampling can be done by the auditor:
Although valuation practice is well established in the case of equity and asset values,
it is historically the case that much less attention has been focused on the valuation of
liabilities. (Lonergan, 1998)
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This obviously questions the truth and fairness of the accounts, and displays the
problems with arbitrary judgements. But can we expect the accountant to chase after
every last euro in a multimillion-euro company? On the other side of things it must be
recognised that immaterial items can add up to a substantial material item, and so the
accountant should take reasonable care. Does one small error mean that the accounts
don’t show a ‘true and fair’ view?
This argument follows on to the social responsibility of the accountant. Is he
reporting on the financial performance of the organisation, or is he advising the
shareholders that their investment is safe, the employees that their jobs are safe, the
public that they are better off with the business in their area and the product or service
being produced. A true and fair view of the business as a whole may suggest this to
the reasonable man, but case law suggests the liability of the accountant/auditor is to
produce the financial statements, provide for any future liabilities and to produce a
health and safety report. To hold the accountant liable for the slightest of errors is to
give him unlimited liability, even for the work of others.
Estimation & Presentation
Global harmonisation of accounting standards will be hard to come by,
judging by the diverse range of businesses and their interpretation of accounting
standards under the ASB based on the ‘true and fair’ formula:
It would be dangerous to claim that the UK's proposals or practices are 'right', and it
would be absolutely absurd to claim that what is the best compromise for the UK is
automatically the best compromise for everybody else. (Alexander, 1998)
The ASB has formulated guidelines, however they are persuasive in Ireland
rather than obligatory as the following case details on Conflict in Financial
Reporting: The Case of Coillte ( McBride, 1997, p75):
This is an interesting case on the over riding principle of true and fair.
Coillte are in the business of looking after the natural forestry of the country. Each
year they valued their forest assets and capitalised the increase in capital in the asset
account and a ‘growth in capital’ account credit. When the timber product was sold
the profit was recognised by ‘total sales income minus historic cost’ as the directors
saw the profit as the increase in shareholder wealth, that is the amount recovered over
and about planting and maintenance costs. This was obviously against the
recommendations of the ASB and with the introduction of FRS3 in 1993, it clearly
stating that a gain in the appreciation in value of an asset should be recognised in the
balance sheet and in the statement of total recognised gains and losses. This gain
should not be recognised again on the sale of the asset. However, the directors argued
that this would mean that the only profit shown would be the increase in capital in the
year of sale. Even after the UITF reviewed the situation and issued a reviewed ED for
companies with slowly maturing assets, Coillte maintained its format and the ICAI
failed to intervene.
The author then explains this:
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‘There is no information excluded that otherwise would have been reported under the
FRS 3 policy. Disclosure is not the issue.’
Therefore, how the information is presented can be persuasive, not just that it
was omitted entirely. The ASB recognises (SOP, 1999, page 10) that:
The presentation of information in financial statements involves a high degree of
interpretation, simplification, abstraction and aggregation.
Thus the issue comes down to what is the ‘true and fair’ nature of events as judged by
the directors and the auditors. Unfortunately consensus can be almost impossible to
come by:
Preparers need to take a far more active role in standard-setting. Only when preparers
express their views, presumably based on a need to communicate better with
shareholders, will accounting standards begin to improve. (Chisman, 1998)
Materiality & Risk
SAS 220 states (page 2): ‘ a matter is material if its omission would
reasonably influence the decisions of an addressee of the auditors’ report. Likewise a
misstatement is material if it would have a similar influence’.
This is the auditors’ code; those who are responsible for assessing the statements in
light of the ‘true and fair’ doctrine. Elsewhere in this standard it is stated:
‘auditors plan and perform the audit to be able to provide reasonable assurance that
the financial statements are free from material misstatement and give a true and fair
view’. (SAS 220, 1995, p2)
In carrying out their duties they are required to test whether proper books of
account have been kept, the financial statements agree with the books of account, all
information and explanations have been received from directors, whether a financial
situation exists, if consolidated accounts agree with group accounts, produce a health
and safety report, check to see if directors’ report is consistent with financial
statements. The auditing standards are built on reasonableness, based on the inherent
and control risks of the organisation. (Companies Acts, Auditor’s Engagement Letter).
It is not a precise science; instead it is based on objective and subjective
judgements depending on the familiarity with the organisation. The Company Acts
put the responsibility of preparing the accounts on the directors. These can be
manipulated in many ways, the more experience management has the easier it is for
them to hide transactions. There are inherent risks in each accounting system, or there
might not be a system of control at all so detection of fraud is almost impossible.
Limited sampling means the auditor can only be ‘reasonably happy’ with the accounts
and if he is, his opinion will be that they give a ‘true and fair’ view.
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Contrary to this Lewis & Pendrill (2000, p191) suggest, ‘if the accountant digs deep
enough the reality of the transaction will emerge.’
However, examining every transaction is not practical. In a large company the scope
is immense, in a small company the resources are not there. If marginal cost is greater
than marginal benefit, chances are it’s not worth checking,
A true and fair view is not a guarantee, but an opinion, as SAS 300 (1995,
p13), para 50 states:
‘audit evidence is generally persuasive rather than conclusive, some detection risk is
usually present even if they [auditors] examine all evidence available of an account
balance or an entire class of transactions’
Balance Sheet Snap-Shot
In drawing up the financial statements, the accountant is providing the
shareholder with a snapshot of the company at a particular date; the balance sheet
does not show the variations in the past, or the events that may occur in the future.
The accounts show the value of the company on a particular date based on
information currently available, by looking at the value of its assets and liabilities. A
perfectly healthy company can have the bottom knocked out of the market by adverse
publicity of its type of product or service, e.g. mobile phones and the health risks
involved. Is it up to the accountant to provide for every conceivable liability that may
occur in the future, such as the chance of getting sued at some time?
In drawing up FRSs and SSAPs the ASB has tried to give financial statements
a larger but definite scope. Cash Flow Statements give the aggregate cash inflows and
outflows of the company over the year and makes them comparable with the previous
year (FRS1). Earnings per share allow comparison on a level playing field with other
companies and the same company over different accounting periods (FRS14).
Contingencies and Provisions adjusted the accounts for future events based on the
‘probability’ of occurrence as the best economic estimate of cash flows (FRS 12).
Post Balance Sheet Events adjust the accounts for changes in the assets or liabilities
that existed at the balance sheet date when new information came to light later on that
changed their value at this date (SSAP17).
It is obvious that these statements are aids to the ‘true and fair’ doctrine, but
there is no such thing as a guaranteed ‘sound investment’.
Substance Over Form
The Accounting Standards Board uses the said definition as frequently, yet it too fails
to define it.
FRS5, Substance over form, page 4, paragraph b states in relation to complex
transactions:
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The true commercial effect of such transactions may not be adequately expressed by
their legal form and, where this is the case, it will not be sufficient to account for them
merely by recording that form
This is the issue of disclosure not being enough, but giving the shareholder a true
interpretation of the commercial effect. Exceptional items:
‘should be separately disclosed by way of note, or where it is necessary in order that
the financial statements give a true and fair view, on the face of the profit and loss
account’(FRS3, 19xx, pxx).
Prudence has long been argued to be the overriding concept, but it should not be
misleading as is the case with long-term contracts (SSAP9. 1988, p5):
to defer recording turnover and taking profit into account until completion may result
in the profit and loss account reflecting not so much a fair view of the results of the
activity of the company during the year, but rather the results relating to contracts that
have been completed in the year’
While there is no definite meaning in the Companies Acts of Ireland for ‘true
and fair’ it is used when describing directors’ responsibility in preparing accounts and
the auditor’s responsibility of reporting an opinion on them. The 1986 Act Section 3
and SAS 140 also let directors deviate from legal requirements if it will give a more
true and fair view in the interest of shareholders:
‘…departure is required in order for the financial statements to give a true and fair
view’ (SAS 140, 1995, p8)
However, this departure must be clearly disclosed in the accounts and in the notes;
otherwise the move would be counterproductive (EU Fourth Directive, Art 2(5)).
In The Introduction To The Statement Of Principles for Financial Reporting,
on page 4 it states: ‘The concept of a true and fair view is fundamental to the whole
system of financial reporting and represents the ultimate test of financial statements.’
Accounting standards and regulated procedures aid a true and fair view. What
constitutes a true and fair view in any given situation is, however, open to
interpretation. There is no universal agreement as to its nature and meaning or on how
it is to be achieved in practice. A true and fair view seems to relate how easily the
user can understand the real substance of the transaction. By its very nature, user
knowledge is very diverse, so a precise balance cannot be struck. But even if the
knowledge is fully interpreted, changing circumstances can mean that information at
the balance sheet date is out of date. A true and fair view is an idealistic aim for
preparers of financial statements to strive for.
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References
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ARTICLES
FRS1: Cash Flow Statements, Revised 1996
FRS3: Reporting Financial Performance, 1992
FRS5: Reporting The Substance Of Transactions, 1994
FRS 12: Provisions, Contingent Liabilities and Contingent Assets, 1998
FRS 14: Earnings Per Share, 1998
SSAP9: Stocks & Long-Term Contracts, 1988
SSAP17: Accounting For Post Balance Sheet Events, 1980
SAS140: Engagement Letters, 1995
SAS220: Materiality And The Audit, 1995
SAS300: Accounting And Internal Control Systems And Audit Risk Assessment,
1995
- The Irish Companies Act 1986
- McBride, Hugh, “Conflict in Financial Reporting: The Case Of Coillte”, The Irish
Accounting Review, Volume 4, No.2, p70, Autumn 1997
- Lonergan, Wayne, “The True and Fair Value of Liabilities”, Charter, Volume 69,
No. 8, 1998 (Web Database)
- Chisman, Neil, “The Politics of the True and Fair View”, Accountancy, London,
Volume 122, No. 1261, 1998 (Web Database)
- Alexander, David, “True and fair: The European Perspective”, Accountancy,
Volume 121, No. 1258, London, June 1998 (Web Database)
- Accounting Standards Board, “Introduction To The Statement of Principles for
Financial Reporting”, 1999.
BOOK REFERENCES
- Elliot, Barry and Elliot, Jamie; Financial Accounting & Reporting, 1997, Prentice
Hall
- Glautier, Mw and Underdown, B; Accounting Theory & Practice, 1994, London:
Pitman
- Arnold, John; Hope, Tony; Southworth, Alan; and Kirkham, Linda; Financial
Accounting, 1994, Prentice Hall
- Lewis, R; & Pendrill, D; Advanced Financial Accounting, 2000, Financial
Times/Prentice Hall
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