What are the applications of the principle of substance over form in accounting?

The principle of substance over form:

It means that an enterprise should conduct accounting according to the economic substance of a transaction or event.

They should not be based solely on their legal form.

In practice, the external or artificial form of a transaction or event does not fully and truly reflect its substance. Therefore, the transactions or events that are intended to be reflected in the accounting information must be accounted for in accordance with the material and economic realities of the transactions or events, and not in accordance with their legal form.

For example, a fixed asset leased in the form of a finance lease.

Although the enterprise does not legally own the ownership of the asset, the lease term specified in the lease contract is quite long, which is close to the useful life of the asset; At the end of the lease term, the lessee has the option of first refusal, and the lessee has the right to dispose of the assets and benefit from them during the lease period. Therefore, in essence, the enterprise controls the right to use and the right to benefit from the asset. Therefore, in terms of accounting, the fixed assets of financial leasing are regarded as the assets of the enterprise.

If an enterprise's accounting is carried out only in accordance with the legal or artificial forms of transactions or events, and these forms do not reflect their economic substance and economic reality, then the final result will not only not be conducive to the decision-making of the users of accounting information, but will mislead the decision-making of the users of accounting information.

The most typical is financial leasing assets. From a legal point of view, financial leasing assets are not assets of enterprises, but from a substantive point of view, financial leasing as an enterprise asset is more in line with the needs of management. This is the application of the principle of substance over form in accounting.

Substance over form is characteristic of the accounting models of China, France and Germany. "Substance" emphasizes the economic substance of an economic business, and "form" emphasizes the legal form of an economic business. Substance over form requires that enterprises should recognize, measure and report according to the economic substance of the transaction or event, not only on the basis of the legal form of the transaction or event.

Typical applications of substance over form are:

1. Financial leasing.

2. After-sales repurchase.

3. Sale and leaseback.

4. Determination of affiliation.

5. Preparation of consolidated statements.

Extended Materials. 1. Substance over form is an accounting principle that embodies "truth and fairness". Accounting is required to focus on the essence of economic operations rather than being confined to the letter of the law. For example, although the enterprise does not legally own the ownership of an asset leased by way of financial lease, the lease term specified in the lease contract is quite long, which is close to the useful life of the asset.

2. At the end of the lease period, the lessee has the option to purchase the asset first; During the lease period, the lessee has the right to dispose of the assets and benefit from them, so from the perspective of its economic substance, the assets leased in the form of financial lease should be regarded as the assets of the enterprise in terms of accounting recognition, measurement and reporting, if the enterprise can control the future economic benefits created by the assets of the financial lessor.

3. In practice, the external legal form of a transaction or event does not always fully reflect its substantive content, and in most cases, the economic substance and legal form of the transaction or event occurring in an enterprise are consistent. But in some cases, inconsistencies occur. At the end of the lease period, the lessee has the option to preemptively purchase the asset, and the lessee has the right to dispose of the asset and benefit from it during the lease period.

The substance over form principle requires that enterprises should account for transactions or events in accordance with the economic substance of their transactions, rather than just in accordance with their legal form.

In practice, the legal form of a transaction or matter does not always reflect its substance in a completely true way. Therefore, in order for accounting information to reflect the transactions or events it intends to reflect, it must be accounted for and reflected on the basis of the economic substance of the transactions or events, rather than solely on the basis of their legal form. The accounting standards and accounting system stipulate that the fixed assets of the financing lease shall be regarded as the fixed assets of the enterprise for accounting.

Although the fixed assets under financial lease do not belong to the enterprise in legal form and their ownership belongs to the lessor, the risks and rewards related to the fixed assets have been substantially transferred to the lessee, so the fixed assets under financial lease are regarded as the fixed assets of the enterprise for accounting.

The substance over form principle means that enterprises should conduct accounting according to the economic substance of transactions or events, and should not only use their legal form as the basis for accounting.

1. "Substance over form" emphasizes that when the economic substance of a transaction or event is inconsistent with its external performance, accountants should have better professional judgment ability and pay attention to economic substance for accounting, so as to ensure the reliability of accounting information.

2. First of all, it should be clarified that the "substance" here refers to the "economic substance" of the transaction or event of the enterprise, and the "form" refers to the "legal form" of the transaction or event of the enterprise. The principle of substance over form emphasizes that enterprises should pay attention to the "economic substance" of transactions or events when conducting accounting, rather than being completely confined to the "legal form" of transactions or events.

3. Under normal circumstances, the "economic substance" of an enterprise transaction or event is unified with its "legal form", and there is no requirement to implement the principle of substance over form. For example, the equipment purchased by the enterprise with its own funds is an asset of the enterprise from the perspective of economic substance, and from the perspective of law, the enterprise also has the ownership and use rights and the right to dispose of the equipment. However, in some individual transactions or matters, there is a certain degree of separation between its "economic substance" and its "legal form".

4. The equipment leased by the enterprise financing has the nature of purchasing the lessor's equipment in installments, and all the equipment payment will be paid only when the lease expires. Before the expiration of the lease period, the lessee did not fully acquire ownership of the asset from a legal point of view. However, from an economic substance perspective, the benefits and risks associated with the asset have been transferred to the lessee, who has effectively exercised control over the asset.

According to the principle of substance over form, the tenant can treat it as its own fixed assets and account for them according to the accounting method of its own fixed assets.