It is very pertinent we understand what is exactly meant by asset in the first place, second what is

usufruct, and here we discuss the implications of substance over form and then analyze and
decide whether usufruct is an asset or not. According to IFRS Conceptual Framework for
Financial Reporting (March 2018) an asset is defined as, “A present economic resource
controlled by the entity as a result of past events. An economic resource is a right that has the
potential to produce economic benefits”. This definition of an asset has three distinctive features
and whatever fulfills these features shall be regarded as asset. First an asset is the economic
resource, not the ultimate inflow of economic benefits. Second, it does not need to be certain, or
even likely, that economic benefits will arise. Third, a low probability of economic benefits
might affect recognition decisions and the measurement of the asset. The recognition criteria,
relevance and faithful representation refers explicitly to the qualitative characteristics of useful
information. The aim is to develop a more coherent set of concepts, not to increase or decrease
the range of assets and liabilities recognized.

It is worth noting that the framework defines asset in terms of control rather than ownership.
While control is generally evidenced through ownership, this may not always be the case.
Therefore, an asset may be recognized in the financial statement of the entity even if ownership
of the asset belongs to someone else. For instance, if a machine is leased to a company for the
entire duration of its useful life, the machine may be recognized in its balance sheet since the
entity has control over the economic benefits that would be derived from the use of the asset.
This illustrates the use of Substance over Form whereby the economic substance of the
transaction takes precedence over the legal aspects of a transaction in order to present a true and
fair view.

Since, by definition, an asset must be controlled by the entity in order for it to be recognized in
the financial statements, certain 'Assets' would not qualify for recognition. Consider a highly
dedicated workforce; a hardworking and motivated workforce is the most valuable asset of any
successful company. But does an entity have control over its workers? The answer is no, because
an employee may quit an organization any day and seek employment in a rival firm much to the
detriment of the company. Therefore, such 'Assets' may not be recognized in the financial
statements of a company.
Assets are generally classified in three ways; convertibility, physical existence and usage.
Convertibility is classifying assets based on how easy it is to convert them into cash. Physical
Existence refers classifying assets based on their physical existence (tangibles vs. intangibles).
Usage refers classifying assets based on their business operation usage/purpose.

A usufruct is a legal right accorded to a person (usufructuary) that confers the temporary right
and control to use and derive income or benefit from someone else's property ( naked owner)
provided its substance is neither impaired nor altered. It is a limited real right that can be found
in many mixed and civil law jurisdictions. For example, a usufructuary right would be
the right to use water from a stream in order to generate electrical power. A usufruct is
considered to be a real right; it confers direct or immediate authority and control over the
property.  A usufruct can apply to real estate, tangible assets and intangible assets. A
usufructuary can use, possess, and administer the property, as well as collect the income, utility,
profits, and other advantages produced from the property. 

A usufruct would come into play, where a husband passes away leaving his home to his children
but stipulates that his wife has use of the property and contents in it for the rest of her life or until
she remarries. While the property is transferred into the name of the children, the usufruct is
registered against the new title deed in favour of the surviving spouse. Although the children are
ultimately the heirs to the property, they will have no right or authority with regard to how the
property is used or enjoyed.

Let us take a house as an example. A right of ownership gives owner three types of prerogatives.
First, the right to use the property (i.e. live in it); second, the right to receive income from the
property (i.e. rent it), and the last, the right to dispose of the property (i.e. sell it). But an owner
can divide these prerogatives into two groups, on the one hand there is the usufruct which
includes the right to use the property and receive income from it, on the other there is the bare
ownership which is the usufruct encumbered property. Usufruct is a useful tool for giving
someone possession without having to give them ownership. Usufruct may be constituted over
immovable, and also movables which are not consumable through use.

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Usufruct rights are many and varied, most dating back to early Roman law. The usufructuary is
first of all entitled to the possession of the property. The usufructuary is entitled to and may take
the fruits of the property. He acquires the ownership in the natural and industrial fruits only when
they are separated from the property; but civil fruits, such as rent and interest due in respect of
the property, vest in the usufructuary without collection by, or payment to him. Since a usufruct
is strictly personal, the usufructuary may not alienate the usufruct itself, that is, he cannot
transfer the usufruct to another person so as to give the transferee the usufruct for his, the
transferee’s lifetime.

The concept substance over form means that the transactions recorded in the financial statements
must reflect their economic substance rather than their legal form. It subdues the legal form of a
transaction and substitutes it with the economic form in order to increase the fairness in the
affairs of a company. The concept signifies that transactions must be seen according to their
economic or financial reality instead of their legal formation to foster a more objective picture of
the transactions and events. It ensures that recording of a transaction should not hide its true
intent, which would mislead the readers of a company's financial statements. It compels to
present the true intentions behind a transaction so that users may not be misdirected.

Some examples clarify its practical implications. Phillip gets into a contract to lease a building
for 50 years, almost all of the useful life of the building. Building is legally owned by the lessor
but according to economic reality, the building will be owned by the Phillip (lessee) because
lessee is controlling building and is deriving maximum economic benefits from it. So according
to this concept (IAS 17) the building will be recorded as an asset in the financial statement of
Phillip and will be depreciated as any normal asset, and remaining payments will be deemed as a
decrease in liability rather than lease rental.

It is particularly relevant in cases of revenue recognition, sale and purchase agreements, etc.
Another example is the situation where a company short of cash sells its inventory/machinery to
the counterparty promising buy the same inventory after a specified time at an inflated price. On
paper, the sale and buy back may be deemed as two different transactions; however the economic
reality of the transactions is that no sale has in fact occurred. The sale and buy back, is actually a
financing arrangement in which the seller has obtained a loan which is to be repaid with interest
(via inflated price). Inventory acts as the security for the loan which will be returned to the

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'seller' upon repayment. So instead of recognizing sale, the entity should recognize a liability for
loan obtained which shall be reversed when the loan is repaid. The excess of loan received and
the amount that is to be paid (i.e. inflated price) is recognized as finance cost in the income
statement. IAS 18 considers the economic substance of the sale agreement while determining
whether a sale has occurred or not. Under the substance-over-form principle, the sale and
subsequent buyback are considered one transaction. Similarly, if two companies swap their
inventories, this event is not accounted as a sale because the substance is a mere in-kind
exchange, despite the possible form of valid enforceable contracts for two sales and deliveries.

Substance over form is a particular concern under US-GAAP, since GAAP is largely rules-
based. Thus, someone intent on hiding the true intent of a transaction could structure it to just
barely meet GAAP rules, which would allow that person to record the transaction in a manner
that hides its true intent. Conversely, International Financial Reporting Standards (IFRS) are
more principles-based, so it is more difficult for someone to justifiably hide the intent of a
transaction if they are using the IFRS framework to construct financial statements.

The issue of ownership versus control is an old one but it got prominence with the advent of
corporate form of businesses. In corporations the owners are shareholders. To manage the affairs
efficiently, they elect board of directors from themselves and BOD in turn hire manager. It is the
manager, a paid employee, who runs and controls the business. Separation of ownership and
control creates agency problem and to mitigate the effects of agency problem, shareholders incur
handsome amount of resources. The separation of ownership and control is also called divorce of
ownership from control. When I deposit money in my account, I am the owner of that money but
bank controls the deposit and gets economic benefit from that deposit because of its control. In
case of trust or guardianship of a minor, trustees and guardians have just a fiduciary duty towards
assigned trust or property, they are not the owners but they control the property and trust and
take all actions independently and in full authority.

There is philosophical aspect of ownership vs. control, since books can easily be lost or stolen;
possessing books is a matter of control, while possessing knowledge is a matter of ownership.
Possessing money is a matter of control, while possessing skills to earn money is a matter
of ownership.

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Patents and franchise are intangible assets as they fulfilled the definition of asset. In case of
franchise, Golden Arches of MacDonald, KFC of Colonel Sanders are owned by someone in
USA but all over the world, thousands of restaurants controlled these logos and trade name and
earned economic resources from them. Oracle is owned by Lawrence Joseph Ellison but they are
used and controlled by thousands of businesses who earn economic benefits so the case of SAP.

From the discussion, it is evident that usufruct is an asset, as it fulfills the criteria of being an
asset. Usufructuary has control over the asset and economic benefits go to him. The conclusion is
also proved by the principle of substance over form.

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