IFRS ‘disconnected’ from true and fair, investors claim

GLOBAL accounting standards are riven by fault-lines and are disconnected from the requirements for true and fair accounts as set out in EU company law, according to a group of institutional investors.

Responding to the True and Fair paper released by the FRC in June, the group of investors – which includes Threadneedle Investments, Royal London Asset Management and the London Pensions Fund Authority – raised “grave concerns” that the adoption of IFRS – with its emphasis on neutrality over prudence – has “dangerously weakened” the true and fair accounting concept.

The group, which has been urging the government to clarify the consistency between IFRS and company law since 2012, claimed that as long as IFRS does not require companies to disclose underlying capital reserves – and which part is available for distribution – businesses are at risk of paying dividends out of capital.

According to the investors, IFRS and company law have “different goals” as that IFRS as currently constituted, “cannot be relied upon to meet capital maintenance requirements that are of vital importance to long-term investors”.

Last week, Betfair admitted it had paid illegal divideds out of capital between 2011 to 2013, the payments of which failed to meet the conditions of realised profits and distributable reserves. The investors said this “highlighted the importance of the matter” despite Betfair reporting under UK GAAP rather than IFRS.

The problem, the investors claim, was “most pernicious” in the case of banks in the run up to the financial crisis. “The Bank of England has long-maintained that the underlying problem was one of solvency, not liquidity, and yet investors could not have gleaned this by looking at banks’ report and accounts. Instead shareholders and taxpayers found out the hard way as share prices nose-dived and capital was destroyed,” the group said.

The concept of true and fair – whereby directors must consider whether, taken in the round, the financial statements that they approve are appropriate – is enshrined in UK law and came into conflict with international accounting rules last year when a group of investors questioned the legality of IFRS.

Doubts were raised by Lincoln’s Inn counsel George Bompas QC, who identified inconsistencies between IFRS and existing company law, suggesting that company directors must override the standards in order to comply with competing legislation.

In October 2013, the FRC and BIS dismissed the claims as “misguided” and published a legal opinion from Martin Moore QC that found that IFRS are legally binding and achieves a true and fair view in financial statements and could, in most instances, be achieved by complying with the rules.

The FRC has since reconfirmed that the presentation of a true and fair view remains a fundamental requirement of financial reporting and said that, in the “vast majority” of cases, a true and fair view will be achieved by compliance with accounting standards. However, where compliance with an accounting standard would result in accounts being so misleading that they would conflict with the objectives of financial statements, the standard should be overridden, the reporting watchdog said.

However, the statement fails to respond the problems outlined in the Bompas legal opinion, the investors said. According to the group of investors, the FRC paper fails to provide clarity over what “true and fair view” means, make clear the availability of the true and fair “override” in the case where accounts do not reveal distributable reserves, or clarify the key features of prudence in company law.

“We remain concerned that a faulty accounting framework, which has contributed to market instability and economic hardship in recent years, has not been properly addressed. We call upon the FRC to revise its “True and Fair paper…and the European Commission to confirm the meaning of the true and fair view with regard to the vital goal of capital maintenance as defined in EU company law,” the group said.

“We recognise that the International Accounting Standards Board is reluctant to set standards according to any particular legal construct, but would welcome efforts on its part to take account of the incompatibility that we identify for the EU. If the IASB and the FRC cannot resolve the matter, there is an urgent need for a robust independent review.”

In a statement, the FRC said: “We always listen to views and consult and that this subject has been raised many times. We have nothing to add to our earlier statements reporting on our and the Government’s thorough review of these issues.”