Auditors: "True and Fair" View

Recent events have highlighted the role and responsibilities of auditors. This post will look at the content of the auditor’s duty; and a subsequent post will look at who the duties are owed to. Typically, auditors have a duty certify whether or not the accounts of a company give a “true and fair” view of the financial state of a company. What exactly this true and fair view constitutes is a matter of some controversy.

“True and fair view”

Initially, an auditor was stated to have been given a broad discretion to rely on information provided by the management – an auditor is a watchdog and not a bloodhound (Re Kingston Cotton Mills No. 2, 1896 2 Ch. 279). However, the auditor cannot simply rely on information provided by the management when suspicious circumstances have arisen. According to Lord Denning, an auditor “must come to (his task) with an inquiring mind – not suspicious of dishonesty, I agree – but suspecting that someone may have made a mistake somewhere and that a check must be made to ensure that there has been none…” (Formento v. Seldson Fountain Pen Co., [1958] 1 WLR 45). For instance, where it was discovered that certain invoices had been altered, it was held that the fact of alteration should have caused the auditors to carry out their own check on the stock, without relying merely on invoices (Re Thomas Gerrard, 1967 2 All ER 535).

A true and fair view of accounts is one which is such that directors or other persons in control are not deprived of knowledge which might have afforded them the opportunity to take remedial action or which might afford them the chance to incur liabilities to third parties on the basis of inaccurate accounts (according to Professor Gower).

It has been held, in observations relied on by the Supreme Court of India, “The auditor must exercise such reasonable care as would satisfy a man that the accounts are genuine, assuming that there is nothing to arouse his suspicion and if he does that he fulfils his duty; if his suspicion is aroused, his duty is to 'probe the thing to the bottom'…” (see ICAI v. P.K. Mukherji, AIR 1968 SC 1104). In general, it can be stated that the accounts will present a “true and fair view” if the accounting standards prescribed by the concerned accounting body are followed. (Gower).

It might be argued that as long as the accounting standards are not breached, the auditor can adopt any interpretation which will best serve his clients’ need or which he thinks fit. Thus, once the AS are complied with, nothing more needs to be done to ensure that the “true and fair view” standard has been adopted. But are they conclusive in the sense that they can never be departed from? In this context, it has been held in England, “they are very strong evidence as to what is the proper standard which should be adopted and unless there is some justification, a departure from this will be regarded as constituting a breach of duty…” (Lloyd Cheyham v. Littlejohn, 1987 BCLC 303). Thus, if the AS are deviated from and yet the auditors certify the accounts as giving a true and fair view, that will in general be regarded as a breach of the duty of care. Only in exceptional situations can a deviation be justified.

In India, the Supreme Court has held that the Accounting Standards are mandatory (JK Industries). The Court stated, “…reference can be made to Section 211(3A), (3B) and (3C). Before introduction of Sub-sections (3A), (3B) and (3C) …these Standards were not mandatory. Therefore, the companies were then free to prepare their annual financial statements, as per the specific requirements of Section 211 read with Schedule VI. However, with the insertion of Sub-sections (3A), (3B) and (3C) in Section 211, the P&L a/c and the balance-sheet have to comply with the Accounting Standards… Thus, the Accounting Standards prescribed by the Central Government are now mandatory qua the companies and non-compliance with these Standards would lead to violation of Section 211 inasmuch as the annual accounts may then not be regarded as showing a "true and fair view".”

Thus, the exception which is permissible in English law does not seem to find a place in Indian law, at least after JK Industries. Compliance with the Accounting Standards is a necessary condition for saying that the accounts reflect a true and fair view. But is it a sufficient condition? Can it be argued that despite complying with the AS, a true and fair view is not satisfied?

On this issue, a recent British decision in Macquarie Internationale Investments. v. Glencore offers some help. As noted by Shantanu Naravane in a post on Indian Corporate Law, “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…” Shantanu’s post is available here. Another post is available here. An opinion in this connection prepared by Martin Moore Q.C. is available here.