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Substance Over Form

Substance over form is an accounting principle that requires financial statements to reflect the economic reality of transactions rather than just their legal form. It means auditors should consider the actual substance of transactions, not just how they are labeled. For example, a lease agreement that functions like a sale would be recorded as a sale, in accordance with the transaction's substance over its form. Auditors must inform partners about violations and document issues thoroughly, and firms may drop clients who do not comply with generally accepted accounting principles regarding substance over form.

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4K views

Substance Over Form

Substance over form is an accounting principle that requires financial statements to reflect the economic reality of transactions rather than just their legal form. It means auditors should consider the actual substance of transactions, not just how they are labeled. For example, a lease agreement that functions like a sale would be recorded as a sale, in accordance with the transaction's substance over its form. Auditors must inform partners about violations and document issues thoroughly, and firms may drop clients who do not comply with generally accepted accounting principles regarding substance over form.

Uploaded by

simson singawah
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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SUBSTANCE OVER FORM

substance over form is an accounting principle use to ensure that the financial statements reflects
the complete relevant and accurate picture of the transactions and events. The responsibility is to
inform the audit partner of the violation. Substance over form emphasizes the economic
substance of an event even though its legal form may provide a different result. An auditors
responsibility is to inform the audit partner of the violation, inform the audit committee of the
violation, document the violation in detail, and then the firm must decide whether to continue the
engagement if the client does not adhere to GAAP.

Substance over form is an accounting concept. It means that you should consider the reality of a
transaction rather than the legal form of it. For example a transaction may be called a lease of
equipment but the terms of the agreement make it a sale then the transaction would be sale.

SUBSTANCE OVER FORM IS WHEN:

• An entity endeavor to ensure that the company’s financial statements reflect the financial
reality of the entity (Substance) rather than the legal form of the transactions and
events(Form) which underlie them.

• It really that simple in the sense that if it is a cow but was disguised in a legal form to
look like a dog, Substance Over Form would prevail to reinstate that it is a cow and not a
dog!
Wow- sound simple.
But, to really substantiate or differentiate Substance Over Form, one need to be vigilant, have
very good inner knowledge of the company’s operation and takes a more investigative in-depth
approach so as to seek further evidence or proof. This is because normally these types of events
or transactions are often quite complex. These events or transactions happen just around the
accounting year ended. (balance sheet date)
We have seen many cases whereby many accounting fraud/ scams/ business fraud occur as a
result of this lack of Substance Over Form. Typical cases are the Enron and Computer Associate
which are described below:

1
EXAMPLE NO 1 OF SUBSTANCE OVER FORM

Exchanging revenue/revenue swap:


In the Computer Associate case, the CEO of the company swap or exchange revenue with
another company. What it did was CSA purchased a certain software/service from the company
A and in turn company A also purchased from CSA. Its look like a sale and it being recognized
as revenues in the Income Statement.

In the Enron’s case we have:


Enron group’s use of over 3000 Special Purpose Entities (SPEs) structured in such a way as to
enable the company to avoid including extensive debt in the consolidated financial statements of
the group.

Company itself fund its own revenue


Let say in a Group of companies, Company A has recorded one transaction as a sale to a
customer. Another transaction records a loan to the same customer for a similar amount. In this
case, when the transactions are considered together, the sale may be without substance as it has
actually been funded by the same group of company.

Transaction should be lease instead of outright purchase


An outright purchase of capital equipment, whereas in fact the substance of the transactions is a
lease of (or perhaps an option to purchase) the equipment.

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