‘Accountants must be allowed to use judgement’

Accountants are professionals and as such should be expected to apply professional judgement. Seeking so-called simple, straightforward guidance as to how to account for and report on a particular set of circumstances, rather than overarching principles that can be applied across a range of transactions, challenges this claim to professionalism.

A rules -based style of accounting guidance may seem initially attractive, but consider the position when the exact circumstances of the transaction do not match the example in the accounting standard.

We are left in a position of effectively having no guidance. Better, in my opinion, to have a set of principles to apply that may require some thought to select the best accounting and reporting solution, but which have widespread applicability.

For example, take leases – a simple standard for lease obligations would say: “If you have a financial obligation arising from a lease arrangement, then that obligation should appear on your balance sheet.”

What else do we need? How do we measure the obligation? Make a judgement and disclose the basis. Is it worth capitalising short leases that really represent equipment rental?

Probably not, as they are likely to be immaterial, but again form a view. These are all issues that the professional accountant should be able to make their own mind up about based on some guiding principles.

However, a mixture of distrust from standard-setters and a desire to look for definitive answers and illustrative guidance in standards means that we have a standard that is considerably longer than the sentence outlined above.

Of course, this is a significant simplification, but my point is that professional accountants have to be prepared to stand back from the formulaic accounting solution and ask: “Does this treatment best represent the underlying transaction?”

This theme was picked up by the UK Financial Reporting Council’s recent paper “True and Fair”. Issued in response to questions about the applicability of this fundamental principle to international accounting standards, the paper emphasises that the concept is as valid now as it has ever been.

The FRC paper quotes an opinion obtained from Martin Moore QC, in which he states: “It does not follow... that the preparation of financial statements can now be reduced to a mechanistic process of following the relevant standards without the application of objective professional judgement applied to ensure that those statements give a true and fair view or achieve a fair presentation.”

Some might wonder why I (and the FRC) refer to the true and fair concept as there are those that believe it has no place in a regime governed by international accounting standards. However, the principle does apply.

For example, IAS 8 states that for information to be reliable, it must be reported in accordance with economic substance, rather than strictly in adherence to its legal form. IAS 1 requires departure from an IFRS if it does not faithfully represent the transaction.

So the true and fair concept is alive, but does require application. Accountants should not hide behind the rules, they should apply professional judgement in the choice of accounting policies when making valuations and determining materiality. And in this respect materiality must be judged on the basis of whether the item in question is likely to impact the key decisions of the user of the accounting information.

Finally, question your reporting – does it faithfully represent the substance of transactions? If not, would additional disclosures help readers of the accounts to better understand the underlying transactions? But beware obscuring the relevant facts with unnecessary disclosures.