As you have already learned about other forms and norms of recording an entity’s accounting information this is a necessary addition to that palette. Every reason is existent here for this to be added in your knowledge base. Now, what should you expect from this one? The simple one is- this is a concept to be implemented to ensure accurate representation. Get an overview:
“Financial reporting should be in such a form where only the mathematical immaculateness and relative disclosures are not enough. There should be representation in such a form where economic values of transactions and also the impact of the transactions are considered while disclosure is made.”
This means a simple form of things should not be overrated and be prioritized over the inside content of the thing.
See, when a transaction is made and the monetary change is made then it is evident that the transaction will appear in financial statements, but, the substance over form states that the transaction when recorded should be evaluated with all its characteristics and the other information which may influence the decision making. So, keeping only the mathematically immaculate data is not enough. Check the example below.
XYZ co. leased machine A to PQR co. at a rate of Tk.20000 per month. The lease is for 20 months. The value of the machinery is Tk.450,000.
Here the machine is not purchased by PQR co. and they are under no obligation to show that in their balance sheet as an asset. But, substance over form dictates otherwise.
As per substance over form:
Though the machine is not purchased and PQR need not show the machine in their balance sheet as per the accounting rules, it is customary for them to show it in their annual reports as a notes inclusion or, even may put that in the balance sheet as an asset.
The reason behind this is the value of the asset is almost 80% covered by the per month rate payments.
So, even though they are not getting the machine completely at the end of the rates payment completion, they will need to go for recording the machine as their asset. The recording makes it possible for the investors to make decision easily and more convincingly as they know everything in full.
To learn about lease and related stuffs with lease go through the lease, present value, future value, amortization schedule and rate payment sections.