What is Substance Over Form?
Substance over form is the accounting principle that transactions should be recorded based on their economic reality rather than their legal label. If a contract is called a sale but functions as financing, it should be accounted for as financing. The principle ensures financial statements reflect the true effect of transactions.
How It Works
- Read the contract and identify the legal form.
- Assess the economic substance: who carries the risks and rewards, what cash flows actually occur, and what is the commercial purpose.
- Apply the IFRS standard that matches the substance (for example, IFRS 16 for leases, IFRS 15 for revenue).
- Disclose any divergence between legal form and accounting treatment.
Saudi Context
Saudi reporters under IFRS apply substance over form across leasing (IFRS 16), revenue (IFRS 15), and financial instruments (IFRS 9). ZATCA also examines the substance of intra-group transactions for transfer pricing, especially when contracts appear designed to shift profits.
Example
A Riyadh company sells equipment to a bank for SAR 5 million with an obligation to repurchase it at SAR 5.4 million after one year. Although legally a sale, the substance is a financing arrangement, so it is recorded as a loan with interest.