True and Fair Accounting

Recent events like Satyam and the economic recession have thrown up several issues about appropriate accounting and auditing practices, discussed here and here. In this context, it is interesting to note a decision of the United Kingdom Queen’s Bench in Macquarie Internationale Investments Ltd. v. Glencore UK Ltd., [2009] EWHC 2267 (Comm). Macquarie Internationale Investments had acquired an interest in Corona Energy Holdings Ltd. from Glencore. However, it contended that incorrect accounting had resulted in some of the charges on Corona’s subsidiaries not being recognised in the accounts, and had breached the warranties contained in the Share-Purchase agreements. A large part of the decision focuses on the precise warranty in question, and the precise nature of the charges in question. However, the three issues that are relevant for discussion here are: the meaning of ‘true and fair accounts’; the relationship between ‘true and fair accounts’ and the Financial Reporting Standards [“FSR”]; and the relevance of the purpose for which the accounts are created.

First, considering the extent of investigation required, the Court categorically held that “it does not seem … 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”. Coming to the meaning of ‘true and fair’ accounts, the Court held that while the two terms meant different things, the phrase could not be read disjunctively. In the words of the Court, “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”. Further, the relevance of general accounting practices to the idea of ‘true and fair’ and the role of cost-effectiveness was also stressed by the Court.

Secondly, on the issue of the relationship between the FSR and the ideal of ‘true and fair’ accounts, the Court accepted that accounts created in accordance with the FSR need not necessarily be ‘true and fair’. However, the concept “must be understood and given effect in light of generally accepted accounting practices”. Only in exceptional circumstances would the Court conclude that FSR-compliant accounts do not give a ‘true and fair’ picture of the accounts of an entity. The issue of inconsistencies in accounting standards has also been discussed here.

Thirdly, MII had argued that the accounts had been used for the purpose of the purchase, and should be considered in that light. However, the Court rejected this contention, holding that “[i]t is one thing for them to be so used, or even to be prepared in the knowledge that they would be so used; the purpose (or a purpose) for which they were prepared is another. As a rule, management accounts are prepared for the purpose of managing a business, and the information in them depends upon the requirements of the business”. In the absence of specific evidence suggesting that the accounts were created for the purpose of the purchase, their mere use for that purpose would not be relevant in determining whether they gave a true and fair picture of the financial state of the group.

While much of the case seems to be decided on the specific facts, the tenor of the decision certainly seems tilted towards the pro-auditor stance adopted by common law courts since Caparo v. Dickman. However, it is this very reaffirmation which assumes great relevance, given the suggestions in other quarters for more stringent accounting standards and practices.

Another discussion on this decision is available here.