TRUE AND FAIR VIEW OF FINANCIAL STATEMENTS :
According to section 128 (1) of the Companies Act 2013, every company shall prepare and keep at its registered office books of account and other relevant books and papers and financial statement for every financial year which give a true and fair view of the state of the affairs of the company.
Further section 129(1) of the Companies Act 2013, states that the financial statements shall give a true and fair view of the state of affairs of the company or companies, comply with the accounting standards notified under section 133 and shall be in the form provided for different class or classes of companies in Schedule III. It also provides also that the financial statements shall not be treated as not disclosing a true and fair view of the state of affairs of the company, merely by reason of the fact that they do not disclose –
(a) in the case of an insurance company, any matters which are not required to be disclosed by the Insurance Act, 1938, or the Insurance Regulatory and Development Authority Act, 1999;
(b) in the case of a banking company, any matters which are not required to be disclosed by the Banking Regulation Act, 1949;
(c) in the case of a company engaged in the generation or supply of electricity, any matters which are not required to be disclosed by the Electricity Act, 2003;
(d) in the case of a company governed by any other law for the time being in force, any matters which are not required to be disclosed by that law.
Thus, the Companies Act requires that the profit and loss account must exhibit a true and fair view of the profit earned or loss suffered by the company during the period for which the account has been prepared. The term true and fair has not been defined nor had it been the subject of any judicial decision. But in order to show a true and fair view financial statement (Statement of Profit and Loss and Balance Sheet) should not mislead the user about the financial health of the oraganisation.
From the accounting point of view, the profit and loss account should be drawn upon the principles stated below:
(a) Materiality: All significant factors which will have an impact on the mind of the reader should be disclosed. For example, if a large quantity of raw materials is sold and there is a sizable profit or loss, the sale should not be included in the Sales Account; instead, the cost of the materials should be deducted from materials consumed and the profit or loss on sale of raw materials should be separately disclosed in the profit and loss account. The reader will then know why the profit or loss is and what it is; the reason will not be clear if the sale of raw materials is added to Sales or deduced from materials consumed. If, however, only a small quantity was sold leading to a rather insignificant profit or loss, separate disclosure is not necessary because such a disclosure will not change the impression of the reader about the profit situation.
What is material and what is not depends upon the judgement of the management. But the materiality of a figure should be judged from the point of view of both the total amount of the item and the amount of the profit or loss. In the above example, materiality has to be seen from the point of view of (i) the amount of materials consumed and (ii) the profit or loss during the year.
(b) Prior-Period Items: The rule in India is that once accounts are adopted at the annual general meeting, they cannot be reopened. If any error is discovered, it can be corrected only in the accounts of the subsequent period. Apart from errors, some of the account relating to previous year may come to knowledge or may be ascertained only in the current year. Suppose rates have been revised with effect from October, 2006 but the decision was made only in March, 2008, The increased wages for 2007-08 can certainly be added to the 2007-2008 wages but the increased wages for six months of 2006-2007 will also have to be taken out into account. Errors and other items relating to previous year should be shown separately in the profit and loss account and not clubbed with the item relating to the current year unless the concerned amounts are not material. Preferably, errors and prior year items should be stated below the line i.e. in the Profit and Loss Appropriation Account.
(c) Extraordinary Items: If expenses or incomes that do not arise in the ordinary course and are material should be stated separately in the profit and loss account. For example, if a fixed asset is sold, its profit or loss has to be shown separately. Another example would be speculation loss or profit; yet another would be subsidy received from government for operational purposes.
(d) Change in Accounting Policies: It is well known that if there is any change in an accounting policy, say method of valuation of inventories or of change in depreciation, there has to be disclosure about the fact of the change and of the fact on profit or loss resulting from such a change.