A of the History and Meaning of True and Fair - Case Study Example

Will 'Fair presentation' Requirements of IAS1 Undermine the UK's View of 'True and Fair' Introduction During the last decades there have emerged two "competing but not mutually exclusive legal standards" one in 'true and fair view" and the other 'presentation fairly in conformity with Generally Accepted Accounting Principles' (GAAP). These theories have been established for the purpose of reporting the financial status of corporate bodies with the required quality. There have been continuing debates on the meaning, adaptability, and importance of these competing standards. It can be stated that while 'true and fair view' takes its base on judgment of the information and data, the latter view on the financial reporting is purely based on moral standards. Countries like UK, EU, Singapore, Australia, and New Zealand have opted to adopt the 'true and fair view', whereas United States preferred to adopt GAAP standards. (Hopwood, Page, & Turley, 1990) While 'Present fairly in accordance with GAAP' took its origin from the US financial reporting regulations in 1939 (McEnroe & Martens, 1998), UK Companies Act 1947 introduced the concept of 'True and Fair View' for the first time in the UK. (Parker & Nobes, 1994) However the latest version of the International Accounting Standard - 1 (IAS 1) which became operative on or after 1st July 1998 recommends the adoption of both the reporting standards. IAS - 1 requires a fair presentation and disclosure in compliance with the IAS and in cases where there is a misleading element in the compliance to the IAS, the reporting can adopt a limited 'true and fair view' to override the fair presentation. (IAS 1, 1998) This paper examines whether the 'fair presentation' requirements of IAS - 1 undermine the UK's adoption of the view of 'true and fair' in the reporting of the financial statements. Meaning of the Concept of 'True and Fair' View There is no authoritative definition of the term 'true and fair view' and some of the approaches to the definition have considered the concept in relation to the individual components of the terms in isolation. (Cowan, 1965) Chastney (1975) suggests that either of the terms does not presuppose the other and the also doubts whether the combined effect of the term amounts to more than the effect of the individual terms. Parker and Nobes (1991) found that majority of the auditors had made a distinction between both the terms 'true' and 'fair'. They also concluded out of their survey on the UK Directors that most of the directors considered both terms are synonymous. Both the terms 'true' and 'fair' have been defined in a precise and exact manner. "The nature of truth, whether it is absolute or relative, whether it exists as a reality, an incontrovertible thing, or as an abstraction, whether it is dependent or independent of the believer/observer and whether any statement can be proven or merely falsified are all aspects that that have been applied to accounting theory and research." (Covaleski & Dirsmith, 1990; Chua, 1986) Meaning of 'Fairly Presented, In Accordance with GAAP' Just like the terms 'true and fair view' there is no precise definition available of the term present fairly in accordance with GAAP' which can be considered as the American Equivalent of 'true and fair view'. Mano et al (1996) observe that the term may mean: The reports presented fairly and also in accordance with the generally accepted accounting principles and The reports are considered as presented fairly because they have been presented in accordance with the generally accepted accounting principles Mano et al (1996) relied on the 1991 American Institute of Certified Public Accountants' (AICPA) Statement on Auditing Standards (No 69) entitled "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles in the Independent Auditor's Report." In order for an auditor to claim that the financial statements are fairly presented in compliance with the generally accepted accounting principles have to satisfy the following criteria: (1) There is a general acceptance of the accounting principles selected and applied in the presentation (2) The selected and applied principles are considered appropriate to the circumstances (3) It must be ensured that all the elements of financial statements including the notes on accounts are quite informative of matters that may contribute to the use, understanding, and interpretation. (4) The classification and summation of the information presented in the financial statements should be of a reasonable quality implying that the statements should not be too detailed nor too condensed (5) The transactions and events corresponding to the financial position, operating results and cash flows are presented in the form of financial statements which are within a range of acceptable limits. Comparison of 'True and Fair view' and 'Presentation under the GAAP' As described above the criteria suggested by the AICPA considers the financial statements as fairly presented simply because they have been presented in accordance with the GAAP. However it may not be sufficient to define fairness just in terms of GAAP. This is so because of GAAP is constituted on the basis of a large number of estimations. In fact it has been estimated by a writer that mere compliance with the possible interpretations of accounting standards under GAAP, certain facts could be presented over a million versions which would still reflect the GAAP truly. (Cooper, 1966) Moreover a 'true' statement under GAAP is not 'true' in its absolute sense. This is due to the difference between relative and absolute view points of the terms 'truth' and 'fairness'. Meiland and Krausz (1982) suggest that the relative view points would always recognise truth only in relation to individual circumstances, perceptions, and frameworks developed on the basis of such perceptions. Objective viewpoints would advocate the theory that there exists a world out there which is irrefutable. But discovering those facts is an essential prerequisite for assessing the 'trueness' in the matters. But such act of discovering the truth is impossibility in the science of accounting which has a social construction. Hence 'true and fair view' is an absolutely relative term which does not have a precise definition. Therefore the claim by the AICPA that the statements are fairly presented if they adhere to the generally accepted accounting principles does not hold ground. Cowan (1965) while making a comparative study of the UK standard of 'true and fair view' and the US requirement of 'fair presentation' concluded that the both the set of the terms obstruct the ultimate objective of the acts of financial reporting and auditing. The objective of the financial reporting and auditing as perceived by Cowan (1965) is to give the shareholders an opportunity for making an unbiased analysis and appreciation of the real facts concerning; (a) the financial status of the firm in terms of the real resources available and the claims that the firm may have to meet against those resources and (b) the earnings that the firm have amassed utilising the resources throughout the accounting period. The author is of the opinion that these objectives are greatly vitiated by the adoption of both the competing standards of presentation. McEnroe & Martens (1998) on the basis of a study of the UK and US individual investors confirmed that both the UK and US investors preferred the 'true and fair view' to that of the 'presentation under the GAAP. But the preference of the UK investors for the term is more than that of the 'presentation under the GAAP' principle. But when the language for the standard unqualified audit report is prescribed both the groups of investors reacted indifferently to the exact phrases of both 'true and fair view' and 'presentation under the GAAP'. "True and fair view' and 'Presentation under the GAAP' in the UK Context Under sections 226 and 227 of the UK Companies Act 1985, the companies are obligated to prepare accounts in such a way that they present a 'true and fair view' of the state of affairs of the company. This statutory obligation overrides any other obligation to prepare and present the financial statements according to specific requirements of any Act or other prescribed accounting standards. This regulation will be applicable to most of the UK companies for quite sometime in the near future. However in respect of the companies which adopt the usage of IAS whether on a voluntary or compulsory basis the EC's IAS regulations become applicable. These companies do not fall within the scope of s 226 and 227. This change in accounting and reporting under UK regulations on IAS has been incorporated in the Act by an amendment indicating, "IAS accounts should state the notes and accounts have been prepared in accordance with the IAS" The UK regulations have also placed an obligation on the auditors to make a report whether the accounts give a true and fair view in accordance with the applicable financial reporting framework. The International Accounting Standards Board Framework advocate that in general there can be an interchange of both the principles of true and fair view and fair presentation. This concept has been well adopted by the UK and the principle is protected by the UK regulations. Schedule 1 Paragraph 20 (3) to the Regulations has inserted a statement in the Act which reads "References in this Part to accounts giving a "true and fair view" are references in the case of IAS accounts, to the requirement under international accounting standards that such accounts achieve a fair presentation." (The Institute of Chartered Accountants of England and Wales) The above statement does not convey any significant meaning to the assertion and the validity can be determined with certainty only by an interpretation there of by competent courts. Thus the law is very vague on the topic of interrelationship between true and fair view and fair presentation. True and fair Override IAS 1 has given an option of using an override of true and fair view in place of fair presentation under circumstances where there are chances that the fair presentation might prove to convey misleading information. The surveys conducted in UK reveal that around 25 percent of the companies listed adopt the statutory allowance of true and fair override. (Company Reporting June 2004) Out of these instances most of them were used to resolve some kind of a conflict between the Act and the Standards. 10 percent of the cases represent overrides of standards commonly used to reflect the merger accounting for convenience of non-group structuring. Hence it can be assumed that the fair presentation under GAAP has not been met with any overt objections or issues relating to the follow up of the presentation against the principle of true and fair view, since there are no significant override usages. (The Institute of Chartered Accountants of England and Wales) Overrides under IAS are likely to be a rarity as envisaged by paragraph 17 of the IAS 1 meaning that there would virtually be negligible chances for the companies to adopt the practice of override. The paragraph also stipulates that the override should happen only in cases where the compliance with the prescribed standard along with the additional disclosure would not provide a fair presentation to the readers of the financial and other accounting statements. Thus in virtually all circumstances a fair presentation is achieved by compliance with the applicable IFRSs and to this extent the fair presentation requirements of the IAS 1 undermines the 'true and fair view' principle being adopted by UK. (The Institute of Chartered Accountants of England and Wales) Conclusion In view of the above discussion it may be observed that both the true and fair view and fair presentation have not been precisely defined and both are assumed to give a meaning in the context of usage of the terms and the relative perceptions and frameworks. Both the concepts have the same ultimate objective. Therefore there is no question of one undermining the other. However it may be ascertained which concept provides the opportunity of more meaningful analysis from the point of view of the users of the financial statements. This again is a subjective issue where a precise conclusion is not possible to arrive at. But depending on the prevalent circumstance in the UK it can be said that the fair presentation has undermined the true and fair view of UK statutorily because of the vague assertion by the regulations and practically as there is no impact on the companies because of the change in the regime. References: Chastney, J.G. (1975) True and fair view: a study of the history and meaning of true and fair and a consideration of the impact of the fourth directive. A report prepared for the Research Committee of the Institute of Chartered Accountants in England and Wales. Sheffield Polytechnic Chua, W.F. (1986). Radical developments in accounting thought. The Accounting Review, 61 (4), 601-32 Covaleski, M.A. & Dirsmith, M.W. (1990) Dialectic tension, double reflexivity and the everyday accounting researcher: on using qualitative methods Accounting, Organizations & Society, 15 (6), 543-573 Cowan, T.K. (1965). Are truth and fairness generally acceptable Accounting Review, 40 (4), 788-794. Hopwood, A., Page, M., & Turley, S. (1990). Understanding accounting in a changing environment Hertfordshire: Prentice Hall IASC (1998) International Accounting Standard: Presentation of financial statements Author Mano, R.M., Anderson, M., Nycum, V., & McBeth, K. (1996) "Fairly presented, in accordance with GAAP": What does it really mean" Management Accounting, 78 (1), 44-48. McEnroe, J.E. &. Martens, S.C. (1998) Individual investors' perceptions regarding the meaning of US and UK audit report terminology: 'Present fairly in conformity with GAAP' and 'give a true and fair view'. Journal of Business Finance & Accounting, 25(3/4), 289-307 Meiland, J.W. & Krausz, M. (Eds.) (1982) Relativism: cognitive and moral Indiana: University of Notre Dame Press Parker, R.H, & Nobes, C.W. (1994) An international view of true and fair accounting London: Routledge The Institute of Chartered Accountants of England and Wales 'True and Fair under IAS' Read More