A recent legal opinion on behalf of UK local authority pension funds has ignited controversy, according to Stephen Bouvier

Imagine a world in which all financial statements prepared under International Financial Reporting Standards might be defective or illegal. Sound insane? That is the prospect mulled in an opinion obtained from the London-based barrister George Bompas QC earlier this year and published by the UK Local Authority Pension Fund Forum.

The opinion addresses a number of issues that are without doubt of vital importance to preparers, the wider accountancy profession, and investors. It examines the interplay between IFRS and the wider UK and EU legal context.

In the UK, Section 393 of the Companies Act 2006 requires company directors to approve only those accounts that present a true and fair view of a business’s assets, liabilities, financial position and profit or loss. Section 495(3) imposes a similar obligation on auditors to certify whether, in their view, a set of accounts gives a true and fair view of a business’s financial performance.

However, at paragraph 5 of his opinion, Bompas argues: “It is questionable whether statutory accounts prepared in accordance with international accounting standards, where those standards form the applicable framework, will always give a true and fair view.”

He continues: “It is questionable whether international accounting standards admit the possibility of departure from any of their requirements, even where the requirements result in accounts not giving a true and fair view and a departure would be necessary for the accounts to give a true and fair view.

In support of this position, Bompas argues:

• The presumption in paragraph 15 of IAS 1 that IFRS “is presumed to result in financial statements that achieve a fair presentation”;

• IFRS fails to articulate any clear true and fair view requirement;

• IFRS has abandoned the prudence concept.

At issue is whether:

• IFRS fails to report a true and fair view of an entity’s performance, and

• The requirements of the UK Companies Act and the European Union’s IAS Regulation take precedence over any requirement in IFRS.

Those instructing George Bompas cited three areas where IFRS fails to report a true and fair view:

• The absence of a capital maintenance purpose for accounts,

• The lack of a requirement that reporting entities prepare accounts on a prudent basis, and

• The failure of individual IFRSs – Bompas notes in particular IASB’s financial instruments standard IAS 39 – to follow statutory accounting principles.

Also pervading the debate within the wider EU context are the Fourth and Seventh Directives, which date back to 1978 and 1983 respectively. These Directives govern the form and content of financial statements within the EU. IFRS is given force of law in EU member states by the so-called IAS Regulation.

On 12 June 2013, the European Parliament approved a new accounting Directive. It essentially merges the two previous Directives and introduces a ‘think-small-first’ principle to reduce the compliance burden on smaller entities. Noteworthy is the retention of the concept of “prudence” in the final text.

Suddenly, on 3 October 2013, the UK Financial Reporting Council published a statement on its website declaring that Bompas was wrong. Badly so, indeed. “On the specific issue of its legality, the Department for Business (BIS) has today confirmed that the concerns expressed by some are misconceived,” the statement reads.

What is more, the FRC has taken its own independent legal advice from Martin Moore QC and this advice “accords with” the BIS view. The FRC has published that opinion on its website.

The regulator argues that a company will present a true and fair view in its accounts in the vast majority of cases merely by complying with accounting standards. The statement goes on to note, however, that “where compliance…would result in accounts that would be so misleading that they would conflict with the objective of financial statements, the standard should be overridden.”

Moore QC contends: “Where the express requirement of financial statements is, by paragraph 15 of IAS 1, to achieve fair presentation and the required explanation for departure from an IFRS is that departure was necessary in order to achieve fair presentation, there is simply no reasonable basis for denying the existence of a true and fair override.”

Nonetheless, the FRC concludes, there is scope for improvement in financial reporting and the IASB’s conceptual framework project is the place to which energies should now be diverted. Indeed, the FRC wants to see both stewardship reporting and prudence explicitly acknowledged in the IFRS framework.

But sources close to the issue have confirmed that not only do some investors mistrust the standard setters, but also that the views of a veritable galaxy of legal stars will settle very little. In fact, it is noteworthy that although we have seen the counsels’ opinions, we have yet to see their instructions.

Moreover, counsel’s opinion is just that. It carries no more legal weight than any other opinion. Of course, the substance of that opinion takes on an entirely different significance once it is litigated; however, that litigation has not yet taken place.

One of the more toxic and immediate side effects of this furore is its impact on the IASB’s project on the conceptual framework, a point acknowledged by the FRC in its 3 October statement.

IASB launched the conceptual framework project in 2012. The plan was to refine and finalise what already exists rather than fundamentally revisiting it. This latest furore could well derail any hope of signing off on the effort by September 2015. A discussion paper on the project is currently out for comment.

Noteworthy in the current debate is that the framework made explicit reference to stewardship before the concept was removed from its 2010 iteration. Chapter 1 previously stated: “Financial statements also show the results of the stewardship of management, or the accountability of management for the resources entrusted to it.”

At paragraph 9.7 of the discussion paper the board argues: “Although Chapter 1 does not use the phrase stewardship, it was not the intention of the IASB to remove the concept of stewardship from the objective of financial reporting.”

Similarly with prudence, IASB took the view that the term – understandably so – has no place in a reporting framework where financial information has the qualitative characteristics of reliability and neutrality. Neutral information, the argument goes, is neither cautious, conservative nor prudent, it is simply unbiased information.

Of course, demands to include prudence in the framework have as much to do with a feel-good word as they have with wider dissatisfaction with financial reporting – particularly by financial institutions. IASB’s inability to finalise a more forward-looking impairment methodology since the start of the Financial Crisis has hardly helped. Recent woes at the Co-operative Bank have served only to underline that failure.

The signs are that political patience within the EU has well and truly run out with the IASB. Although IASB chairman Hans Hoogervorst might have declared somewhat imperiously in 2009 that the European Parliament was “getting out of hand”, a similar view now pervades a growing body of European opinion about the IASB.

Because now, the Parliament, with the lead taken by the chair of the ECON committee, Sharon Bowles, wants to link future EU funding for the IASB with outcomes in standard setting that further European interests. And those interests, it appears, include the inclusion of prudence in any revised conceptual framework.