Question

Using any three examples, explain what the term Substance Over Form means.

Answer 1

Ans.

SUBSTANCE OVER FORM

Substance over form is an accounting principle used "to ensure that financial statements give a complete relevant and accurate picture of transaction and events". if an entity practices the 'substance over form' concept, then the financial statements will show all the overall financial reality of the entity (economic substance), rather than the legal form of transactions (form) in accounting for business transactions and other events, the measurement and reporting is for 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 cases of revenue recognition,sale and purchases agreementsm etc. the key point of the concept is that a tranctions should not be recorded in such a maner as to hide the true intent of the transaction, which would mislead the readers of a company's financial statements.

These are some examples of substance over legal form.

Example-1 Sale and Leaseback

Mr. X has sold a machinary to ABC Bank on that terms that tha same asset will be leased back to Mr. X under finance lease agreement the asset is sold for 1,00,000. How the tranction will be recorded in the books of Mr. X ?

Solution: Although the asset is sold to ABC bank and legally bank is the new owner, however the risks and rewards are still witn Mr. X exactly the way they were before sale as asset is given back to Mr. X under finance lease agreement for 10 years.

Therefore, substance over form concept will be applied and transaction is not a sale tranction rather a secured loan transaction and thus asset will remain in the books of Mr.X and any money recevied from ABC bank by Mr. X will be recorded as Non-current liability.

Example 2 - Sale and Leaseback

Mr.X sold an asset to Mr. Y with terms to acquire the same asset under oprating lease. The lease is for 10-years. Disposal consideration receicved by Mr. X is 55,000

How the transaction should be reported in Mr. X's books.

Solution: As the risk and rewards associated with the asset has transferred from Mr. X to Mr. Y and asset is possessed by Mr. X under operating lease the transaction will be considered a sale transaction and 55,000 will be recorded as disposal of asset with gain or loss on carrying amount accounted for appropriately. Asset will be removed from the books of Mr. X.

Example 3- Consignment

Mr. Tom and Mr. Harry are a contract. Mr. Tom manufactures units and send them to Mr. Harry who ultimately sell the units. As per contract any proceeds collected by Tom are sent to Harry after deducting agreed upon del credere commission. Once units reach Tom, any units lost or damage are to be repaired by Tom.

Solution: In the contract between Tom & Harry, The losses are on Tom only. for both units damage or lost and if customers don't pay (because of del credere commission in place ) Tom will have to take up the loss

In such case, inventory will be written in the books of Mr. Tom at the time of arrival