REPORTING THE SUBSTANCE OF TRANSACTIONS F.R

REPORTING THE SUBSTANCE OF TRANSACTIONS
QUESTION ONE
Importance of Reflecting the Substance of Underlying Transactions
The principle of substance over form ensures that financial statements present a true and fair
view of an entity’s financial position, performance, and cash flows. This principle requires that
transactions are recorded based on their economic reality rather than merely their legal form.
Why It Is Important:
1. True and Fair Representation:

o Economic reality often provides more relevant and reliable information to users of
financial statements, such as investors and creditors.
o Legal form alone may mislead users about the nature of the transactions.
2. Decision-Making:
o Financial statements based on substance allow stakeholders to make informed
decisions regarding resource allocation.
3. Compliance with IFRS:
o The Conceptual Framework for Financial Reporting by the IASB prioritizes
faithful representation, which incorporates the principles of completeness,
neutrality, and freedom from error. Substance over form is crucial for achieving th
Features Indicating Differences Between Substance and Legal Form:
1. Retention of Risks and Rewards:

o If an entity retains significant risks and rewards of ownership, the transaction may
not constitute a true sale.
2. Control of the Asset:
o When an entity retains control over the asset despite transferring legal ownership,
the economic substance suggests that the asset should remain on the books.
3. Repurchase Agreements:
o Agreements allowing the seller to repurchase the asset at a later date may indicate
a financing arrangement rather than a sale.
4. Special Purpose Entities (SPEs):
o Transactions structured through SPEs may hide liabilities or assets to present a
stronger financial position.
5. Contingent Payments:
o When payment terms are contingent on future events, the transaction may not
represent an outright transfer of economic benefits.
Impact of Not Recording the Substance of Transactions

Failure to record transactions based on their substance can adversely affect financial statements
in the following ways:
1. Misrepresentation of Financial Position:
• Assets, liabilities, and equity may be overstated or understated, providing an inaccurate

picture of the entity’s net worth.
• For example, treating a financing arrangement as a sale would understate liabilities.
2. Inaccurate Revenue Recognition:
• Premature or delayed recognition of revenue can distort performance metrics, such as

profit margins and earnings per share.
3. Misleading Stakeholders:
• Investors and creditors may make poor decisions due to unreliable financial information.
• For instance, overstated profits may attract investors who later face losses.
4. Violation of Accounting Standards:
• Non-compliance with IFRS or GAAP could lead to regulatory sanctions or loss of

investor confidence.
5. Loss of Comparability:
• Financial statements that do not reflect substance over form hinder comparability with
other entities.
• This affects stakeholders' ability to benchmark performance or assess risks effectively.
6. Hidden Risks:
• Off-balance sheet financing, improperly recorded liabilities, or retained risks can lead to
unforeseen financial difficulties.
Adhering to the principle of substance over form is essential for creating financial statements that
faithfully represent an entity's economic reality. Failure to do so undermines the integrity, reliability, and
utility of financial information, jeopardizing stakeholders’ trust and the entity’s compliance with global
accounting standards.
QUESTION TWO
Analysis of the Transaction

The transaction involves the sale of a maturing product to Easyfinance with a right of
repurchase at a fixed price. Although the legal form suggests a sale, the substance of the
transaction indicates a financing arrangement. This is because Werema retains significant risks
and rewards of ownership, including the ability to repurchase the product and benefit from its
increase in value.
Key Details:
• Cost (April 2019): Tshs 5 million

• Fair Value (April 2019): Tshs 7 million
• Sale Price to Easyfinance (April 2019): Tshs 6 million
• Repurchase Price (March 2022): Tshs 7,986,000
• Retail Price (March 2022): Tshs 10 million
• Interest Rates:
o Year 1: Tshs 600,000
Reflecting the Legal Form of the Transaction
Under the legal form, the transaction is treated as a sale. Werema recognizes the sale proceeds in
Year 1 and no longer records the asset on its books. The profit is calculated as the difference
between the sale price (Tshs 6 million) and the carrying amount (Tshs 5 million).
Extracts from the Statement of Profit or Loss:
Year Ended 31 March 2020 (Year 1):
• Revenue: Tshs 6 million

• Cost of Sales: Tshs 5 million
• Profit on Sale: Tshs 1 million
Year Ended 31 March 2021 and 2022:

No further entries related to this transaction
Reflecting the Substance of the Transaction
Under the economic substance, the transaction is a financing arrangement. The Tshs 6 million
received is treated as a loan, and the asset remains on Werema's books. Interest expenses are
accrued over the three years based on the agreed rates, and no revenue is recognized until the
product is sold to a third party.
Extracts from the Statement of Profit or Loss:

• Finance Cost: Tshs 600,000
No revenue or cost of sales is recognized until the product is sold.
Summary of Treatment
Aspect Legal Form Substance

Revenue Tshs 6 million in Year 1 None until product is sold in
2022
Cost of Sales Tshs 5 million in Year 1 None until product is sold in
2022
Finance Cost None Tshs 600,000, 660,000, 726,000
Asset Derecognized in Year 1 Retained until sold
The substance approach reflects the true economic nature of the transaction and adheres to IFRS
principles, ensuring accurate financial reporting.
QUESTION THREE
Analysis of the Transaction
The arrangement with Abbeyfax Plc includes an option for the buyer to require Nemesis to
repurchase the goods at the original selling price plus a fee. This implies that Nemesis retains
significant risks and rewards associated with ownership, which indicates the economic
substance is not a sale but rather a financing arrangement.
According to IFRS 15 (Revenue from Contracts with Customers) and the IASB Conceptual
Framework, revenue should only be recognized when the risks and rewards of ownership have
been transferred to the buyer and there is no obligation to repurchase the goods. Since the
repurchase option exists, this transaction does not meet these criteria.
Accounting Treatment
The Tshs 12 million received should be treated as a loan rather than revenue, with the inventory
retained on the books. The fee of Tshs 360,000 is treated as an interest or financing cost.
Calculation:
• Cost of goods sold:
Selling price/1.25=Tshs 12,000,000/1.25=Tshs 9,600,000\text{Selling price} / 1.25 =
\text{Tshs } 12,000,000 / 1.25 = \text{Tshs }
9,600,000Selling price/1.25=Tshs 12,000,000/1.25=Tshs 9,600,000
• Interest expense (fee): Tshs 360,000
Journal Entries
1. Initial Receipt of Cash (October 2015):
Dr Cash Tshs 12,000,000
Cr Financial Liability Tshs 12,000,000
2. Retain Inventory (No Cost of Goods Sold is recognized): No entry to remove inventory as
risks and rewards are not transferred.
3. Recognize Financing Cost (December 31, 2015): To accrue the fee for the repurchase option
Dr Financing Cost Tshs 360,000
Cr Financial Liability Tshs 360,000
Presentation in the Financial Statements
1. Statement of Financial Position:

o The Tshs 12 million is presented as a financial liability under borrowings.
o Inventory remains recorded at Tshs 9,600,000.
2. Statement of Profit or Loss:
o The Tshs 360,000 financing cost is included under finance expenses
QUESTION FOUR
General Features of Transactions Where Economic Substance Differs from

Legal Form
The economic substance of a transaction may differ from its legal form when the underlying
reality of a transaction has different implications than what is explicitly stated in the contractual
agreements. Some common features indicating a potential difference are:
1. Repurchase Agreements: Agreements that include provisions for repurchasing an asset,

suggesting the transaction might be a financing arrangement rather than a sale.
2. Retention of Significant Risks and Rewards: When an entity retains substantial risks
and rewards of ownership despite transferring legal title.
3. Non-Performance-Based Conditions: When terms like contingent payments or return
rights alter the actual timing or recognition of revenue.
4. Economic Dependency: When the transaction design makes one party economically
dependent on another, suggesting control without legal ownership.
(i) Sale and Repurchase Agreement
Analysis:
The agreement to repurchase the land at a predetermined price suggests this is not a genuine
sale but rather a financing arrangement. EFD Ltd retains the risks and rewards of ownership
because the price is fixed, and the buyer is compensated through a repurchase premium.
Accounting Treatment:
No sale should be recognized. The Tshs 5 million received is treated as a loan, and the Tshs
5.5 million repurchase price includes an implicit financing cost.
Journal Entry (1 August 2015)
Dr Cash Tshs 5,000,000
Cr Financial Liability Tshs 5,000,000
Recognition of Financing Cost (31 July 2016)
Dr Finance Cost Tshs 500,000
Cr Financial Liability Tshs 500,000
(ii) Delivery of Goods with Right of Return
Analysis:
The risks and rewards have not been fully transferred to the customer due to the right of return
and EFD Ltd's ability to request the return. This arrangement suggests consignment, not a sale.
No revenue should be recognized until the goods are sold by the customer or the return period
expires.
Journal Entry (1 July 2016):

Dr Inventory (Consignment) Tshs 400,000
Cr Finished Goods Inventory Tshs 400,000
If goods are sold by 31 August 2016, revenue will be recognized then. If goods are returned, inventory
remains unchanged.
(iii) Delivery of Goods Without Right of Return
Analysis:
The absence of a return right indicates that the risks and rewards have been transferred to the
customer. The transaction qualifies as a sale under IFRS 15 even though payment is deferred.
Revenue and cost of goods sold are recognized upon delivery.
Journal Entry (10 July 2016):
Dr Accounts Receivable Tshs 250,000
Cr Revenue Tshs 250,000
Journal Entry to Record Cost of Goods Sold:
Dr Cost of Goods Sold Tshs 160,000
Cr Inventory Tshs 160,000
By adhering to IAS 18/IFRS 15 (Revenue from Contracts with Customers) and the principle of "substance
over form," the above treatments reflect the economic substance of these transactions.

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REPORTING THE SUBSTANCE OF TRANSACTIONS

Importance of Reflecting the Substance of Underlying Transactions

1. True and Fair Representation:

Features Indicating Differences Between Substance and Legal Form:

1. Retention of Risks and Rewards:

Impact of Not Recording the Substance of Transactions

1. Misrepresentation of Financial Position:

• Assets, liabilities, and equity may be overstated or understated, providing an inaccurate

2. Inaccurate Revenue Recognition:

• Premature or delayed recognition of revenue can distort performance metrics, such as

4. Violation of Accounting Standards:

• Non-compliance with IFRS or GAAP could lead to regulatory sanctions or loss of

Analysis of the Transaction

• Cost (April 2019): Tshs 5 million

Reflecting the Legal Form of the Transaction

Extracts from the Statement of Profit or Loss:

Year Ended 31 March 2020 (Year 1):

• Revenue: Tshs 6 million

Year Ended 31 March 2021 and 2022:

Reflecting the Substance of the Transaction

Extracts from the Statement of Profit or Loss:

Year Ended 31 March 2020 (Year 1):

Year Ended 31 March 2021 (Year 2):

• Finance Cost: Tshs 660,000

Year Ended 31 March 2022 (Year 3):

• Finance Cost: Tshs 726,000

No revenue or cost of sales is recognized until the product is sold.

Aspect Legal Form Substance

Analysis of the Transaction

1. Initial Receipt of Cash (October 2015):

Dr Cash Tshs 12,000,000

Cr Financial Liability Tshs 12,000,000

Dr Financing Cost Tshs 360,000

Cr Financial Liability Tshs 360,000

Presentation in the Financial Statements

1. Statement of Financial Position:

General Features of Transactions Where Economic Substance Differs from

1. Repurchase Agreements: Agreements that include provisions for repurchasing an asset,

(i) Sale and Repurchase Agreement

Journal Entry (1 August 2015)

Dr Cash Tshs 5,000,000

Cr Financial Liability Tshs 5,000,000

Recognition of Financing Cost (31 July 2016)

Dr Finance Cost Tshs 500,000

Cr Financial Liability Tshs 500,000

(ii) Delivery of Goods with Right of Return

Journal Entry (1 July 2016):

Cr Finished Goods Inventory Tshs 400,000

(iii) Delivery of Goods Without Right of Return

Revenue and cost of goods sold are recognized upon delivery.

Journal Entry (10 July 2016):

Dr Accounts Receivable Tshs 250,000

Cr Revenue Tshs 250,000

Journal Entry to Record Cost of Goods Sold:

Dr Cost of Goods Sold Tshs 160,000

Cr Inventory Tshs 160,000

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