The objective of IAS 24 Related Party Disclosures is to ensure that an entity’s financial statements contain sufficient disclosures to highlight the possibility that the entity’s financial position and / or performance may have been affected by:
- The existence of related parties and
- Transactions and remaining balances with related parties
It is important to realise that IAS 24 is a standard which focuses on disclosure requirements. It does not require financial statements to be redrafted because such a requirement might well prove to be impractical. Transactions might not have occurred or amounts involved might be difficult to determine, if the related party relationship did not exist.
IMPACT ON THE FINANCIAL STATEMENTS
Users of financial statements normally expect that the financial statements reflect “arms length” transactions, i.e. transactions that occur on normal commercial terms. If this was not always the case, users would have to be informed of such transactions and of the relationships underlying the financial statements. This would result in important information being provided to the users, because related parties might enter into transactions with each other on terms that unrelated parties might not.
Various types of transactions might occur between related parties (for example a parent company and its subsidiary) that may have a material impact on the Financial Statements.
Such transactions may or may not be on normal commercial terms (“at arm’s length”). Even if they are, it is still important to see them as related party transactions. It is possible, after all, that they might not have occurred in the first place but for the fact that the parties to the transaction were related.
A parent company may buy goods from its subsidiary at normal prices. On the face of it, this may seem perfectly proper. But it could mean that without the support of the parent, the revenue and profits of the subsidiary might be far less than reported.
The definition of a related party is one of the longer definitions in accounting. The standard also defines a related transaction.
A party is related to an entity in any of the following situations:
- The party controls the entity, or is controlled by it, (either directly or through intermediaries)
- It has significant influence over the entity
- It has joint control over the entity
- The parties are under common control
- The party is an associate
- The party is a joint venture in which the entity is a venturer
- The party is a member of the key management personnel of the entity or its parent. Key management personnel are individuals with authority for planning, directing and controlling the activities of the entity, including all directors (executive and nonexecutive)
- The party is a close family member of any of the above
However, when considering whether a related party exists, the entity must examine the substance of any possible relationship and not simply its legal form. For example, even though Mr. X might be a director of two separate companies, those two companies might not be considered related parties unless it can be shown that Mr X exerts influence over transactions involving both companies.
Close family members are those family members who may be expected to influence (or be influenced) by that individual and include:
- The individual’s partner, children and dependants
- Children or dependants of the individual’s partner
IAS 24 gives examples of likely exemptions, i.e. where related party relationships would not normally exist. But again, it is important to examine the substance of the relationship before a final decision is made.
Examples of entities that are usually not related parties are:
- Two venturers that simply share joint control over a joint venture
- Providers of finance
- Trade unions
- Public utilities
- Government departments and agencies
- Customers, suppliers, franchisors, other agents with whom the entity transacts a significant volume of business
Related Party Transactions
A related party transaction is a transfer of resources, services or obligations between related parties, whether or not a price is charged.
See section B above for examples of such transactions
IAS 24 requires the following disclosures, irrespective of whether transactions have taken place:
- Name of entity’s parent
- Name of the ultimate controlling party, if different.
If transactions between related parties have occurred, the following information must be disclosed, irrespective of whether a price was charged:
- Nature of the related party relationship
- Amount of the transactions
- If an outstanding balance remains, detail:
- Terms and conditions
- Existence of any guarantees
- Any bad debts provision
- The expense recognised in the period in respect of bad or doubtful debts due from related parties.
The disclosures above should be given separately for each of the following categories of related party:
- The parent
- Entities with joint control or significant influence over the entity
- Joint Ventures in which the entity is a venturer
- Key management personnel of the entity or its parent
- Other related parties
In addition, IAS 24 requires full disclosure of compensation and remuneration to key management personnel, in total, and for each of the following categories:
- Short-term employee benefits
- Post-employment benefits
- Other long-term benefits
- Termination benefits
- Share-based payments
Which of the following fall within the definition of a related party of Company X?
- A company in which the spouse of a director of Company X has the majority of voting shares?
- A company in which W, who is a director of Company X, is a non-executive director?
- A bank that has lent money to the entity?
- A supplier that supplies Company X with 65% of its raw material?
Answer 1 is the only correct response.
IAS 24 states that two parties are not necessarily related merely because they have a director in common, regardless of the fact that key management personnel are included within the definition of related parties. Further investigation would be required to examine the extent to which W has exerted influence in any dealings between the two companies of which holds directorships.