The European Union Endorsement Process for International Financial Reporting Standards: A Telos-Based Analysis

Abstract

The paper discusses the process for the endorsement of an IFRS in the European Union with regard to its compliance with teleological principles and with regard to the true and fair view. It begins with an exposition of the teleological principle under Roman law and its relationship to the true and fair view override, as known in the UK and in the EU. We then discuss firstly the telos-based criteria against which a new Standard is appraised during the endorsement process, and secondly the application of the true and fair view principle to the issue of which criteria an EU-endorsed IFRS should be appraised against as regards its application, using IFRS 3 as a specific illustration. The teleological principle is a crucial element in our conclusions. We show that this principle can be used, and in the EU is being used, to bypass democratic processes. The issues raised by this paper concern the operation of regulations designed to be, at least theoretically, context-neutral, within a specific legal and operational framework, that is, the European Union. But similar issues are likely to require consideration in other geographical areas, outside the European context.

Notes

France 1804 Code Civil; Austria 1812 Allgemeines Bürgerliches Gesetzbuch; Germany 1900 Bürgerliches Gesetzbuch; Switzerland 1912 Zivilgesetzbuch.

Second Council Directive 77/91/EEC of 13 December 1976, OJ L 026, 31 January 1977, pp. 1–13.

As discussed in Section 2.1.

In the light of later attacks on IFRS in general and fair value in particular by banks, banking regulators and others, it is worth drawing attention to footnote 11 of the 2000 Communication:

• The Commission proposal does not address supervisory issues and the specific information required by supervisory authorities. The implementation of the proposal should not lead to a lessening of the prudential requirements for regulated entities.

In other words, the Commission believes (believed) that IAS are implicitly unsuitable for, and explicitly are not recommended to be used for, prudential regulation by supervisory authorities.

Several issues arising from the above exposition were discussed in Alexander (2006), Nobes (2006) and Wüstemann and Kierzek (2006). Alexander argued that legal certainty is completely impractical, for a whole variety of reasons. Nobes, supported by Alexander, argued that the [sic] European TFV doesn't exist, and that TFV is a flexible (‘dynamic’) concept anyway. Wüstemann and Kierzek responded, and a good discussion was had by all.

An additional complication here is that the ECJ judges in 1996 clearly misunderstood and misinterpreted what true and fair is all about. A recent ‘opinion’ by legal Counsel in the UK states as follows (FRC, 2008, para. 16 of Appendix):

• In a rather opaque passage the ECJ referred to the exceptional case exception in Article 31(2) [Fourth Directive] in this way:

• 31. Since the directive does not define what is meant by ‘exceptional cases’, this expression must be interpreted in the light of the directive's view, which, as indicated … above, is that the annual accounts of companies concerned must give a true and fair view of their assets, of their financial position and of their profit or loss.

  32. The exceptional cases referred to in Article 31(2) are therefore those in which separate valuations would not give the truest and fairest possible view of the actual financial position of the company concerned.

Counsel describes para. 32 as ‘puzzling’, which is presumably one lawyer being polite about other lawyers. It is simply wrong in logic and in law. ‘A true and fair view’ could not possibly be synonymous with ‘the truest and fairest possible view’. The issues involved here are complex and legalistic, and the present authors are addressing them elsewhere.

Interestingly, the Austrian enactment of TFV, as ‘ein möglichst getreues Bild’, could be argued to give some limited support to the ECJ statement. This might back-translate as ‘a picture as true as possible’. This fits exactly with our discussion at the beginning of Section 2.2 (where we refer to ‘the best information possible’), but crucially differs from the ECJ phrase by its use of ‘a picture’ rather than ‘the picture’. However, the German enactment, identical to the original German language version of the Fourth Directive itself (prepared long before Austria became an EU member), is quite different, and would not provide even the limited support we suggest here.

One of the authors recalls a private conversation (in a hotel bar) with Karel van Hulle in 2000, very shortly after the release of the 2000 Communication. He said that by this Communication, the EU was saving the IAS from oblivion. The author's (unspoken) reaction was that firstly this was perfectly true, but secondly the IASC was also saving the EU's influence on financial reporting from oblivion.

It is of course pragmatically possible that, for a particular enterprise, differences are small enough to allow compliance with both. But the point remains that two separate claims need to be made (and audited).

We do not feel it necessary or helpful here to investigate lengthy details of discussions in the various advisory committees in the European context. We have already shown that EFRAG, a supposedly significant part of such structures, was critical of the proposals anyway, so its criticisms were presumably cheerfully ignored by the Commission. The Commission report (European Commission, 2008) on the operation of IFRSs and the endorsement process states as follows:

• The European Financial Reporting Advisory Group (EFRAG) has supplied timely, high-quality analyses and endorsement advice to the Commission. The endorsement advice has provided the Accounting Regulatory Committee and the European Parliament with the technical input needed for their decisions.

Obviously the high quality of this technical input still allows the Commission to do the opposite of what the advice suggests. We hope we have made it clear that we do not criticise EFRAG, which has produced wide-ranging and well-argued critiques of a number of proposals. Our concern is that its critiques seem so easily ignored.