Substance Over Form

June 20th, 2006 Comments off
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To ensure that the financial statements reflects the complete, relevant and accurate picture of the transactions and events, it is important to appreciate and adhere to this concept called Substance Over Form

WHAT IS SUBSTANCE OVER FORM?
When an entity practice the Substance Over Form, it means that the financial statements reflect the financial reality of the entity (Substance) rather than the legal form of the transactions and events(Form) which underlie them.To put it very simply: if it is a goat but it was disguised in a legal form to look like a dog, Substance Over Form would prevail to reinstate that it is a goat and not a dog!To be able to differentiate Substance Over Form, we need to be vigilant, have very good inner knowledge of the company’s operation and takes a more investigative in-depth approach so as to seek further evidence or proof. This is because normally these types of events or transactions are often quite complex. These events or transactions happen just around the accounting year ended. (balance sheet date)

We have seen many cases whereby many accounting fraud occur as a result of this lack of Substance Over Form.

Cases like Enron and Computer Associate are describe below:

Examples:Exchanging revenue/revenue swap:In the Computer Associate case, the CEO of the company swap or exchange revenue with another company. What it did was CSA purchased a certain software/service from the company A and in turn company A also purchased from CSA. Its look like a sale and it being recognized as revenues in the Income Statement

In the Enron’s case we have:

Enron group’s use of over 3000 Special Purpose Entities (SPEs) structured in such a way as to enable the company to avoid including extensive debt in the consolidated financial statements of the group.

Other examples like:-

Company itself fund its own revenue

An outright purchase of capital equipment, whereas in fact the substance of the transactions is a lease of (or perhaps an option to purchase) the equipment.

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