Substance Over Form Concept Example - Definition - Meaning - Explanation - Importance

Here we study about Substance Over Form Concept with Example, which is very important Accounting Concept.

Substance Over Form Concept Definition And Meaning

All the events should be recorded and analyzed on the basis of their substance and economic benefits and not merely on the legal form or ownership.

This concepts emphasizes that in a Business Transaction, we take into account two aspects (i) Legal Form which means Ownership of Property or Asset (ii) Substance Form which means Economic Benefits, Rights And Risks associated with the Property or Asset. Where only Ownership of an asset is transferred to other party but benefit associated with that asset are not transferred, then economic benefits are preferable over legal form.

For Example, if an entrepreneur disposes of the an Asset to other person and transfers the ownership of asset but the future economic benefits associated with that particular asset are still enjoying by that Entrepreneur, then the recording, analyzing and financial reporting of this transaction can not represent true and fair view of financial statements of company businesses or entrepreneurs’ businesses. So, the company is responsible for the rewards and loos associated with that asset but other party to whom the ownership is transferred and should record and report it on its Financial Statement.

Importance Of Substance Over Form

Substance Over Form Concept has great importance for an organization who conducting its business according to the requirements of Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) previously known as International Accounting Standards (IAS).

By implementing this concept, the organization can provide reliable and fair view of Financial Statement to Users of Financial Statements as the business considers the economic benefits associated with the assets and not see merely legal form or ownership of the assets.

Limitations / Criticism On Substance Over Form Concept

Both Legal form (Ownership, Legal Status) and Substance (Risks And Rewards, Possessions) Form are important in a Business Transaction, as it affects the parties involved in a transaction. Moreover, it is against the Accounting Concept Reliability, that financial Statements must provide true and reliable information to Users of Financial Statements necessary for Fair Presentation of Financial Statements (IAS-1). For Example, in case of Financial Lease, the ownership is with the Lessor but Financial Statements of Lessors’s business doesn’t show about the ownership of this asset’s information and see only Substance Form and ignore Legal Form that is not true.

So, we can not ignore one aspects and override one another in a Business Transactions in order to give reliable, true and fair view of Financial Reporting To Users of Financial Statements.

So, We Conclude that under Substance Over Form Concept, Substance And Economic Benefits associated with a Particular Asset Are Preferred Over Legal Form when Only Ownership Is Transferred to other party. So, while recording and analyzing Business Transactions and interpreting of financial statements, we must consider not only substance and economic realities but also their legal forms. So, we can not ignore substance and economic reality associated with an asset and merely concentrate on its legal form.