Question

The basic concept of "substance over form" influences lease accounting. Explain

Answer 1

One of the accounting concepts of "Substance over Form" says that the Business transactions should be recorded in the books of accounts based on the economic purpose instead of their legal form in order to have a true and fair view of the records. The main purpose is that the business transactions should not be recorded in a way that it will hide their true intent.

In Lease Accounting, it applies to Capital Lease or Finance Lease where there is no transfer of title of the asset under Finance lease during the payment of lease installments but a finance lease is accounted as a purchase of an asset, The Lessee records it as an asset by recognizing and repaying the lease liability through installment payments to the Lessor containing both interest and principal amounts. Lessee records such interest as an expense and the principal amount reduces the liability and also Lessee depreciates the leased assets as other assets of the lessee. But this process of record the asset by the Lessee is against the concept of "Substance over form" as there is no asset or liability should be recorded by the lessee as Lessee should record lease payments as expenses when the legal form needs to be given effect.