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True and fair accounting

26 September 2016 by Peter Swabey

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It is for directors to decide whether the accounts give a true and fair view without specific disclosure of distributable profits

In september, Councillor Kieron Quinn, Chair of the Local Authority Pension Funds Forum (LAPFF), wrote to the chairmen of a number of FTSE 350 companies with a follow up to the LAPFF’s correspondence of December 2015. Those who received their earlier letter will recall that the LAPFF and George Bompas QC, who has been engaged by the LAPFF in this matter, are asserting the correctness of one of two interpretations of the Companies Act, a view they have held for at least three years.

The matter at issue is whether or not the requirement under s393 that: ‘(t)he 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 … of the company’ necessitates that distributable profits be specifically disclosed. The LAPFF say that it does.

The Financial Reporting Council (FRC) does not share this view and has been quoted as stating that: ‘Our position on this issue is clear: the Companies Act 2006 does not require the separate disclosure of a figure for distributable profits. Ultimately interpretation of the Act is a matter for the courts’.

At first sight, this might seem an accounting technicality but it goes deeper than that. Two of the central principles underlying the original LAPFF letter are that the Companies Act always takes precedence over International Financial Reporting Standards (IFRS) and, consequently, that compliance with IFRS does not necessarily, and of itself, constitute compliance with the Companies Act. There is little with which to find fault in either statement.

In October 2013, Martin Moore QC, was asked by the FRC to consider an earlier opinion by Mr Bompas. One of the points that Mr Moore made in his opinion was that although compliance with IFRS might be assumed to constitute compliance with the Act, ‘more than slavish adherence to IFRS is required to achieve fair presentation.’

There is, however, a third principle which is restated in the latest letter from the LAPFF that: ‘Mr Bompas is very clear that unless the accounts enable a determination of the distributable profits from the numbers as stated in the accounts, then the accounts will not give a true and fair view of the assets, liabilities financial position and profit or loss’.

When ICSA raised the issue with BIS last year, we were told that there is no requirement in the Act which obliges companies to disclose a figure for distributable profits separately in their annual financial statements, although some companies may wish to provide their shareholders with additional information. The latest LAPFF letter argues that the Act requires distributable profits to be shown, but this may be more than one figure and so it need not be ‘a figure’. This feels like special pleading.

This letter also focuses on an exchange of correspondence between the FRC and BIS, obtained under the Freedom of Information Act, around whether or not BIS agreed with the FRC view that the LAPFF was wrong. Again, this seems to be irrelevant – either the Act requires a statement of distributable profits in the accounts, or it does not.

The LAPFF says that all this is important to directors because it creates a risk that a company may make an unlawful distribution, for which the directors would be liable, even if the distributable profits existed when the distribution was made.

The Act states that: ‘a company may only make a distribution out of profits available for the purpose’ (s830) and subject to a net assets test (s831); that a distribution must be justified by reference to the accounts (s836); and that additional requirements apply dependent on whether the last annual accounts, interim accounts or initial accounts are used (ss837-839).

ICSA’s view is that it is for the directors to decide whether the accounts give a true and fair view, as required under the Act, without specific disclosure of distributable profits. It may be helpful for investors to have this information and it may do no harm to include it but, unless this is clearly mandated in law or accounting standards, or serves a useful purpose, such disclosure should be set against the importance of the accounts being clear, balanced and understandable. This means keeping unnecessary clutter to a minimum.

Given that the LAPFF disagrees with what appears to be a widespread interpretation of the law on this point, it would be more appropriate for it to approach the Government with a view to asking BIS either to clarify the law or to make a formal statement, rather than to seek to engage with individual companies, particularly in such an unfortunate tone.

In the meantime, companies would seem well served by relying on the guidance of their independent auditor on the matter.

Peter Swabey is Policy and Research Director at ICSA: The Governance Institute

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