(228)-ACCOUNTING FOR SUBSTANCE

Accounting for Substance

Substance over form

The principle of substance over form was introduced in international accounting standards.
International accounting standards refers to three fundamental accounting assumptions:

1. Going concern
2. Consistency
3. Accrual

International accounting standards further refers to three considerations that should be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form.

Substance over form is defined as follows: “transactions and other events should be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form”.

Accounting for substance

The concept of substance over form has now been replaced by the concept of accounting for substance. The incidence of so-called “creative accounting” has added increased urgency to the need to develop this concept.

That can be defined as follows: “accounting for transaction in accordance with its substance requires that its accounting treatment should fairly reflect its commercial effect”.

Reporting the substance of transaction proposes that “a reporting entity’s financial statements should report the substance of the transactions into which it has entered”.

Examples of accounting for substance

• Goods sold subject to reservation of title: legal title does not pass to the purchaser until the goods have been paid for. Nevertheless accounts are drawn up including the goods in stock with a corresponding creditor, in accordance with the commercial substance of the transaction.
• Fixed assets acquired under hire purchase contracts: legal title does not pass until the final installment is paid. Nevertheless the fixed asset is included in the balance sheet right from the start together with a corresponding creditor. Again this reflects the commercial substance of the transaction.
• Finance leases: a lessee may obtain the use of a fixed asset over its useful economic life by means of a financial lease contract. Although the lessee never actual obtains legal title the lessee has rights and obligation similar to those of an outright purchaser.

Further considerations

One particular point about the types of transactions that are caught within the accounting for substance was also referred to as follows:

Many transactions are straightforward and embody a number of standard rights and obligations with the result that the commercial effect and consequent accounting treatment are well known.
Some transactions, on the other hand, combine or divide up rights and obligations in ways that make it difficult to discuss their effect on the enterprise’s assets and liabilities.

The following are common features of transactions that combine or divide up rights and obligations:

• Severance of legal title to an item from the ability to enjoy the principle benefits and exposure to the principle risks associated therewith;
• Linkage of a transaction with one or more others in such a way that the commercial effect cannot be understood without reference to the series as a whole;
• Inclusion in the terms of a transaction of one or more options or conditions whose terms make it reasonably probable that the option will be exercised or the condition fulfilled.

Some more examples for accounting for substance

• Sale of goods with a commitment to repurchase: at first sight, a sale of goods might appear to be a trading transaction, with stock replaced by cash. However, the commercial effect is that the transaction is a financing transaction. The cash received should be regarded as receipt of a loan, not as sale of goods.
• Sale and leaseback: a sale and leaseback which involves a finance lease is effectively a financing transaction and both the asset and liability should appear on the balance sheet.
• Consignment stock: consignment stock arrangements are particularly common in the motor trade. Consignment stock is held by one party but legally owned by another on terms which give the holder the right to sell the stock in the normal course of his business or, at his option, to return it unsold to the legal owner.

(227)-VARIATIONS IN ACCOUNTING PRACTICE

Variations in Accounting Practice

The accounting standards programmed has sought to eliminate the scope for variations in accounting practices, both within company annual reports and between one company and another. Nevertheless there remains significant scope for variations. Some of the more common areas are referred to below.

Impact of fixed asset revaluations

Depreciation charges may be based on either historical cost or revalued amount.

Long term contracts

Where a particular contract of less than 12 months’ duration is accounted for as long-term may well be a matter of fine judgment.

In addition, for long-term contracts which are expected to be profitable, there are several acceptable ways of allocating profit over the life of the contract.

Group accounts matters

Business combinations which satisfy the merger conditions may be consolidated either on a merger accounting basis or an acquisition accounting basis.

Where foreign subsidiaries are translated using the closing rate/net investment method, profit and loss accounts items may be translated at either average rate or loosing rate.

Under acquisition accounting, there is scope for determining the extend to which provisions for losses and reorganization costs may be taken into account under the fair value exercise. A future standard is likely to restrict this scope significantly.

Extraordinary and exceptional items

Until there has been considerable scope for deciding whether particular reorganization costs should be treated as exceptional or extraordinary. However, a financial reporting standard effectively abolish extraordinary items and introduces significant changes in both accounting disclosures.

Intangible fixed assets

Goodwill- purchased goodwill may be eliminated against reserves are as soon as it arises. Alternatively it may be carried forward as an intangible fixed asset amortized over useful life.
Development costs which satisfy the criteria may be written off to profit and loss account as they arise. Alternatively they may be capitalized as an intangible fixed asset amortized over a period.

Deferred revenue expenditure

Certain borrowing costs may be capitalized as part of the cost of a fixed asset or they may be charged to profit and loss as incurred.

Pre-opening expenses relating to new hotels or store may be carried forward in the balance sheet and expenses over a period. Alternatively they may be written off as incurred.

Pension costs

Companies were offered a choice of radically different traditional provisions. The effect of this choice will last many years.

Post balance sheet events

Certain post balance sheet events which would normally be classified as non-adjusting may be treated as adjusting in special circumstances.

The above examples are many and varied but the list is by no means comprehensive. The purpose of the above is underlining the scope for significant variations in accounting practice between different companies.

(226)-FUNDAMENTAL ACCOUNTING CONCEPT

Fundamental Accounting Concepts

Disclose of accounting policies refers to four basic assumptions underlying the periodic financial statements of enterprises. The turn used to describe these broad assumptions is fundamental accounting concepts.

• Going concern concept
  This assumption that the enterprises will continue in operational existence for the foreseeable future. This means that there is no intention or necessary either to liquidate the entity or to curtail significantly its activities.
• Accruals concept
  Revenue is included in accounts when earned rather than when money is received. Costs are included when incurred rather than when paid. Revenues dealt with in the profit and loss account are then matched with associated costs in order to determined profit.
  Should the accruals concept conflict with the prudence concept, the prudence concept prevails.
• Consistency concept
  This assumes consistency of treatment of similar items within a particular accounting period as well as from one period to the next.
• Prudence concept
  Revenues and profits are not anticipated. They are recognized in the profit and loss account only when realized either in the form of cash or of other assets. Whose cash realization can be determined with reasonable certainty?
  Provision should be made for all known liabilities whether the amount of these is known with certainty or is a best estimate in the light of the information available.
  If financial statements are not drawn up on the basis of the above assumptions, the facts should be disclosed.

Future Assumptions and Principles

These are including:

• Entity assumptions
  This assumes that for accounting measurement purposes, the business is regarded as a separate entity quite apart from its owners or proprietors. A business is regard as owning the resources which it uses and as owing the claims against those assets. The assets and liability of the business are kept completely separate those relating to the owners.
• Money measurement assumptions
  This assumes that all assets liabilities and transitions can be quantified in monetary terms.
• Stable standard of measurement assumption
  Following on from, historical cost accounting assumes that transactions occurring over a period of time can be measured in terms of a single stable measuring unit $ dollars. The obvious weaknesses of this assumption lad to calls for some form of system of accounting for price changes
• Objectivity principle
  This principle requires accounting to be carried out on an objective and factual basis. However, subjective opinions and estimates play an important part in historical cost accounting. Example of subjectivity includes estimate lives of fixed assets and net realizable value of stock items.
• Dual aspect principle
  Every change in one element of an entity (assets, liabilities, equity) is accompanied by another change of a similar amount, but in an opposite direction. This principle underlies the basis of double-entry book-keeping.
• Substance over form
  Transactions should be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form.

(225)-FINANCIAL STATEMENTS

Financial Statements

Terminology

The term “financial statements” is usually taken to include the balance sheet, profit and loss account and cash flow statement together with notes to the accounts. The term will include the additional statements and notes required by financial reporting standards (FRS).

Accounting conventions

1. Pure historical cost
   Financial statements some companies are usually prepared on the basis of the historical cost. This is taken to mean the monetary amount scarified or lay out at the date of acquisition. This basis is used both for asset measurement and profit measurement.
   2. Modified historical cost
   However, it is common for some companies to incorporate fixed assets valuations into their balance sheets. This means that under statement of standards accounting practice (SSAP) the depreciation charge will be based on the revalued amount. On a sale of the asset, the profit or loss on sale will be determined by comparing, proceeds of sale and net book value at the date of sale, based on revalued amount. The implementations of both these matters are important from the viewpoint of financial reporting standards (FRS).
2. Current cost accounting
   Some companies draw up their financial statements on a current cost basis. For example, electrical companies present current cost information.

(224)---SOME IMPORTANT LEGAL REQUIREMENTS IN FINANCIAL STATEMENTS

Some Important Legal Requirements in Financial Statements

• Terminology
  Accounting reference period (ARP), the period by reference to which the financial statements have to be prepared and presented to members. Accounting reference date (ARD), the date on which the Accounting reference period ends. Financial year (FY), the period covered by the statutory profit and loss account, whether or not this is a year.
• Accounting reference dates
  The companies Act introduced some changes to the rules. Ignoring transitional provisions companies must notify the register of companies of their Accounting reference date within nine months of incorporation.
• Accounting reference period
  The first Accounting reference period begins on the date of incorporation and ends on the Accounting reference date, and is a period of more than six months and less than 18 months. Succeeding Accounting reference periods will be for 12 months unless appropriate notice is given of a change of Accounting reference date.
• Financial year
  The financial year of a company will usually be the same as its Accounting reference period. However, to cover special situations, the financial year may begin or end on dates which are not more than seven days before or after the Accounting reference date.

Accounting Records

The companies Act required accounting records to;

1. Be sufficient to show and explain the company’s transactions
2. Disclosure with reasonable accuracy the company’s financial position at any time
3. Enable the directors to ensure that any accounts which they are required to prepare comply with companies Act.

The records must contain, entries from day to day of all sums of money received and expended and matters in respect of which the receipts and expenditure take place, a record of the company’s assets and liabilities, for a trading or merchant company dealing in goods.

(223)-PREPARATION OF ACCOUNTS AND FILLING REQUIREMENTS

Preparation of accounts and filling requirements

Form and content

Company Profit and loss accounts and balance sheets must comply with the company's act format requirements. These must be accompanied by notes which comply with the disclosure requirements of the company's act as well as the relevant standards.
In additionally to the accounts a director’s report is required
Large public limited companies which are quoted on stock exchange frequently provide more than the minimum required.

Approval and signing

Accounting for post balance sheet date events standard requires the date on which the directors approve the financial statements to be disclosed in the financial statements.
The company's act requires the balance sheet to be approved and signed on behalf of the board by a director.
The director’s report must be approved by the board of directors and signed on behalf of the board either by a director or by company secretary.

Audit

Every company must be audited by a registered auditor. The audit report must accompany the financial statements. Note that the audit requirement applies to unlimited companies and to company's limited by guarantee.

Filling

The directors are required to file with the registrar of companies a copy of the annual accounts, directors’ report and auditors report. This requirement does not apply to unlimited companies.
Special concessions are available to small and medium-sized companies. The directors of these companies may file abbreviated accounts.
There is a time limit for felling of accounts. Private companies within 10 months of the end of there reference period, public companies within seven months.

Summary financial statements

The general rule is that all shareholders and debenture holders must the sent a copy of the full accounts.

(222)-STOCK EXCHANGE DISCLOSURE REQUIREMENT

Stock exchange disclosure requirements

The international stock exchange requires the annual report and accounts of a listed company to disclose a large number of matters including the following

• a statement by the directors as to the reasons for any significant departures from applicable standard accounting practices
• An explanation, should trading results shown by the current period's accounts differ materially from any published fights forecast made by the company.
• A geographical analysis of net turnover and of contribution to trading results of those trading operations carried on outside the United Kingdom and Ireland.
• The name of the principal country in which each subsidiary operates.
• the following particulars regarding each company in which the group interest exceeds 20% of the equity capital
  (1) The country of operation
  (2) Particular of its issued capital and debt securities
  (3) The percentage of each class of debt securities attributable to the company's interest.
• A statement at the end of the financial year shoring as regards.
  (1) Bank loans and overdrafts
  (2) Other borrowing of the company/ group, the aggregate amounts payable
• A statement of the amount of Interest capitalized during the year together with an indication of the amount and treatment of any related tax relief.

a statement showing whether, so far as the directors are aware, the company is a close company for taxation purposes and whether there has been any change in that respect since the end of the financial year.