Substance over form is an accounting principle that requires transactions to be presented based on economic substance rather than legal form, with completeness, relevance, and accuracy being the three requirements. Integrity and relevance are more significant than accuracy, and companies should prioritize the bottom line.
Substance over form is a financial statement standard based on basic accounting principles. The purpose of the statement compels accountants to present transactions based on economic substance rather than legal form. Three requirements make up this accounting principle: completeness, relevance, and accuracy. Each transaction must meet these requirements on the principle of substance over form. Financial statements prepared using this principle often present information as truthfully as possible.
Integrity requires that all financial transactions represent the bottom line of each business activity. Companies must record each transaction in its entirety. If a transaction has multiple parts that will occur over time, accountants should only record the part that affects the current accounting period. Disclosures are often necessary to inform interested parties of long transactions. Any schedules or other calculations necessary to record the transactions may also need disclosure to interested parties.
Relevance means that a financial transaction has an impact on the business. For example, the cost paid several years ago for assets should not factor into replacement decisions. The price originally paid may not recur. Therefore, accountants should not include the information in any report to make a new purchase. Another example of relevance in substance over form is where the cost differs under different alternatives; only the considered alternative has a relevant cost.
Accuracy in substance over form dictates that all recorded transactions be free from error. Calculations must be clear and concise, showing the effect of financial information. In many cases, an accounting manager or supervisor may need to sign the accounting reports and statements. This signature indicates that a second person reviewed the documents, calculations, and transactions for accuracy. Reconciliations may also be necessary to test accuracy.
In some cases, accountants may sacrifice accuracy when completing financial statements. Integrity and relevance are more significant under substance than form. While accountants should strive for accuracy at all times, spending too many hours working on a project can cause financial statement delays. Other activities may also suffer when counters are delayed due to time related issues. For example, a business may not meet tax reporting or public filing deadlines.
While companies are legally required to report all information, this is not necessarily the most important aspect of financial reporting. A company usually has a legal department that reviews this information. Accountants prefer the bottom line, that is, whether the business made a profit. Trying to satisfy both legal and financial aspects on substance over form is too cumbersome for accountants.
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