The idea of “Substance over Form” suggests that rather than relying exclusively on a corporation’s legal structure, the capture and recording of financial transactions should consider the economic substance of the business.
The Finance lease agreement, in which the lessee does not legally own the leased item but is portrayed as an asset for the business since it is utilized to generate revenue for the enterprise, is a classic example used to illustrate this notion.
A transaction is an example of an occurrence that might change a corporate entity’s financial situation. The majority of the time, a contract between a buyer and a seller created assets for one party and/or a liability for the other party. Business transactions include things like purchasing raw materials, selling inventories, entering into contracts and obtaining a bank loan.
Example of Substance over form
Substance = Realism (true value)
Form = Value in documents (legal value/form)
This concept believes that accountant should value the transaction at substance. Let’s understands the concept with the following example.
You found out during an audit at Michael Sdn Bhd that the company paid RM 2,000 to TT Sdn Bhd for RM 1,000 sqf land. You become aware of how a RM 1,000 plot have been acquired for RM 2000 in this way.
So, you meet with the company’s management and look over any supporting documentation. You were taken back by the RM 2,000 agreed-upon selling deed. It was then uncovered that Michael Sdn Bhd had committed to giving a certain production method (internally created) in exchange for RM 2,000 and this. However, the agreement made no mention of it. The site therefore had a RM 20,000 market value, and a scale document was created for RM 2,000 instead.
In the above statement, there are two forms.
Substance form (Real value) = RM 20,000
Legal form (Value in documents) = RM 2,000
Therefore, documenting transactions of RM 2,000 will result in a breach of the accounting principle known as content over form. As a result, the transaction recording needs to be corrected and it must be done at a genuine value of RM 20,000 instead of the incorrect number.
So, Michael Sdn Bhd needs to record the transaction as follows:
The debit impact of the transaction is recorded for the plot purchased. The second credit is cash paid for the purchase plot. However, the market value of the plot is RM 20,000. So a balance of RM 18,000 (20,000 – 2000) is a balancing figure, which will be the value of the production technique sold to TT Sdn Bhd
The crucial accounting practice is to prioritize content above form. It indicates that the financial statement should reflect the transaction’s actual form. This idea contributes to the financial statement’s increased dependability. Additionally, it aims to improve the financial statement’s accuracy and fairness.
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