Understanding Bookkeeping

An entity endeavor to ensure that the company’s financial statements reflect the financial reality of the entity (Substance) rather than the legal form of the transactions and events(Form) which underlie them.

It really that simple in the sense that if it is a cow but  was disguised in a legal form to look like a dog, Substance Over Form would prevail to reinstate that it is a cow and not a dog!  

Wow- sound simple.

But, to really substantiate or differentiate Substance Over Form, one 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:

(b) 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

© Company itself fund its own revenue

Let say in a Group of companies, Company A has recorded one transaction as a sale to a customer. Another transaction records a loan to the same customer for a similar amount. In this case, when the transactions are considered together, the sale may be without substance as it has actually been funded by the same group of company.

(d) Transaction should be lease instead of outright purchase  

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.