True and fair is a legal need

The Companies Act requires that every balance sheet of a company should give a true and fair view of the state of affairs of the company as at the end of the financial year and every profit and loss of a company should give a true and fair view of the profit or loss of the company for the financial year. Thus, ‘true and fair view’ is a legal requirement. Therefore, it is the Court to decide whether a set of financial statements present the true and fair view of the financial position and performance of the company. In deciding the question, the Court relies on accounting standards and accounting practices adopted by accountants. Compliance with accounting standards is prima facie evidence that financial statements provide true and fair view. A deviation from accounting standards is prima facie evidence that financial statements do not provide true and fair view. However, preparation of financial statements is not a mechanical exercise. In certain rare situations, compliance with accounting standards might distort the true and fair view and results in misleading information. In those situations it is necessary to deviate from the accounting standard.

 

Indian Companies Act specifically provides that every profit and loss account and balance sheet of the company should comply with the accounting standards. Therefore, in those situations when deviation from an accounting standard is necessary, a conflict between the ‘true and fair requirement’ and the requirement for ‘compliance with accounting standards’ arises. In those situations true and fair view requirement overrides the requirement to comply with accounting standards.

The UK Companies Act provides that the principle of ‘true and fair view’ overrides the principle of ‘compliance with accounting standards’. The Indian Companies Act does not provide any guidance on this issue. Some auditors take the view that the requirement of compliance with accounting standards overrides the true and fair view requirement. This argument leads to the conclusion that a company should comply with an accounting standard even if the application of the same distorts the true and fair view. Although this view suits the auditor because that reduces audit risks, it is not acceptable to users of financial statements.

The Companies Act provides that where financial statements do not comply with an accounting standard, the company should disclose the deviation. Presumably, it was visualised that in rare situations deviations from accounting standards might be necessary and therefore, the requirement for disclosure of deviations was incorporated in the companies Act. The Companies Act does not impose any penalty for such a deviation. Therefore, it is appropriate to interpret that true and fair view overrides the requirement of compliance with accounting standards.

IAS-1, which deals with presentation of financial statements, stipulates that in extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements the entity shall depart from that requirement if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure. The objective of financial statement is set out in the ‘Framework for the preparation and presentation of financial statements’ issued by IASB. The objective is “ ...to provide information about the financial position, performance and cash flows of an enterprise that is useful to a wide range of users in making economic decisions”. The objective is achieved only if financial statements provide a true and fair view.

India will have an accounting standard equivalent to IAS-1 in the set of accounting standards fully convergent with IFRS. Therefore, in absence of a prohibition in the Companies Act, the stipulation in IAS-1 will be applicable and companies will be allowed to deviate from accounting standards, if application of the accounting standard results in misleading information.

IFRS and Indian accounting standards are principle based and are not rule based. Implementation of accounting standards requires judgment on how accounting principles and methods should be translated into an appropriate accounting policy. Therefore, evaluation of accounting policy to form an opinion on whether the accounting policy is consistent with the accounting standards is not a straight forward exercise. Auditors should not take a mechanistic approach. Such an approach creates hardship for companies and does not do good to users of financial statements.

Email: asish.bhattacharyya@gmail.com