Abheer (student) (217 Points)
19 December 2011there is given one qualitative characteristics of financial statement i.e. 'SUBSTANCE OVER FORM'. i want to know the meaning of this statement with a suitable example. i m currently preparing for cpt.
* Krishna *
(CA Student)
(6149 Points)
Replied 19 December 2011
Substance over form is an accounting principle used "to ensure that financial statements give a complete, relevant and accurate picture of transactions and events". If an entity practices the 'substance over form' concept, the financial statements will show the financial reality of the entity (economic substance), rather than the legal form of transactions (form)[1]. In accounting for business transactions and other events we measure and report the economic impact of an event instead of its legal form. Substance over form is critical for reliable financial reporting. It is particularly relevant in case of revenue recognition, sale and purchase agreements, etc.
Examples
A lease might not transfer ownership to the leasee but the leasee has to record the leased items as an asset if it intends to use it for major portion of its useful life or where the present value of lease payment is fairly equal to the fair value of the asset, etc. Although legally the leasee is not the owner, so the leased item is not his asset, but from the perspective of the underlying economics the leasee is entitled to the benefits embedded in the use of the item and hence it has to be recorded as an asset. A company is short of cash, so it sells its machinery to the bank and obtains it back on a lease. It is called sale and leaseback. Although the legal ownership has transferred but the underlying economics remain the same and hence under the substance over form principle the sale and subsequent leaseback are considered one transaction. If two companies swap their inventories they will not be allowed to record sales because not sales has occurred even if they have entered into valid enforceable contracts.
Source: wikipedia
Rashid
(Student)
(34 Points)
Replied 20 December 2011
Where real substance takes precedence over legal form.
It happens when the legal form of a transaction can differ from its real substance. Where this happens, accounting should show the transaction in accordance with its real substance which is, basically, how the transaction affects the economic situation of the business. This means that accounting in this instance will not reflect the exact legal position concerning that transaction.
Source: https://www.accountingexplanation.com/accounting_dictionary/substance_over_form_definition.htm
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