true and fair view
by Roderick Ramage, solicitor, www.law-office.co.uk
first published in New Law Journal (www.newlawjournal.co.uk) on 27 October 2017
This article is not advice to any person and may not be taken as a definitive statement of the law in general or in any particular case. The author does not accept any responsibility for anything that any person does or does not do as a result of reading it.
The Companies Act 2006, s393(1), reads: ‘The directors of a company must not approve accounts for the purposes of this Chapter unless they are satisfied that they give a true and fair view of the assets, liabilities, financial position and profit or loss …’.
What meaning should the law give to the expression “true and fair”?
A starting point for the interpretation of statutes is at 332 in Macarthys Ltd v Smith  3 All ER 325:
‘As the meaning of the words [Equal Pay Act 1970, s1(1) and (2)] is clear, and no ambiguity, whether patent or latent, lurks within them, under our rules for the construction of Acts of Parliament the statutory intention must be found within those words’
Two differing means of finding the meaning of the words “true and fair view” are these.
The Shorter OED
True: ‘Consistent with fact; agreeing with reality; representing the thing as it is.’.
Fair: ‘Free from bias, fraud, or injustice; equitable, legitimate’.
View: ‘A particular manner of way of considering or regarding a matter or question; a conception opinion or theory formed by reflection or theory. An aspect or light in which something is regarded or considered.’
The joint opinion of Leonard Hoffman QC and Mary H Arden (as they both then were)
The joint opinion of 13 September 1988 was given to the Accounting Standards Committee, now the Accounting Standards Board ((“ASC” and “ASB”)
True and fair view:
‘The courts have never attempted to define “true and fair” in the sense of offering a paraphrase in other languages and in our opinion have been wise not to do so. When a concept can be expressed in ordinary English words, we do not think that it illuminates their meaning to attempt to frame a definition.’
‘…because accountants are professionally obliged to comply with a SSAP [Statement of Standard Accounting Practice], it creates in the readers an expectation that the accounts will be in conformity with the prescribed standards. This is in itself a reason why accounts which depart from the standard without adequate justification or explanation may be held not to be true and fair.’
In short, they say that the words have their ordinary meaning, but accounts which are not in accordance with the accounting standards are prime facie not true and fair.
This opinion is the first of a series of opinions, of which those addressed to the ASB broadly confirm the original joint opinion. The prevailing practices of accountants, informed by the above and subsequent opinions, was questioned by George Bompas QC in his opinion of March 2013 addressed to the UK Shareholders’ Association, in which he concluded that there is a tension between the requirements of the International Accounting Standards and the statutory true and fair obligation. The controversy continues and can be followed in the opinions available at the following link.
These are learned opinion by highly regarded counsel, in comparison to which this article consists of merely the simple thoughts of a solicitor on the Clapham omnibus.
Of these two, it is not the unadorned dictionary meaning of a true and fair view that companies follow, but the meaning that accountants give those words with the support of the support of the Hoffman/Arden and later opinions.
I illustrate the difference between these approaches to the meaning of true and fair by two examples, the first looking at the reasoning of the joint opinion, based on historic cost accounting and the second the effect of the accounting standards in their treatment of pension schemes in company accounts.
example 1 : current or historic cost accounting
Paragraph 2 of the joint opinion explained, as background, that the ASC had decided that future standards would deal with matters of ‘major and fundamental importance’ but that standards would continue to apply ‘to all accounts intended to show a true and fair view’. This paragraph concluded with the writers’ understanding of the ASC’s opinion expressed as follows.
A SSAP is therefore a declaration by the ASC, on behalf of its constituent professional bodies, that save in exceptional circumstances accounts which do not comply with the standard will not give a true and fair view.
In paragraph 8, which appears to be the heart of the joint opinion, the writers say that, in judging whether accounts give a true and fair view, the courts would look to the ordinary practices of accountants, and that
‘Accounts will not be true and fair unless the information they contain is sufficient in quantity and quality to satisfy the reasonable expectations of the readers to whom they are addressed.’
They concluded in this paragraph that ‘the expectations of the readers will have been moulded by the practices of accountants because by a large they will expect get what they ordinarily get and that in turn will depend upon the normal practices of accountants.’
In other words, the courts can be expected to decide that accounts are true and fair if they reflect users’ expectations based on what accountants tell them to expect.
Paragraph 10 of the joint opinion contains the following passage in support of the expectations argument in paragraph 8.
The importance of expectations was emphasised by the Court of Appeal in what may be regarded as a converse case, Re Press Caps  Ch.434. An ordinary historic cost balance sheet was said to be "true and fair" notwithstanding that it gave no information about the current value of freehold properties because, it was said, no one familiar with accounting conventions would expect it to include such information.
Re Press Caps Ltd was about a share scheme under s209 of the Companies Act 1948 (Power to acquire shares of shareholders dissenting from scheme or contract approved by a majority, re-enacted in the CA 1985 s428 and repealed by the CA 2006). A minority shareholder claimed that the terms of the scheme were unfair on the ground that the balance sheet value of the company’s freehold property was shown at £23,708, which was its cost less depreciation plus a small addition, whereas its market value was about £90,000. The scheme was based on a valuation of the shares in excess of their market value on the Stock Exchange value, and the court held that it was right to base the scheme on the Stock Exchange value. Moreover, obiter, the balance sheet showed patents and goodwill at £45,115, while the evidence showed they were worth nothing like that.
The point however is that balance sheet values were considered solely in in relation to the question, following re Hoare & Co Ltd  150 LT 374, whether share scheme was unfair. The court did not in any way, directly or indirectly consider the directors’ duty to produce accounts that gave a true and fair view (then in the Companies Act 1948, s149). Nor did the court give any support to the arguments in the joint opinion that the accounts should show the accounts in the way (in this case the historic cost basis) that reflected the expectation of the users of accounts.
The nearest that the court came to this point, was the finding that,
this figure in the balance sheet in accordance with what is very common practice does not appear (emphasis added) as a valuation of the property as at the date of the balance sheet, but is cost less depreciation. Therefore, it does not seem to me that there is anything misleading about it.
The point here had nothing to do with s149, but solely that, in this context, the amount in the balance sheet did not purport to be a valuation and that the dissenting member’s argument based the balance sheet failed to show that the scheme was unfair.
example 2 : accounting for defined benefit pension schemes
In this explanation, I assume that the pension scheme is a final salary or other defined benefit scheme and that, as is the case for most of these schemes, it is in deficit.
Shareholders and managers of companies, lenders and other people dealing with them and pension scheme members need the following information about a company and its pension scheme:
first whether the company, as long as it continues in business, can afford to fund the scheme sufficiently to enable it to meet its liabilities as and when they become payable and to continue to do so for the whole, or at least the foreseeable, life of the scheme; and
secondly whether, if a debt under s75 of the Pensions Act 1995, becomes payable (typically when the company becomes insolvent and the pension scheme must be wound up or one employer in a multi-employer scheme ceases to be an employer in relation to the scheme) and members’ benefits must be fully secured with an insurance company, the company will have sufficient assets to discharge the debt.
If the meaning of “fair and true” were governed by the ordinary meaning of the words, a company’s accounts would provide the above information. However, accounts prepared in accordance with the present accounting standards, which are in FRS 102 (Financial Reporting Standards issued by the Financial Reporting Council in September 2015) do not attempt or even pretend to provide this information.
Instead, FRS 102 requires the company to show (a) in its balance sheet the value of the scheme’s liabilities, calculated on a specified actuarial basis, less the market value of the scheme’s assets and (b) in the P&L account (or income statement) the cost of the scheme as, mainly, the change in the deficit since the previous year end plus interest on the deficit for the year.
Not only do accounts drawn in accordance with FRS 102 fail to give information that people need, but they are misleading in at least following ways.
1. The deficit is shown as a liability in the balance sheet. A normal lay (and legal) understanding of a liability is that it is something that the company must pay, now or in the future, but the company cannot in any circumstances be liable to pay the FRS deficit. It is not a debt, ie it is not “real”, but is a mathematical calculation based on assumptions of future interest rates, investment returns, longevity etc. The only normally liability on the employer is to pay contributions.
2. If the scheme is to be wound up, the amount to be paid to secure the scheme’s liabilities will be a “real” amount, because money must be paid to an insurance company to secure member’s benefits; and the amount to be paid is almost certainly to be very much higher than the deficit calculated under FRS102.
3. The cost to be shown in the P&L account is the difference between the present deficit and the corresponding amount at the end of the previous year, which bears no relationship to an estimated annual amount necessary to ensure the scheme will be able to pay its obligations as they fall due.
There is an actuary’s rule of thumb, which illustrates the artificiality of the FRS method. It is that, if interest rates increase by a 1% point, the amount of a more or less typical mature scheme’s liabilities calculated actuarially will decrease by 12%, and conversely if interest rates drop. If there were such an increase in interest rates during the accounting year, the balance sheet will, at the end of the year, show a reduced deficit or even a surplus and the P&L account will show a reduced cost or even a gain, even though neither the scheme’s investments nor its liability to pay pensions will have altered.
Cynics amongst lawyers and in the pensions industry might suspect that the need in Wall Street and the Square Mile to eliminate uncertainty and accountants’ collective wish to future-proof businesses against risk, influenced the development of an accounting standard, the natural consequence of which is the closure of DB pension schemes and so to enable employers to shift the risks of (mainly) longevity and investment returns from themselves to their present and former employees. Kindlier readers might merely be amused to compare accountants with Alice in Wonderland in her conversation at the Mad Hatter’s tea party, at which the March Hare said, ‘You should say what you mean’, to which Alice replied, ‘I mean what I say – that’s the same thing, you know.’
copyright Roderick Ramage
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