Faithful Representation


Information presented in the financial statements should faithfully represent the transaction and events that occur during a period.

Faithfull representation requires that transactions and events should be accounted for in a manner that represent their true economic substance rather than the mere legal form. This concept is known as Substance Over Form.

Substance over form requires that if substance of transaction differs from its legal form than such transaction should be accounted for in accordance with its substance and economic reality.

The rationale behind this is that financial information contained in the financial statements should represent the business essence of transactions and events not merely their legal aspects in order to present a true and fair view.

Example

A machine is leased to Company A for the entire duration of its useful life. Although Company A is not the legal owner of the machine, it may be recognized as an asset in its balance sheet since the Company has control over the economic benefits that would be derived from the use of the asset. This is an application of the accountancy concept of substance over legal form, where economic substance of a transaction takes precedence over its legal aspects.

Test Your Understanding

ABC LTD sold 3000 bread loafs to XYZ Bakers in the year 2011 costing $1 each. XYZ Bakers has the option to return unsold breads to ABC LTD within 7 days of the sale. In the first week of 2012, XYZ Bakers returned 200 of unsold bread loafs to ABC LTD. How much sale should ABC LTD recognize in the income statement for the year 2011?

$3000

$2800