International Standards on Auditing (ISAs) make it quite clear that the terms ‘true and fair’ and ‘present fairly’ which are used in audit reports in many other countries, mean the same thing. There is no definition of either term in legislation or standards anywhere. Although both have existed for a long time.
IAS 1 (revised) Presentation of Financial Statements states that financial statements should ‘present fairly’ the financial position, performance and cash flows of and enterprise and goes on to state that financial statements prepared in accordance with IASs (with additional disclosures if necessary) will generally result in fair presentation. The ‘true and fair’ override, as used in the UK, that allows any accounting standard to be departed from, in the interest of giving a true and fair view, is only to be applied on ‘extremely rare circumstances’.
The term true and fair was first used in the UK, where it originates, in legislation of 1948. However, prior legislation had used similar phrases.
Companies legislation dated 1844 required UK companies to present a full and fairbalance sheet, though the meaning of this phrase was never defined. A company was required to keep full and true accounts. By 1900 the auditor was required to state whether the balance sheet was properly drawn up so as to exhibit a true and correct view. This phrase was retained until 1948.
The Kenya Companies Act Cap 486 is based on the UK Companies Act of 1948
At no stage has any legal definition of the meaning of these terms been provided. ISAs does not set out what is meant by either ‘true and fair’ or ‘present fairly’.
Attempts at definition of the ‘true and fair’ view
The following quotations represent authoritative views on the meaning of true and fair view.
A true and fair view implies that all statutory and other information is not only available but is presented in a form in which it can be properly and readily appreciated. (Sir Russell Kettle).
A true and fair view implies appropriate classification and grouping of items .. (and) consistent application of generally accepted principles. (The Institute of Chartered Accountants in Australia – Recommended on Accounting Principles 1964).
… the meaning attached to (the words true and fair) has been built up over the years by standards of presentation specifically required by the Act; established accounting techniques; case law decisions; the natural desire of responsible directors of companies and auditors to ensure that the facts and figures which are presented in the public properly reflect the position; and last but not least common sense. (Sir Henry Benson 1962).
For an auditor to be able to say that a financial statement is true and fair it must be:
- Relevant to the business transactions etc it purports to describe
- Objective, being free from any bias … and being based on unprejudiced and verifiable evidence which us capable of supporting it (Lee).
… true and fair has become a term of art. It is generally understood to mean a presentation of accounts drawn up according to accepted accounting principles using accurate figures as far as possible and reasonable estimates otherwise, and arranging them so as to be show within the limits of current accounting practice as objective a picture as possible free from willful bias, distortion, manipulation or concealment of material facts. (Lee).
It must be concluded that there has been little attempt precisely to define true and fair.
The Companies Act requires an auditor to report in true and fair view terms as regards the balance sheet and the profit and loss account. The Companies Act however, does not define what constitutes a true and fair view. We have no decided case in Kenya or anywhere in the world that has given a definition of true and fair view.
It has therefore been left to the profession to try to define the meaning of true and fair view or at least to determine what not a true and fair view is. The Companies Act in the 6th Schedule gives the minimum disclosure requirements of items in the balance sheet and profit and loss account. It would therefore seem to follow that compliance with the requirements of the 6th Schedule, would result in the accounts giving a true and fair view.
Professional thinking has tried to put a meaning to this expression by analysing the two words separately. If we took this approach we would come up with the following decision:
Meaning of ‘true and fair’/present fairly’
Truth in accounting is quite different form scientific truth. Accounting does not deal with that type of truth which has a fixed and unchanging quality. Costs and revenues for any accounting period which is less than the full life of each venture involved cannot be determined with precision. In accounting only cash draws close to the concept of scientific truth, but since the value of cash changes with time, it lacks total correspondence with the precision of scientific truth.
The auditor should attempt to ensure that the accounts which are subject of his audit present clearly and equitably the financial state of affairs of the enterprise. This suggests that in order to achieve the statutory true and fair view it is necessary not only to present certain information impartially but also that this data is shown in such a way that it is clearly understood by the user.
A dictionary definition of true includes such words as:
• In accordance with reality;
• In accordance with reason, or correct numbers or perceived standard;
• We can also think of truth as meaning: not false, or not fictitious and in accordance with facts.
We can clearly identify that accounts contain elements of truth in that if the balance sheet states that the company has got land and buildings valued at 10 million shillings then it is either true or not true that the company owns the land. Therefore statements made in the accounts can be tested to prove whether they are true of false. In this case, we are concerned with ownership of assets and liabilities, we are concerned with their existence and we are concerned with their proper definition or description and classification. Hence the auditor looks for evidence to confirm stated and implied assertions in the accounts. True does not relate to value because value is dependent on many factors.
The word fair can have the following meanings: on the one hand clear, distinct and plain and on the other impartial,just and equitable. All can be considered relevant when fair is used in an accounting text
We ask ourselves the questions—fair to whom? And it seems that we should be fair to the user of the accounts in that the user of the accounts has certain expectations. He expects that accounts will comply with the Companies Act requirements and he also expects that the accounts will conform to generally accepted accounting principles and the IAS, hence if we can satisfy the expectations of the user it can be felt that we have been fair. This therefore leads us to relevance, in other words, the accounts must give a view that is relevant to the needs of the user. It will therefore be expected that the accounts will show the resources employed in the company, claims against those resources, the changes in the resources and claims over a period of time. The accounts also report on historical events. They are therefore not intended to be used for decision making although they are regularly used for this purpose.
Most accounting figures are subjective and contain substantial elements of subjective judgement. Many business transactions have financial effects that spread over many years. Decisions are therefore to be made, as to the extent to which expenditure incurred in one year can reasonably be expected to produce benefits in the form of revenue in other years. Objectivity therefore requires that accounts state externally verifiable changes rather than subjectively considered opinions. The accounts must therefore be free from bias, thus the producer of the accounts should not allow personal preferences to enter into their accounts preparation work. In practice, all activities are influenced by personal experience and prejudice. An important thing is for the auditor to be aware of this and also for him to be aware of the tendency to bias in all financial reporting.
Although the user of the accounts expects the accounts to conform to general accepted accounting principles and the IFRSs, simple rigid conformity can lead to a misleading view. Thus if we simply included profits from overseas branches and those profits are not available to shareholders because of exchange control restrictions, then the accounts would be misleading.
The concept of prudence is highly esteemed in the accounting profession. However, taken to extremes it could result in accounts not giving a true and fair view as in the case of long term construction contracts, contingent liabilities and in substance over form transactions. The accountant is a pessimist by nature but the auditor must guard against over conservatism.
Accounting Principles and Policies
The user of the accounts expects that the accounting principles and policies used will be in conformity with IAS, be generally accepted, be widely recognised and supported and be appropriate and applicable in the particular circumstances. It is crucial for the auditor to get evidence that the accounting policies used are appropriate in the circumstances, not only acceptable.
Substance over Form
Transaction should show the commercial reality rather than the legal form. These would require therefore that the accounts should show all the assets and liabilities of the organization even though legally the assets or liabilities do not relate to the organization.
Presentation and Disclosure
The overall result and final position can only be appreciated by aggregating transactions and balances into suitable classes and categories. The description given to these classes and categories must show their true nature.
An item is material if its disclosure or non-disclosure would make any difference to the view received by the user of the accounts. Fairness is therefore a function of materiality. The accounts must not be cluttered with trivialities or amounts and statements that are insignificant to the overall view given by the accounts. The auditor has to keep the concept of materiality in mind at all times.