Form v. substance

Financial statements drawn up under the Companies Act 1985 are in many ways legal documents. In a literal sense they are required to be produced by law, and to be filed at Companies House. In another sense, too, they must comply with the many detailed requirements of the Act. Yet, there is a strong notion of ‘substance’ in accounting. This has become stronger in the last twenty years or so. In earlier, simpler, times, following the legal form of a transaction generally gave an appropriate accounting result. But, as business transactions have become more complex, there have been an increasing number of transactions in which legal form and economic substance have diverged from each other; gradually, it became clear that following the legal form did not properly reflect the commercial transaction.

To accountants, the basic legal requirement that accounts must give a ‘true and fair view’ (discussed in chapter 3 at pp. 26–7) means that they must reflect the economic substance of a transaction and not just its legal form. This is not stated in law; it is merely the accepted view of accountants.

Early examples

For some years, there were examples of substance over form being applied to common transactions, almost as second nature, rather than by applying a specific rule or even consciously applying the substance over form principle. One example is accounting for an asset being ‘bought’ under hire purchase.