BEIS responds to Sir Donald Brydon’s recommendation to replace ‘true and fair view’ with ‘present fairly, in all material respects’
James Barbour highlights BEIS’ response to Sir Donald Brydon’s recommendation to replace ‘true and fair view’ with ‘present fairly, in all material respects’.
One of the more surprising recommendations in Sir Donald Brydon’s review into the quality and effectiveness of audit was the proposal to replace the long-standing cornerstone of UK financial reporting ‘true and fair view’ with ‘present fairly, in all material respects’.
The Companies Act 2006 requires that directors must only approve a company’s annual accounts if they are satisfied that they ‘give a true and fair view of the financial position and profit or loss’ for the company and/or the group. Statutory auditors are in turn required to report on whether, in their opinion, the annual accounts give a true and fair view of the company/group’s financial position and profit or loss for the financial year.
Although introduced into UK company legislation in 1947, the meaning of ‘true and fair’ has never been expressly defined. To some, this has been one of its greatest strengths whereas to others this has been cited as a weakness. The Financial Reporting Council (FRC) has obtained various legal opinions in recent years and issued guidance, for directors and auditors, on applying ‘true and fair’ in practice. There is also an overarching requirement in International Financial Reporting Standards (IFRS) for the financial statements to give a fair presentation of financial position and performance. The FRC’s view – as reflected in its guidance and auditor reporting standards – is that the ‘true and fair view’ and ‘fair presentation’ requirements are different articulations of the same test.
The Brydon Review considered that the ‘present fairly, in all material respects’ wording better reflected the purpose now served by financial statements, which typically include a number of forward-looking accounting estimates and judgements and therefore cannot be ‘true’ in a literal sense. The Review considered that the use of the phrase ‘true and fair view’ confuses rather than informs some users of financial statements and audit reports. It also recommended that a new user guide to audit be developed by the regulator, with input from the Plain English Campaign, to explain clearly the meaning of the different elements of an audit report; and that it should be signposted in every Annual Report.
The Government supports developing a new user guide to audit terminology and the FRC has agreed to take this forward, and considers that this is likely to prove more effective in improving user understanding than replacing ‘true and fair’ in financial statements and audit reports with ‘present fairly, in all material respects’. The Government recognises that as well as potentially changing the foundation of UK financial reporting, changing the wording of the legislative test also carries the risk of unintended consequences. In contrast, a new user guide could explain how the true and fair requirement is applied by auditors in practice, making clear that this includes an assessment of whether key accounting estimates and judgements underlying the numbers reported in the financial statements are both reasonable and adequately disclosed. Presumably, this guide would also apply to directors who are responsible for ensuring that the financial statements show a true and fair view and for applying the appropriate accounting framework.
IFRS and UK GAAP are both ‘fair presentation’ financial reporting frameworks which recognise that achieving a fair presentation, or a true and fair view, may require providing disclosures beyond those specified or, exceptionally, departing from a relevant requirement of the framework. Such a departure is referred to as invoking the ‘true and fair override’. It is now very rare in practice for directors or auditors to conclude that meeting the true and fair view requirement necessitates a departure from a requirement of the relevant financial reporting framework. IFRS and FRC guidance both indicate that, while additional disclosures may sometimes be needed, in the majority of cases compliance with the requirements of accounting standards should be consistent with giving a true and fair view.
The Brydon Review considered the ‘true and fair override’ to be a valuable safety valve, requiring both directors and auditors to exercise judgement beyond assessing compliance with the applicable financial reporting framework. It recommended that auditors apply the proposed new Principles of Corporate Auditing in judging the appropriateness of its use or proposed use by directors (which might, in turn, lead to directors giving greater consideration as to whether departing from a requirement of the financial reporting framework is necessary to achieve a true and fair view). The Government agrees that the consideration of ‘true and fair’ needs to go beyond nominal compliance with the financial reporting framework, with the possible need to provide additional disclosures being an important element of this. However, it is not aware of any systemic issues in this respect and believes that the bar for justifying a departure from a requirement of the framework needs to be set at a high level.
In summary, the Government is not minded to confine ‘true and fair’ to the vaults of history. This statement is certainly true (at least at the point of writing), but I will leave to the reader to decide whether the Government’s approach is fair.