What does the term 'substance over form' mean in accounting?

The term 'substance over form' in accounting emphasizes that transactions and events should be accounted for and presented in accordance with their economic reality rather than merely their legal form. This principle ensures that the financial statements provide a true and fair view of an entity's financial position and performance, which may differ from the legal arrangements in place.

For example, a lease agreement might legally classify as an operating lease, but if it effectively transfers most of the risks and rewards of ownership to the lessee, it may need to be treated as a finance lease for accounting purposes. By focusing on the underlying economic reality, this principle helps to prevent manipulation of financial statements that may arise from strict adherence to the legal form without consideration of the actual substance of the transactions.

This understanding supports transparency and accuracy in financial reporting, aligning it more closely with the interests of stakeholders who rely on the financial statements to make informed decisions.