FASB to Practitioners: ‘Substance Over Form’ for Me but Not for Thee – An Apologia

Symposium: Substance over Form in Accounting

1. The Decline of Substance over Form in Accounting, by Dov Fischer, Ortal Ellman and Sholom Schochet, https://doi.org/10.1515/ael-2019-0052.

2. The Decline of Substance over Form in Accounting: A Problematic Dichotomy, by Paul F. Williams, https://doi.org/10.1515/ael-2021-0119.

3. FASB to Practitioners: ‘Substance Over Form’ for Me but Not for Thee – An Apologia, by Dov Fischer, https://doi.org/10.1515/ael-2022-0046.

1 Introduction

Fischer et al. (2021, The decline of substance over form in accounting. Accounting, economics, and law: A convivium) discuss the decline of “substance over form” as a concept guiding the practice of individual accountants and auditors. Williams (2022, 2021, The decline of substance over form in accounting: A Problematic Dichotomy. Accounting, economics, and law: A convivium) raises several objections to Fischer et al. First, Williams notes that substance is an ephemeral concept; it is not an absolute, objective, observable phenomenon. Williams further notes that substance and form are not antipodes, so the apparent lament by Fischer et al. about the relative decline of substance over form is misplaced since one does not come at the expense of the other.

2 Reformulating “Decline of Substance Over Form” to: “Decline of ‘Substance Over Form’”

Williams understood the meaning of “Decline of Substance over Form in Accounting” in the title of Fischer et al. to indicate that there has been a decline of substance relative to form in the practice, theory, or regulation of accounting. I posit that the actual intent of the Fischer et al. was to convey a slightly different idea, which could have been better expressed as “The decline of ‘substance over form’ in Accounting.” Indeed it is the whole concept of ‘substance over form’ and the related practice which has been declining over time, notably during the FASB era.

Consequently, the difference between the former (as published) and latter (clarified) titles is as follows. The former (“Decline of Substance over Form in Accounting”) claims that substance has declined relative to form. It also implies that substance and form are antipodes and that when one rises it does so at the expense of the other. The revised formulation (“The decline of ‘substance over form’ in Accounting”) refers to the concept of “substance over form” as a guiding principle in the practice of accounting and auditing, and it claims that the use of this concept as a guiding principle has declined.

The revised expression avoids the implication that form and substance or antipodes. Fischer et al. do not actually claim or document that substance has declined relative to form nor do they malign form. As Williams points out, form and substance are complementary. What Fischer et al. document, and what our title should have conveyed more clearly, is that FASB has de-emphasized the concept of “substance over form” as a guiding principle for practicing accountants (but not as a guiding principle for their own standard-setting process).

If substance and form are not antipodes, why then is “substance over form” a relevant concept, and why is FASB wrong to de-emphasize it for practitioners? Our answer is that the “substance over form” concept does not imply that they are antipodes. Rather, it states that when the two generate different reporting outcomes then practitioners should have the prerogative to prioritize substance over form. Furthermore, substance should inform the nature and direction of the form in which accounting practice develops.

3 FASB Monopoly on Substance

Another way looking at the phenomenon is to ask whether standard-setting should be a top-down or bottom-up enterprise Sunder (2017). As expressed by the term “generally accepted accounting principles” (GAAP), accounting standards were originally a bottom-up enterprise in that standards developed based on practice. In cases when individual practitioners judged GAAP to violate economic substance they had the prerogative to over-ride GAAP and eventually the (pre-FASB) standard setters confirmed the evolution of GAAP based on practitioners’ judgement.

In the past few decades, standard-setting has taken a top-down approach with FASB adjusting accounting standards based on theoretical formulations Biondi (2011). In practice, this has removed the prerogative of individual practitioners to organically evolve “generally accepted accounting principles.” In fact, under the current standard-setting regime, the term GAAP is a misnomer. Like the Holy Roman Empire (which was neither holy, nor Roman, nor an Empire), GAAP is neither “generally”, nor “accepted”, nor “principles” (some would say not even “accounting”). A more appropriate acronym would be Centrally Mandated Accounting Rules (CMAR).

As Fischer et al. (2021) point out, “substance over form” has never been stronger as a concept in FASB’s internal standard-setting process. That is, FASB has been actively reformulating financial reporting standards based on the board members’ and staff views of what the substance of financial statements should communicate. At the same time, Fischer et al. (2021) show that FASB has taken away degrees of freedom from practitioners to use their independent professional judgement to over-ride accounting standards when these standards come into conflict with the economic substance of transactions.

In retrospect, a much better title for Fischer et al. would have been “FASB to practitioners: ‘Substance over Form’ for me but not for thee.”