ACCA SBR ^UK Syllabus B. The Financial Reporting Framework - Faithful Representation in more detail - Notes ^{5 / 18}

Faithful Representation means..

1. Substance over form

   Faithful representation means capturing the real substance of the matter.

2. Represents the economic phenomena

   Faithful means an agreement between the accounting treatment and the economic phenomena they represent.

3. Completeness, Neutrality & Verifiability

   The accounts are verifiable and neutral.

Examples

Sell and buy back = Loan

An entity may sell some inventory to a finance house and later buy it back at a price based on the original selling price plus a pre-determined percentage. Such a transaction is really a secured loan plus interest. To show it as a sale would not be a faithful representation of the transaction.

Convertible Loans

Another example is that an entity may issue convertible loan notes. Management may argue that, as they expect the loan note to be converted into equity, the loan should be treated as equity. They would try to argue this as their gearing ratio would then improve. However, it is recorded as a loan as primarily this is what it is.

As noted previously, simply following rules in accounting standards can provide for treatment which is essentially form over substance. Whereas, users of accounts want the substance over form.

The concept behind faithful representation should enable creators of financial statements to faithfully represent everything through measures and descriptions above and beyond that in the accounting standard if necessary.

Limitations to Faithful Representation

1. Inherent uncertainties

2. Estimates

3. Assumptions