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:


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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