A STUDY OF FINANCIAL STATEMENT LAW IN SOUTH AFRICA

A STUDY OF FINANCIAL STATEMENT LAW IN SOUTH AFRICA

       1          INTRODUCTION AND CONTEXT

Apart from its far-reaching consequences on the law and society in general, the Constitution of the Republic of South Africa, 1996 (Constitution) created a paradigm shift in respect of statutory interpretation. No area of South African law can be analysed or interpreted without recourse to the Constitution, which is the supreme law of the country. Section 39 (2) of the Constitution, which is a peremptory provision, obliges a court, tribunal, or forum when interpreting any legislation to promote the spirit, purport, and objects of the Bill of Rights. The Bill of Rights also applies to a juristic person to the extent required by the nature of the rights and the nature of that juristic person. Section 32 of the Constitution directly affects the considerations and propositions as postulated in this paper. Section 32 (1) (a) of the Constitution provides that everyone has the right of access to any information that is held by another person that is required for the exercise of protection of any rights of any person. Section 32 (2) creates a legal obligation of government to enact legislation to give effect to these rights. It is submitted that the Companies Act 71 of 2008 (Act 71 of 2008) is one such piece of legislation. Section 7 (a) of Act 71 of 2008 provides that ‘The purposes of this Act are to promote compliance with the Bill of Rights as provided for in the Constitution, in the application of company law’.

Financial statements have for over 90 years have been the central regulatory device through which a company communicates its financial information to external parties. In the context of the Constitutional right to information, the question arises as to what information should be included in financial statements that would be sufficient and appropriate to enable those who have a right to such information, to facilitate the protection of their rights?

Section 29 (1) of Act 71 of 2008 creates what is an ostensibly redundant requirement that when companies prepare financial statements they must comply with two standards: ‘present fairly’ and ‘Financial Reporting Standards’ (FRS) when deciding what information should be contained in financial statements. The punctuation applied in s 29 of Act 71 of 2008 is crucial in the determination of its interpretation. The use of a semi-colon in the wording of s 29 (1) of Act 71 of 2008 at the end of a single platform sentence implies that s 29 (1) (a) to (e) must be applied equally and do not represent alternative choices.

 Section 29 (1) (a) mandates that a company apply FRS when preparing financial statements, if any such standards are prescribed and s 29 (1) (b) requires that when preparing financial statements, they are to ‘present fairly’, s 29 (1) (c) requires a company to disclose in their financial statements the company’s assets, liabilities and equity, as well as its income and expenses, and any other prescribed information, s 29 (1) (d) requires a company to disclose in their financial statements the date on which the statements were published, and the accounting period to which the statements apply, and s 29 (1) (e) requires a company to disclose in their financial statements the manner in which the financial statements have been assured, if at all.

Section 29 (1) (a) to (c) of Act 71 of 2008 created the legislation that regulates the content of financial statements. It is these three provisions which create the conundrum in relation to the content of financial statements, as they appear to contain duplications of the law. Section 29 (1) (a) of Act 71 of 2008 reads as follows: ‘If a company provides any financial statements, including any annual financial statements, to any person for any reason, those statements must satisfy the financial reporting standards as to form and content, if any such standards are prescribed.’ For all public companies incorporated in terms of Act 71 of 2008, there is an obligation to apply International Financial Reporting Standards (IFRS) of the International Accounting Standards Board. Section 29 (1) (b) of Act 71 of 2008 reads as follows: ‘If a company provides any financial statements, including any annual financial statements, to any person for any reason, those statements present fairly the state of affairs and business of the company, and explain the transactions and financial position of the business of the company’.

Section 29 (5) (1) of Act 71 of 2008 states that if any FRS are set they must ‘must promote sound and consistent accounting practices’. IFRS have been adopted as being compliant with those criteria. One of those is International Accounting Standard 1 Presentation of Financial Statements (IAS 1) which sets out the overall requirements for the presentation of financial statements, guidelines for their structure and minimum requirements for their content.

 It is the standard to be applied in preparing and presenting general purpose financial statements in accordance with IFRS. IAS 1, paragraph 15 is important to this debate and provides as follows:

‘Financial statements shall present fairly the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful presentation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework. The application of IFRSs, with additional disclosure, when necessary, is presumed to result in financial statements that achieve a fair presentation.’

Self-evidently, the IFRS is the means, and fair presentation is the end. IAS 1 in paragraph 17 goes on to give substance to the idea of a fair presentation. It provides as follows:

‘In virtually all circumstances, an entity achieves a fair presentation by compliance with applicable IFRSs. A fair presentation also requires an entity: (a) to select and apply accounting policies in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. IAS 8 sets out a hierarchy of authoritative guidance that management considers in the absence of an IFRS that specifically applies to an item. (b) to present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information. (c) to provide additional disclosures when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and financial performance.’

It goes on to allow departure under paragraph 19 in these terms:

‘In the extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, the entity shall depart from that requirement in the manner set out in paragraph 20 if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure.’

The Framework referred to is the Framework for the Preparation and Presentation of Financial Statements approved by the IASB in July 2001. IAS 1 also deals in paragraph 20 with what must be done in those circumstances. It requires, amongst other things, the disclosure that the entity ‘has complied with applicable IFRSs, except that it has departed from a particular requirement to achieve a fair presentation’ (emphasis added).

This presents directors with a conundrum as if by satisfying the requirements of IFRS, ‘present fairly’ would be achieved and there would be no need to make the ‘present fairly’ requirement a separate provision of Act 71 of 2008.

 Section 29 (1) (c) of Act 71 of 2008 reads as follows: ‘If a company provides any financial statements, including any annual financial statements, to any person for any reason, those statements show the company’s assets, liabilities and equity, as well as its income and expenses.’ IAS 1 deals in paragraph 9 with the same requirement:

‘Financial statements also show the results of the management’s stewardship of the resources entrusted to it. To meet this objective, financial statements provide information about an entity’s: (a) assets; (b) liabilities; (c) equity; (d) income and expenses, including gains and losses; (e) contributions by and distributions to owners in their capacity as owners; and (f) cash flows.’

This presents directors with a conundrum as if by satisfying the requirements of IAS 1 paragraph 9, the requirements of s 29 (1) (c) of Act 71 of 2008 would be complied with and there would be no need to make s 29 (1) (c) a separate provision of Act 71 of 2008.

This paper will demonstrate that the creation of s 29 (1) (b) and (c) of Act 71 of 2008 as separate but equal provisions it indicates that these provisions have a higher purpose, to safeguard rights as enshrined in the Constitution. The central thesis of this paper is that s 29 (1) (b) and (c) of Act 71 of 2008 provide for a constitutional override to ensure that the provisions of the Constitution are complied with. The objective of this paper has jurisprudential importance, as such a legislative override, have a significant impact on how jurists would perceive the quality of the information contained in financial statements which would satisfy the public understanding of the duty of accountability, which the law imposes on companies and their directors.