Parliamentary Commission for Banking StandardsFurther written evidence from Cormac Butler

I note that the Chartered Financial Analysts Society (CFA) wrote to you on 12 December 2012 as part of your Commission on Banking Inquiry. As the extract below shows, it has attempted to define “true and fair” as a concept that removes bias and suggest that this definition is endorsed by the legal opinion of Martin Moore QC. As this is an often misunderstood area I would like to offer my comments.

According to the CFA:

“Users want a “true and fair” view of accounts and take that to mean an unbiased view of performance during the period and of the valuation of assets and liabilities on the balance sheet date. The use of IFRS does not contradict or diminish this concept—see the opinion of Martin Moore QC.”

This is different to what appears in the EU Regulations. These regulations state that where an accounting standard clashes with the “Objective of the Framework”, the entity must depart from the accounting standard and give appropriate explanations to the shareholder. IAS 39 is one such example The “incurred loss” rules in that standard which prevents banks from recognising certain “expected losses” is not prudent and therefore contrary to paragraph 37 of the IAS Framework document which requires prudence.

In Mr Moore’s legal opinion (paragraph 29), he reminded the Financial Reporting Council that the term “true and fair” and “present fairly” (a term used in the Regulations) were synonymous. He also advised the FRC that mechanical compliance with the IFRS did not guarantee that a true and fair result could be reached (paragraphs 41–43).

The concept of “true and fair” or “presents fairly” is set out very clearly in Regulation 1725/2003. The relevant extracts appear below:

Paragraph 13 page 7:

“Financial statements shall present fairly the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework.

Paragraph 17 page 7

“In the extremely rare circumstances in which management concludes that compliance with a requirement in a standard or an interpretation would be so misleading that it would conflict with the objective of financial statements set out in the Framework, the entity shall depart from that requirement in the manner set out in paragraph 18 if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure.”

Finally, Paragraph 3 of the IASB Framework (below) does not restrict the application of Regulation 1725/2003 (paragraphs 13 and 17). It simply states that an entity must use the true and fair override if the objectives of the Framework are different from a relevant accounting standard. This is obvious because entities are prevented from claiming to be in full compliance with the IFRS if even one accounting standard is not followed.

IASB Framework paragraph 3

“The Board of IASC recognises that in a limited number of cases there may be a conflict between the Framework and an International Accounting Standard … the requirements of the International Accounting Standard prevail over those of the Framework … the number of cases of conflict between the Framework and International Accounting Standards will diminish through time” Paragraph 3 IASB Framework”

The accountancy firm Deloitte confirms that banks who do not reveal “expected losses” are not in compliance with the prudence objective (as defined in the IAS Framework). It states

“So when banks were told that, under IAS 39, they could only provide for incurred losses and no longer hold general provisions on their balance sheets for expected losses from future downturns in house prices it raised a few eyebrows. To many, a crash in house prices and subsequent loan losses were inevitable and not providing for them flew in the face of prudence. However the Standards setters’ logic was clear-expected losses, however likely, were not to be provided for, on the basis that they had not been incurred at the balance sheet date”
(Source: Deloitte Banking and Capital Market Insight 2008—

The IASB clarifies paragraph 13 of Regulation 1725/2003 as follows:

“The Board decided to clarify in paragraph 13 of the Standard that for financial statements to present fairly the financial position, financial performance and cash flows of an entity, they must represent faithfully the effects of transactions and other events in accordance with the definitions and recognition criteria for assets, liabilities income and expenses set out in the Framework for the Preparation and Presentation of Financial Statements.”
(Source BC 5 IAS 1)

I hope this helps. If I can clarify this further or you need more assistance please let me know.

19 March 2013

Prepared 24th June 2013