UK: key trends in the accountancy profession - POB report

The Professional Oversight Board, part of the Financial Reporting Council, has published the eighth edition of its Key Facts and Trends in the Accountancy Profession report: see here (pdf). The report notes, for example, that:

Over the past six years, the Big Four have experienced a steady increase in the proportion of fee income from non‐audit work for non‐audit clients. In contrast their fee income from non audit work to audit clients has been falling".

UK: England and Wales: the true and fair view

Judgment was given yesterday by the Court of Appeal in Macquarie Internationale Investments Ltd v Glencore UK Ltd [2010] EWCA Civ 697. The court upheld the trial judge's finding (at [2009] EWHC 2267 (Comm)) that there had been no breach of a warranty which provided that [a] audited accounts were prepared in accordance with accounting standards and a true and fair view of a company's assets and liability [b] a set of management accounts had been prepared in accordance with relevant accounting standards.

The decision is of interest because of what is said about the true and fair view; in this regard, Jackson LJ observed (paras. [51] and [52]):

... a joint opinion written by Mr Leonard Hoffmann QC and Ms Mary Arden in September 1983 has been highly influential and was relied upon by the judge in the present case. I recall that that joint opinion was in general circulation in the 1980s. It appears to have left an imprint on judicial thinking and on legal writing in subsequent decades. The essential thesis of Mr Hoffmann and Ms Arden was that the concept of "true and fair view" as used in the Companies Acts is an abstraction. It is for the courts to decide in any given case whether the accounts do give a true and fair view. However, in deciding this question the courts look for guidance to the ordinary practices of accountants and in particular to the standards published by the relevant professional body. These published standards not only guide accountants in the preparation of accounts but also mould the expectations of those who read or use the accounts. Therefore compliance with professional standards is prima facie evidence that the accounts present a true and fair view of the assets and liabilities of the company or the group. Deviation from accepted accounting principles is prima facie evidence that the accounts do not present a true and fair view of the assets and liabilities of the company or the group.

In subsequent decisions courts have treated compliance with published professional standards as strong evidence that the accounts in question did present a true and fair view: see Lloyd Cheyman & Co Ltd v Littlejohn & Co [1987] BCLC 303 at 313; Senate Electrical Wholesalers Ltd v STC Submarine Systems Ltd (20th December 1996, unreported) at page 20 of the transcript; Bairstow v Queen's Moat Houses plc (23rd July 1999) at pages 31-32 of the transcript and Revenue and Customs Commissioners v William Grant & Sons Distillers Ltd [2007] UKHL 15; [2007] 1 WLR 1448 at paragraphs 2 and 38".

USA: IFRS and US GAAP convergence

Following the publication of a joint statement (here, pdf) by the IASB and FASB in connection with their standards convergence work, the chairmain of the Securities and Exchange Commission, Mary Shiparo, has announced (see here):

I foresee no reason that the adjustment to the targeted timeline for certain joint projects should impact the staff's analyses under the Work Plan issued in February 2010, particularly when that adjustment is designed to enhance the quality of the standards. Indeed, focused efforts on those standards the boards consider highest priority for the improvement of U.S. GAAP and IFRS will facilitate the staff's analyses. Accordingly, I am confident that we continue to be on schedule for a Commission determination in 2011 about whether to incorporate IFRS into the financial reporting system for U.S. issuers".

Japan: international financial reporting standards

Japan's Financial Services Agency has announced that certain companies will have the option to prepare their consolidated financial statements, for fiscal years ending on or after 31 March 2010, using international financial reporting standards. Further information is available here (pdf). 

UK: England and Wales: major professional negligence claims against accountants

Law firm Reynolds Porter Chamberlain LLP reports "a sudden jump in the number of professional negligence claims against accountants last year (to December 31st) ... there were 13 major High Court professional negligence claims launched against accountants last year, eclipsing the four claims there had been over the previous five years". See here for further information.

Europe: relaxing the financial reporting obligations of small companies

The European Parliament has adopted a text supporting the Commission's proposal to give Member States the power to remove the financial reporting obligations imposed on small companies by Directive 78/660/EEC (on the annual accounts of certain types of company). See here for further information about the Commission's proposal.

USA: Lehman Brothers, the Valukas Report and the auditor's role

Anton R. Valukas, chairman of law firm Jenner and Block, published his Chapter 11 Proceedings Examiner's Report for Lehman Brothers Holdings Inc. last week: see here. To quote from the report (vol 1, p. 3):

Lehman’s financial plight, and the consequences to Lehman’s creditors and shareholders, was exacerbated by Lehman executives, whose conduct ranged from serious but non‐culpable errors of business judgment to actionable balance sheet manipulation; by the investment bank business model, which rewarded excessive risk taking and leverage; and by Government agencies, who by their own admission might better have anticipated or mitigated the outcome"

Much attention has focused on the devices through which the balance sheet manipulation was achieved and the role of the firm's auditors in this regard, discussed in volume 3 of the report: see here (pdf). To quote from the report (pp. 732-)

Lehman employed off‐balance sheet devices, known within Lehman as 'Repo 105' and 'Repo 108' transactions, to temporarily remove securities inventory from its balance sheet, usually for a period of seven to ten days, and to create a materially misleading picture of the firm’s financial condition in late 2007 and 2008 .. Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet ... Lehman never publicly disclosed its use of Repo 105 transactions, its accounting treatment for these transactions, the considerable escalation of its total Repo 105 usage in late 2007 and into 2008, or the material impact these transactions had on the firm’s publicly reported net leverage ratio ... Repo 105 transactions were not used for a business purpose, but instead for an accounting purpose: to reduce Lehman’s publicly reported net leverage and net balance sheet ...

... The Examiner concludes that sufficient evidence exists to support colorable claims against Ernst & Young LLP (“Ernst & Young”) for professional malpractice arising from Ernst & Young’s failure to follow professional standards of care with respect to communications with Lehman’s Audit Committee, investigation of a whistleblower claim, and audits and reviews of Lehman’s public filings".

So, once more, the value of the external audit is under the spotlight in the USA and beyond. The UK's Financial Reporting Council has requested information from Ernst & Young as part of an enquiry into how the 'Repo' transactions were accounted for and audited in the UK. With regard to the auditor's function, an editorial in today's Financial Times newspaper offers some interesting suggestions, including:

A more manageable change might be a shift from the binary convention that accounts are either fine or qualified. One way to beef up the due diligence value of the audit would be for the auditor to pass judgment on the quality of the information provided – perhaps on some scale with reasons given. This would give the investor a clearer appraisal of the value of the financial information. It would also force the auditor to remember who its customer actually is".

UK: England and Wales: unfair prejudice - improper accounting and removal of an auditor

Judgment was given today in Kohli v Lit & Ors [2009] EWHC 2893 (Ch), a case in which a shareholder successfully sought relief for unfairly prejudicial conduct under sections 994 to 996 of the Companies Act (2006). The allegations were wide-ranging but of particular interest are those concerning the preparation of accounts and the non-disclosure of directors' remuneration, which the trial judge (HHJ Purle QC, sitting as a High Court judge) held established unfair prejudice. The trial judge also discussed Section 994(1A) and this would appear to be the first time that this new provision has been judicially considered. 

In the case, the remuneration of the highest paid director was not, as required, disclosed and had been included in an amount for "administrative expenses".  It was argued that this did not matter because a shareholder could have asked a question at an annual general meeting in order to elicit further information. The trial judge rejected this position, observing that (para. [218]): 

Transparency demands that the unvarnished truth should be revealed by the accounts, not hidden, and not left to the shareholder to ask questions at a shareholders' meeting".

Although the trial judge found that there was no deliberate plan to conceal the truth from the petitioning shareholder, it was, he observed (para. [224]):

... readily understandable that the improper accounting should cause her to lose all confidence in the competence and integrity of the board, or (which is probably a more realistic appraisal of the situation) that such possibility that there ever was that she should regain trust and confidence in the board has been destroyed".

It would appear that this finding was an important factor in the trial judge's finding of unfair prejudice.  In reaching this decision, HHJ Purle QC briefly considered the knowledge of accounting to be expected of individual directors (para. [220]):

It would be wrong to expect individual directors to be on top of the detail of the accounting requirements of successive Companies Acts and allied regulations. It is their duty, however, to read the accounts carefully before their approval and query anything that strikes them as odd, or questionable".

Elsewhere in his judgment, when exploring the extent to which breaches of companies legislation should be unfairly prejudicial, he referred to Section 994(1A) - inserted by Regulation 42 of the Statutory Auditors and Third Country Auditors Regulations 2007 - and which provides that "a removal of a company's auditor from office - (a) on grounds of divergence of opinions on accounting treatments or audit procedures, or (b) on any other improper grounds - shall be treated as being unfairly prejudicial to the interests of some part of the company's members". HHJ Purle QC observed that the effect of Section 994(1A) was that (para. [20]): 

[there must] be a finding of unfair prejudice even though the effect of the conduct complained of has no necessary impact on the value of the complaining shareholders' investment. Moreover, a board acting in good faith may genuinely, and correctly, disagree with (say) the accounting treatments, but removal of the auditor on those grounds will be unfairly prejudicial, reflecting the importance the law attaches to absolute standards of behaviour in the accounting process. Whilst this particular provision is new, I regard it as declaratory (except as to its mandatory application) of the kind of conduct that can amount to unfair prejudice, both today, and in a case concerning events before 2008, as this case does. Having said that, it does not follow, even where unfair prejudice is established, that the Court will necessarily grant relief. There will be cases where the Court concludes that the unfair prejudice is not sufficiently serious to justify its intervention, or its intervention may be limited".

UK: the future of UK GAAP - ASB consultation reveals divergent views

In August 2009 the Accounting Standards Board published a consultation paper in which it set out proposals regarding the future of UK Generally Accepted Accounting Practice (GAAP) and its convergence with International Financial Reporting Standards (IFRS). Substantial and wide ranging change was proposed. The responses received have now been published - see here - and these, the ASB notes in an accompanying press release, "demonstrate a divergence of views on many important issues and the ASB will have a challenging task in analysing them and in coming to firm recommendations".

Accounting standards and standard setting - IASCF Monitoring Board reaffirms fundamental principles

The Monitoring Board of the International Accounting Standards Committee Foundation has published a statement reaffirming the fundamental principles on which accounting standards and the standard setting process should be based. The Board notes in its statement:

Accounting standard setters, both nationally and internationally, are currently considering how accounting standards can be improved in light of the recent credit crisis. We strongly support these efforts and agree that the credit crisis offers important lessons for how accounting standards can be improved to offer greater transparency in times of market stress, to the benefit of both investors and market stability.

... The International Accounting Standards Board (IASB) in its Framework and the U.S. Financial Accounting Standards Board (FASB) in its Statements of Financial Accounting Concepts provide objectives of financial reporting and describe the characteristics of accounting standards that support those objectives. These collectively form the foundation on which individual standards are developed. They are universal in that they apply to financial reporting for businesses of all sizes, across all industries. Though each standard setter has presented these objectives and characteristics in its own way, consistent principles can be readily identified. We view the primary objective of financial reporting as being to provide information on an entity’s financial performance in a way that is useful for decision-making for present and potential investors. To be considered decision-useful, information provided through the application of the accounting standards must, at a minimum, be relevant, reliable, understandable and comparable".

UK: England and Wales: financial reporting and the true and fair view

Last year the Financial Reporting Council published a legal opinion written by Martin Moore QC concerning the status of the 'true and fair' concept in UK financial reporting. In his opinion, Mr Moore QC endorsed the analysis contained in earlier legal opinions written by Lord Hoffmann and Dame Mary Arden and observed that the 'true and fair' concept "...remains at the heart of the preparation of financial statements. It can aptly be described as an overarching concept which should inform all decisions by the preparers of such statements" (para. 46). 

Against this background, the judgment of Mr Justice Andrew Smith in Macquarie Internationale Investments Ltd v Glencore UK Ltd [2009] EWHC 2267 (Comm), handed down yesterday, is interesting and important. The judgment contains discussion of the application of accounting principles, Financial Reporting Standards (FRSs) and the relationship between the 'true and fair' concept and FRSs. This makes the case unusual because such issues are not often considered by the courts.  

The case concerned a claim for damages by Macquarie against Glencore for breach of warranties in a sale and purchase agreement for the acquisition by Macquarie of the shares in Corona Energy Holdings Ltd. The warranties provided that accounts had been prepared in accordance with relevant accounting standards and gave a true and fair view of assets and liabilities. Macquarie claimed that Corona's subsidiaries had incurred charges that were not recognised in the relevant accounts and, had they known about these charges, they would have paid less for the shares. The trial judge found Glencore not in breach of the warranties and, in the course of his judgment, observed: 

[Para. 106] ... in order for an item to be recognised as an asset or a liability there should be sufficient evidence of its existence. No doubt evidence will be sufficient for this purpose if, while not itself demonstrating the existence of the item, it sufficiently indicates it to call for enquiries about the position and reasonable and proportionate enquiries would provide sufficient evidence of its existence. But it does not seem to me that extravagant and disproportionate investigations are demanded, or that there is sufficient evidence of an item if its existence might be established only by investigations which the entity or those preparing its financial statements could not be expected to conduct if exercising reasonable diligence and making sensible enquiries.

[Para. 166] ... Although it might be that the quality of being "true" is directed to the accuracy of statements of fact and the quality of being "fair" reflects that accounts involve matters of assessment and judgment, it would be an arid and unhelpful exercise to decide whether financial statements are (i) true and (ii) fair as if they were separate questions. The sensible and generally accepted approach is to recognise that "true and fair" is a composite phrase, and the requirement that financial statements be "true and fair" is a single, indivisible requirement.

[Paras. 167-169] The concept of a "true and fair view" was considered by Mr. Leonard Hoffmann QC and Ms Mary Arden in a Joint Opinion written for the Accounting Standards Committee (the predecessor of the Accounting Standards Board) and dated 13 September 1983 ... [The] Joint Opinion ... explains why the "true and fair" concept necessarily relates to the expectations that accounting practices generate. It is of some interest that Mr Hoffmann and Ms Arden recognise that the application of the "true and fair" concept involves "judgment in questions of degree" and observe that cost-effectiveness is relevant to deciding what information is required in order to prepare financial statements that give a true and fair view. So too, as I have explained, it seems to me that both judgment and the cost-effectiveness and proportionality of potential investigations are relevant to deciding whether there is sufficient evidence to recognise an item as an asset or a liability. None of this means that financial statements that are prepared in accordance with FRSs necessarily give a true and fair view.

[Para 170] ... I find it difficult to envisage circumstances in which, because an entity has no or no sufficient evidence of a liability and therefore does not provide for it in its financial statements, they would on that account fail to give a true and fair view of the entity's financial position. I have already concluded that the Accounts were prepared in accordance with Relevant Accounting Standards, and I cannot accept that, this being so, the Accounts did not give a true and fair view of the assets and liabilities ...".

UK: IFRS8 and segment reporting by companies - FRRP expresses concern

The Financial Reporting Review Panel, part of the Financial Reporting Council, yesterday expressed concerns with the way in which some companies are reporting the performance of key parts of their business in accordance with IFRS 8 - Operating Segments: see here for further information.

UK: online filing of accounts - HMRC and Companies House joint approach statement

HMRC and Companies House have published a statement concerning their joint approach to the online filing of accounts, the development of which was one of the recommendations in the Carter Review (2006). The statement explains:

HMRC has now decided that statutory accounts and tax computations showing the derivation from those accounts of the entries in the Company Tax Return must be delivered electronically using Inline XBRL (iXBRL) format. Inline XBRL will allow companies and agents to submit their accounts and tax computations to HMRC with all branding, stylistic and terminological preferences in the human-readable form. The use of iXBRL will be mandatory when filing accounts with HMRC as part of a Company Tax Return for all accounts prepared under the Companies Act 2006. Companies with less complex tax affairs will be able to use HMRC’s software, provided free on their website, which will allow those companies to fully meet their HMRC filing obligations after mandation.

HMRC will introduce their iXBRL service in November 2009. Companies House will add iXBRL software filing for unaudited full accounts to their service by the summer of 2010 and then continue to develop their iXBRL capability for all the main accounts types they receive by summer 2011".