Literature Review On True And Fair View In Financial Reporting

The True and Fair View Concept and its Application

Discuss about the Literature Review on True and Fair View.

The ‘true and fair view’ (TFV) concept whose origin can be traced back at least to the Joint Stock Companies Registration and Regulation Act of 1844 (UK), that required preparation of ‘full and fair’ balance sheets is still integral to corporate financial reporting regimes in the UK and many other English speaking countries of the world. It evolved as a device for curtailing the unscrupulous activities of corporate opportunists that impeded the efficient functioning of corporate capitalism – a modern western European phenomenon which originated in the sixteenth century and was exported to the rest of the world by political colonialism and economic empire-building (Zeff, 2016). Since the issuance of the European Community’s Fourth Directive in July 1978, this concept has also been extended to the nations of the European Economic Community5 and more recently adopted by the Nordic countries as well.6 Notwithstanding the widespread application of this term, its interpretation has been the subject of dispute between accountants and lawyers ever since it was formally introduced by the Companies Act 1948 (UK) and the purpose served by it remains unclear. In Australia, the TFV concept has been in the companies’ legislation since the Victorian Companies Act of 1890.8 Following the amendments to the Corporations Law 1989 emanating from the Corporate Law Economic Reform Program 1997-1998; however, its status has been subordinated by the Australian accounting standards. The Corporations Act 2001 (Cth) now makes compliance with accounting standards mandatory (s296) and the TFV requirement is to be satisfied through the notes, only if necessary (s297). In addition, the statutory provisions of the Corporations Act 2001 (Cth) (previously referred to as the Corporations Law) that supported the TFV requirement (old s294 and Schedule 5) have also been repealed.

The ‘true and fair view’ concept is one of two competing but not mutually exclusive legal or professional standards for financial reporting quality that have been subject to debate on their meaning, use and importance. The other is ‘present fairly in accordance with generally accepted accounting principles. While the former is closely identified with judgment and is used in the European Union, Singapore, Australia, and New Zealand, the latter is the standard for United States financial reporting and tends to be more rules based. The ‘true and fair view’ legal requirement either overrides other financial reporting requirements (EU3 and Singapore) or is additional (Australia and New Zealand). Australia has similar colonial roots and tended to follow the U.K. example, especially in early legislation (Man & Ciurea, 2016). However, both countries appear to be moving away from ‘true and fair’ as a literal concept to a more technical meaning that also requires compliance with a set of rules included a schedule of rules for auditing and accounting, together with the overriding requirement for a ‘true and fair view’. However, the Companies Act 1993, in conjunction with the Financial Reporting Act 1993, requires financial statements that comply with generally accepted accounting principles (GAAP) with an additional requirement of ‘true and fair view’. Prior to the passing of the 1993 Acts, it was suggested that companies could use the legislative power of ‘true and fair view’ to avoid complying with GAAP. It is claimed that the 1993 legislation effectively removed this option for companies that are reporting entities. Thus the ‘true and fair view’ rule is no longer overriding, but co-exists with GAAP in that, while complying with GAAP is a legal requirement, directors still have the obligation to provide additional information to ensure that the financial reports represent substance as well as form. Following a diverging path from U.K. influences, the scholars also uses the terms ‘fairly reflect’ and ‘fair presentation’ and states that the terms are equivalent. This may possibly signal a move away from ‘true and fair view’ towards the U.S.A. requirement for ‘fair presentation’.

TFV and Other Standards of Financial Reporting Quality

The mainly prescriptive literature suggests that countries that require compliance with ‘true and fair view’ tend to address and interpret the concept according to country-specific historical, social, cultural, legal, political and economic roots and environments. This has been confirmed by earlier empirical research. Thus the concept has been described as a formula for international disharmony and as ‘an exercise in dehumanization’. Yet the ‘disharmony’ may not be confined to different national cultures, but may include within-country groups. If terms such as ‘true and fair view’ and ‘present fairly’ have different meanings for different participants in financial accounting, they may contribute to an expectations gap. This gap is defined here as the difference between the perceptions and expectations users have of general purpose financial statements’ quality and meaning, and the quality and meaning of general purpose financial statements the accounting profession prepares and audits. Nobes (2015) describes this succinctly as the gap between what financial statements mean and what many non-accountants think they mean. Although the ‘audit expectation gap’ has been extensively researched, the financial reporting gap has the potential to be more extensive and more misleading to users. The audit gap arises from differing interpretations of an auditor’s role, whereas the financial reporting gap may exist because of a persistent lack of ‘truth’ in GAAP itself or from a gap in perceptions of standards for financial reporting quality held by financial statement users, preparers and auditors The ‘true and fair view’ concept has not been authoritatively defined. Some approaches to definition consider ‘true and fair view’ in relationship to its individual components. The scholars raise the question of whether the terms true and fair together amount to more than their separate parts and suggests neither presupposes the other. Although Nobes and Parker’s’ 1991 survey of U.K. auditors concluded that the majority of auditors distinguished between the terms ‘true’ and ‘fair’, their 1991 survey of U.K. directors found most saw ‘true and fair view’ as a hendiadys. () found Australian directors also did not distinguish between true and fair. Tracing the ‘true and fair view’ concept’s history in Australia, Parker (1994) concluded that the term had become an exercise in deharmonisation between Australia and the U.K. Scholars came to a similar conclusion when they compared the U.K. findings of Nobes and Parker (1991) on auditor perceptions with those of an Australian study. As reported by () the survey of Australian auditors found, in contrast to Nobes and Parker’s U.K. findings, that only 7 per cent of Australian auditors as opposed to 80 per cent (U.K.) distinguished true from fair. Piketty and Ganser (2014) saw this difference as evidence that the attitudes to ‘true and fair view’ in the two countries differed as a result of accounting practices drawing apart, con- firming the cultural and contextual nature of accounting. Giordano-Spring, Martinez and Vidal (2015), found that, like their Australian counterparts, most New Zealand auditors also saw true and fair as a hendiadys. This result is also consistent with much of the descriptive literature.

The Expectations Gap and Misleading Accounts

In the US we have recently witnessed the collapses of Enron and WorldCom. In Australia we have had HIH, One.Tel and Harris Scarfe. While there has been a tendency to blame the auditors, these disasters have not been caused by auditing practices. Bad management is inevitably a root cause. But misleading accounts serve to exacerbate the destruction, with investors buying and selling on the stock exchange unaware of what the accounts are failing to disclose (Denoncourt, 2015). Something is seriously wrong when the financial statements of apparently healthy but, in reality, doomed companies have largely complied with the demands of accounting standards.

The Corporations Act 2001 requires that financial reports of Australian public companies to both comply with accounting standards and give “a true and fair view” of the financial position and performance of the company. If there is a conflict between the two requirements, then the true and fair view must be reflected through further information incorporated in the notes to the accounts. The explanatory memorandum which accompanied the 1998 amendments to the Corporations Law, inserting a reference, for the first time, to “the financial position and performance of the company”, stated that this approach was viewed as being consistent with “information that is relevant to the assessment of performance, financial position and financing and investing” (Edwards, 2013). A move to market value and economically realistic accounting, through a “mark to market” approach, is necessary to give such a true and fair view. Some say that this would bring in too much subjectivity and too much judgement and ought therefore to be categorically rejected.

There is no agreement or authoritative court judgments on what true and fair view means. The requirement is to give a true and fair view – not the true and fair view, so that there may be a range of acceptable views in any given case. But just because we cannot find a one size fits all definition doesn’t mean that we are entitled to render the concept totally devoid of content and therefore useless. Whether or not mark to market accounting is adopted, it is beyond argument that in many cases compliance with accounting standards can and does produce grotesque and misleading accounts that in no way comply with the true and fair view requirement (Giordano-Spring, Martinez & Vidal, 2015). It’s clear from recent evidence that, in practice, those who audit our companies either don’t understand, or, more alarmingly, choose to ignore their legally mandated obligations to do just that.

Conclusion

The ability to sidestep such crucial legislative requirements is made possible by the fact that the ASIC either cannot, or will not, enforce the law. The ASIC believes it would be a very heavy burden to require every board of directors to separately enquire whether any set of accounts which complies with accounting standards also reflects a true and fair view. Yet the assumption of this burden is a legal requirement. In failing to enforce the law, the ASIC is suggesting that it is never possible to demonstrate that directors did not take all reasonable steps to comply with the true and fair view requirement (Lee, 2015). Australia is not alone, and certainly not the worst offender. Until recently in the US heavy reliance has been placed on accounting standards, there having been no requirement to provide a true and fair view. Using as an example aircraft market prices pre – and post – September 11, 2001, Walter Schuetze, the former chief accountant of the Securities and Exchange Commission, highlighted the problems with the US approach in his testimony to a Senate committee earlier this year.

Pre – September 11, the major airlines, to the extent that they own aircraft instead of leasing them, had, on their balance sheets, aircraft at the cost of acquiring them. Post – September 11, the market prices of each aircraft fell about 50 per cent – say from $100 million to $50 million. Yet, under the US rules, those airlines continue to report each aircraft on their balance sheets at $100 million. Under mark to market accounting, he claims, each aircraft would be reported on the balance sheets at its real value of $50 million. It is no wonder, given recent events that the law in the US has recently changed to require CEOs and CFOs to certify, in effect, their belief that the company’s accounts are true and fair. The real challenge for all of us now is to persuade directors, auditors and the ASIC to better understand what the law requires and to encourage the ASIC to take appropriate steps to enforce it (Maynard, 2013). The current debate highlights just how poorly served the investing public is by auditors. In other markets, we have focus groups to ensure that the customer’s needs are targeted and satisfied. In the securities market the investor is the customer. But, in this market, unlike any other, the customer continues to be patronised by the arcane world of auditing practices, and doubly so because of the ASIC’s failure to police accounts according to legislative requirements. 

Reference List and Bibliography

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Denoncourt, J. A. (2015). Patent-backed debt finance: should company law take the lead to provide a” true and fair” view of SME patent assets? (Doctoral dissertation, University of Nottingham).

Edwards, J. R. (2013). A History of Financial Accounting (RLE Accounting) (Vol. 29). Routledge.

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Giordano-Spring, S., Martinez, I., & Vidal, O. (2015). Historical Cost vs. Fair Value to Measure INCOME in Accounting. Comptabilité-Contrôle-Audit, 21(3), 119-148.

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Maynard, J. (2013). Financial accounting, reporting, and analysis. Oxford University Press.

Nobes, C. (2015). IFRS Ten Years on: Has the IASB Imposed Extensive Use of Fair Value? Has the EU Learnt to Love IFRS? And Does the Use of Fair Value make IFRS Illegal in the EU?. Accounting in Europe, 12(2), 153-170.

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