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The purpose of the letter is to explain how EFRAG has reached its conclusion that IFRS 9 Financial Instruments is not contrary to the true and fair principle, as stated in its endorsement advice issued on 15 September 2015.
The letter does not purport to provide additional elements of assessment on the subject but only to piece together the elements, contained in Appendices 2 and 3 to EFRAG’s endorsement advice to the EC, that are relevant for the assessment of true and fair.
Context of EFRAG’s assessment
EFRAG assessment as to whether IFRS 9 would not be contrary to the true and fair principle has been performed against the European legal background that is briefly described below.
The IAS Regulation provides that the international accounting standards can only be adopted if they are not contrary to the principle set out in Article 4(3) of Council Directive 2013/34/EU ('The Accounting Directive').
Article 4(3) of the Accounting Directive provides that:
The annual financial statements shall give a true and fair view of the undertaking's assets, liabilities, financial position and profit or loss. Where the application of this Directive would not be sufficient to give a true and fair view of the undertaking's assets, liabilities, financial position and profit or loss, such additional information as is necessary to comply with that requirement shall be given in the notes to the financial statements.
The IAS Regulation clarifies that ‘to adopt an international accounting standard for application in the Community, it is necessary firstly that it meets the basic requirement of the aforementioned Council Directives, that is to say that its application results in a true and fair view of the financial position and performance of an enterprise - this principle being considered in the light of the said Council Directives without implying a strict conformity with each and every provision of this Directive’ (Recital 9 of the IAS Regulation).
EFRAG approach in its assessment of the true and fair principle in relation to IFRS 9
To assess whether an IFRS is not contrary to the true and fair view principle, EFRAG refers to Article 4(3) of the Accounting Directive reproduced above and notes that to provide a true and fair view of the undertaking’s assets, liabilities, financial position and profit or loss, financial statements need the following attributes:
(a) Not to be subject to financial reporting requirements which would lead to unavoidable distortions or significant omissions in the representation of that entity’s assets, liabilities, financial position and profit or loss. In concluding that an IFRS provides relevant, reliable, comparable and understandable information and leads to prudent accounting, EFRAG provides the assessment that an IFRS does not impede financial statements from providing a true and fair view. This is assessed on a ‘stand-alone’ basis, as is explained in full detail in Appendix 2 of the endorsement advice and is summarised below.
(b) All disclosures that are necessary to provide a complete and reliable depiction of an entity’s assets, liabilities, financial position and profit or loss should be included. Generally each IFRS includes specific disclosure requirements. However, a specific standard, IFRS 7 Financial Instruments: Disclosures, deals with disclosure requirements related to financial instruments. IFRS 9 Financial Instruments has been issued together with amendments to IFRS 7, the whole being referred to as “IFRS 9”. Changes in, and additions to, disclosure requirements have been assessed together with the accounting requirements and have been deemed appropriate. These specific requirements are supplemented by the requirements, contained in paragraphs 15 to 17 of IAS 1 Presentation of Financial Statements, to provide additional disclosures so that the financial statements, taken as a whole ‘present fairly the financial position, financial performance and cash flows an entity’. Furthermore the application of the materiality principle, as defined in IAS 1, requires that any supplementary information that can influence the economic decisions that users make on the basis of the financial statements to be provided. In reaching its conclusions EFRAG does not make reference to the above-mentioned disclosure requirements because they apply generally to all financial statements prepared in accordance with IFRS; however EFRAG’s assessment implicitly relies upon them.
(c) EFRAG has also identified that the implementation of IFRS 9 in the context of the current application of IFRS 4 Insurance Contracts would create or enlarge distortions in the measurement of insurance contract liabilities and financial assets that back them, in particular when insurance contract liabilities are currently measured on a cost basis. However, it was noted that the current IFRS 4 allows entities to change their accounting for insurance contract liabilities to adopt current measurements of those liabilities, and thereby mitigate the effects of the additional distortions that may have arisen otherwise. Entities are therefore not prevented from preparing financial statements that meet the true and fair view principle upon implementation of IFRS 9.