What principle dictates that transactions should be recorded based on their economic reality?

The principle that dictates that transactions should be recorded based on their economic reality is known as "substance over form." This principle emphasizes that the financial statements should reflect the true nature of a transaction rather than merely the legal form it takes.

In practical terms, this means that when recording transactions, accountants must consider the underlying economic reality and significance. For instance, if a company enters into a lease that effectively functions as a purchase of an asset, it should be treated as such in the financial records, regardless of the legal documentation indicating a lease agreement. This approach ensures that financial statements provide a true and fair view of the company's financial position and performance, aligning with the objective of high-quality financial reporting.

This principle is essential for the credibility and usefulness of financial information, as it helps users of the accounts to make informed decisions based not just on the surface details but also on the actual implications of transactions conducted by the entity.