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True and fair

The Meaning of 'True and Fair'

The aspect 'true and fair' is one of the most conventional words used in the financial industry now-a-days. It is used to define the prescribed standard of financial reporting but duly 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.

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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.

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'.

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:

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?

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 overriding 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. 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. 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'.

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.

Answer No 2

Materiality, relevance and reliability make financial information useful.

This Statement identifies materiality, relevance and reliability as the primary qualitative characteristics which financial information should possess in order to be the subject of general purpose financial reporting. However, this Statement does not rank either characteristic above the other. For financial information to be relevant it must have value in terms of assisting users in making and evaluating decisions about the allocation of scarce resources and in assessing the rendering of accountability by preparers. If information is to assist users in making decisions about the allocation of scarce resources, it must assist them in making predictions about future situations and informing expectations, and/or it must play a confirmatory role in respect of their past evaluations. The predictive and confirmatory roles of financial information are inter-related. For example, financial information about the current level and structure of asset holdings will have value to users when they endeavour to assess an entity's ability to take advantage of opportunities in the market place. It should also be noted that in that example the preparers of the information relating to asset levels and structures would have needed to make predictions about future cash flows in order to determine appropriate measurements for the assets (for example, the carrying amounts of debtors, inventories and noncurrent assets would need to have been assessed for recoverability). The reliability of financial information will be determined by the degree of correspondence between what that information conveys to users and the underlying transactions and events that have occurred and been measured and displayed. Reliable information will, without bias or undue error, faithfully represent those transactions and events. It is important that financial information be reliable. Information may be of a type which bears upon users' decision-making, that is, be relevant, but be as unreliable in nature or representation as to be useless or potentially misleading. For example, if an entity takes legal action against another entity for damages, and the validity and amount of the claim involved are seriously disputed, it would normally be inappropriate for the plaintiff to recognise prior to judgement an asset for the face value of the claim.

A distinction needs to be drawn between faithful representation of transactions and events and effective representation of them. For example, it is possible to report the historical cost of an asset in a manner that conveys to the user that no attempt is being made to ascribe a current value to it; that it is a dated cost and nothing more. An assessment as to whether the historical cost is the most effective basis of measurement would flow from considerations of the objective of general purpose financial reporting and from the concept of relevance, rather than from considerations of reliability, Unless current values were inherently unreliable .involve the assessment of probabilities and require the exercise of professional judgement. Implicit in those criteria is the concept of reliability. Under a long-term construction contract, for example, Revenues and expenses are to be recognised when certain levels of assurance are reached in respect of stages of completion, estimated costs and estimated proceeds. General purpose financial reporting should, if it is to be reliable, be free from bias (that is, be neutral). It should not be designed to lead users to conclusions that serve particular needs, desires or preconceptions of the preparers. Bias can stem from deliberate Misstatement of financial information for fraudulent purposes and it can also stem from misguided conservatism, resulting in preparers filtering the information provided and thereby usurping the rights of users to make their own decisions. The role of independent audit is important in relation to reliability. In part, the auditor is concerned with ensuring that general purpose financial reports represent what they purport to represent, that their contents are verifiable and that there is an absence of bias. However, the auditor's attention is not confined to reliability, as the auditor must also consider the relevance of what is being reported. The user will also develop an attitude toward the reliability of the general purpose financial reports as a result of the success of past decisions or evaluations.

If financial information is to be both relevant and reliable it is necessary that the substance rather than the form of transactions or events be reported. The concept of relevance indicates the type of information with which general purpose financial reporting should be concerned, and this will not always be consistent with legal or contrived form. The Inclusion of immaterial information in financial reports may well impair their understand ability. The materiality test is concerned with assessing whether omission, Misstatement or non-disclosure of an item of relevant and reliable information could affect decision-making about the allocation of scarce resources by the users of a general purpose financial report of an entity. For example, it may be argued that information about secured non-current liabilities could be expected to be relevant to the decisions of potential lenders and be capable of being reliably determined. However, in a particular entity it could be that total debt is so small in comparison to available collateral that dissection of existing debt between the secured and unsecured portions would be immaterial. The assessment of materiality needs to be carried out not only in relation to individual items but also in relation to classes of similar items. For example, errors in individual items may be immaterial in their own right, but material in aggregate. Although the issuance of an Accounting Standard on a topic indicates to preparers, auditors and others that the type of financial information in question should be presumed to be relevant, those parties still need to assess materiality. For example, Accounting Standards require certain reporting entities to disclose information about their segments. It would be inappropriate for a preparer or auditor to conclude that segmental information is not particularly useful in general, and decide that the Standards do not apply to the reporting entity. Rather, those parties need to assess whether there are distinguishable components of the entity which face significantly different risks or prospects. If those Components exist; they need to be reported in the manner specified in the Standards.