Related parties Chapter learning objectives Upon completion of this chapter you will be able to: determine the

he parties considered to be related to an entity identify the implications of related party relationships and the need for disclosure

1 Definition of a related party IAS 24 Related party disclosures, as revised in November 2009, states that a party (an individual or an entity) is related to another entity if it:

 controls, is controlled by, or is under common control with the entity has significant influence over the entity has joint control over the entity is an associate of the entity is a joint venture of the entity is a member of the key management personnel of the entity or its parent is a close family member of anyone with control, joint control or significant influence over the entity or of any members of key management personnel is controlled, jointly controlled or significantly influenced by any individual referred to above is a post-employment benefit plan for the benefit of employees of the entity or any of its other related parties. Previously, if a government controlled, or significantly influenced, an entity, the entity was required to disclose information about all transactions with other entities controlled, or significantly influenced by the same government. The revised standard still requires disclosures that are important to users of financial statements but eliminates requirements to disclose information that is costly to gather and of less value to users. It achieves this balance by requiring disclosure about these transactions only if they are individually or collectively significant. Similarly, the revised definition introduces symmetry in the definition to either identify two entities as either being related or not related, from whichever perspective is considered. The main amendments to the definition are: (1 The inclusion ) of: the relationship between a subsidiary and an associate of the same parent, in the individual financial statements of both the subsidiary and the associate. two entities where one is an investee of a member of key management personnel (KMP) and the other is the entity managed by the person that is a member of KMP. (2 The removal of: ) situations in which two entities are related to each other because a person has significant influence over one entity and a close member of the family of that person has significant influence over the other entity. The most common related party relationship occurs where one

Expandable text - Further detail on definitions direct. An example: parent owns more than half the shares in a subsidiary. indirect. An example: parent owns more than half the shares in subsidiary 1, which owns more than half the shares in subsidiary 2, Through its direct control of subsidiary 1, which itself has direct control over subsidiary 2, parent has indirect control over subsidiary 2. Test your understanding 1 - X X is an 80% owned subsidiary of T. The directors of X are A, B, C and D. Which of the following are related parties of X? (a V, which is not part of the T group, but of which A ) is a director. (b Y, who owns 20% of the shares in X. ) (c K, the financial controller of X (who is not a ) director). (d M, the wife of the chairman of Q, an entity in the ) T group. Test your understanding 1 - X Show Answer (a V and X are subject to common influence from A, but V is not a ) related party unless one or both companies have subordinated their own separate interests in entering into a transaction. (This assumes that A is the only director to serve on both boards; if there were a common nucleus of directors, a related party relationship would almost certainly exist.) (b Y is almost certainly not a related party. According to the ) definition Y might be presumed to be a related party, but the existence of a parent entity (T owns the other 80% of the shares) means that Y is unlikely to be able to exert significant influence over X in practice. (c K may be a related party, despite the fact that he or she is not ) a director. A financial controller would probably come within the definition of key management personnel (i.e. those persons having authority and responsibility for planning, directing and controlling the activities of the entity). The issue would be decided by the extent to which K is able to control or influence the policies of the entity in practice. (d M may be a related party. Companies Q and X are under ) common control and M falls within the definition of close family of a related party of Q. M is not a related party if it can be demonstrated that she has not influenced the policies of X in such a way as to inhibit the pursuit of separate interests. 2 The need for disclosure of related parties

A related party transaction is the transfer of resources, services or obligations between related parties, regardless of whether a price is charged. Transactions between related parties are a normal feature of business. But a related party relationship can affect the performance and financial position of an entity as shown by its financial statements. Expandable text - Illustration Users of the financial statements need to be made aware of any related party transactions that have occurred. They also need to be made aware of the existence of related party relationships even where there have been no transactions during the period. Expandable text - Examples of related party transactions purchases or sales of goods purchases or sales of non-current assets giving or receiving of services e.g. accounting or management services leasing arrangements, e.g. allowing the use of an asset transfers of research and development financing arrangements (including loans) provision of guarantees or collateral settlement of liabilities on behalf of the entity. An entity may enter into transactions which may not have occurred if the relationship did not exist, e.g. a subsidiary may sell most of its production to its parent, where it might have found an alternative customer if the parent company had not purchased the goods. An entity may enter into transactions on different terms from those with an unrelated party, e.g. a subsidiary may lease equipment to another group company on terms imposed by the parent, possibly at a low rent or for no rent. Transactions with third parties may be affected by the existence of the relationship, e.g. a parent could instruct a subsidiary to sell goods to a particular customer or to close down a particular operation. 3 Disclosure of related parties

Disclosure of control IAS 24 requires that relationships between parents and subsidiaries are disclosed including the: name of the parent name of the ultimate controlling party (if different) relationship, whether or not any transactions have taken place between the parties during the period. Disclosure of management compensation Any compensation granted to key management personnel should be disclosed in total and for each of the following categories: short-term employee benefits post-employment benefits other long-term benefits termination benefits share-based payment. Disclosure of transactions and balances If there have been transactions between related parties, the reporting entity should disclose: the nature of the related party relationship a description of the transactions the amounts of the transactions the amounts and details of any outstanding balances allowances for receivables in respect of the outstanding balances the irrecoverable debt expense in respect of outstanding balances. Disclosure should be made whether or not a price is charged. Expandable text - Further detail on disclosures

 the parent entities with joint control or significant influence over the entity subsidiaries associates joint ventures in which the entity is a venturer key management personnel other related parties. providers of finance trade unions utility companies government departments and agencies customers, suppliers, franchisers, distributors and general agents with whom the entity transacts a significant volume of business. Test your understanding 2 - Ace

Ace The objective of IAS 24 Related party disclosures is to ensure that an entitys financial statements contain the disclosures necessary to draw attention to the possibility that its financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances with such parties On 1 April 20X7, Ace owned 75% of the equity share capital of Deuce and 80% of the equity share capital of Trey. On 1 April 20X8, Ace purchased the remaining 25% of the equity shares of Deuce. In the two years ended 31 March 20X9, the following transactions occurred between the three companies: (i) On 30 June 20X7 Ace manufactured a machine for use by Deuce. The cost of manufacture was $20,000. The machine was delivered to Deuce for an invoiced price of $25,000. Deuce paid the invoice on 31 August 20X7. Deuce depreciated the machine over its anticipated useful life of five years, charging a full years depreciation in the year of purchase. (ii On 30 September 20X8, Deuce sold some goods to Trey at an ) invoiced price of $15,000. Trey paid the invoice on 30 November 20X8. The goods had cost Deuce $12,000 to manufacture. By 31 March 20X9, Trey had sold all the goods outside the group. (iii For each of the two years ended 31 March 20X9, Ace provided ) management services to Deuce and Trey. Ace did not charge for these services in the year ended 31 March 20X8 but in the year ended 31 March 20X9 decided to impose a charge of $10,000 per annum to each company. The amounts of $10,000 are due to be paid by each company on 31 May 20X9. Required: (a Explain why related party ) disclosures are needed. (6 marks) (b Summarise the related-party disclosures which will be ) required in respect of transactions (i) to (iii) above for BOTH of the years ended 31 March 20X8 and 31 March 20X9 in the financial statements of Ace, Deuce and Trey. (14 marks)

Test your understanding 2 - Ace

Show Answer (a The financial statements would be very difficult to understand ) if readers were not informed of any related party transactions. For example, cost or selling prices could be distorted by the fact that goods are being purchased from or sold to a related party. In extreme cases, this might be part of a deliberate strategy to manipulate the apparent profitability of one or other party. For example, one person might own two businesses and might have one sell to the other at a premium or a discount. This could make one business appear more profitable if our owner ever decides to sell it. There could also be tax advantages to making one generate a profit and the other a loss. (b Disclosure of related party ) transactions the consolidated financial statements of Ace the individual financial statements of Deuce the individual financial statements of Trey. name of related party with which the transaction was made description of the relationship between the parties description of the transaction and the amounts involved (including the fair value of the transaction if this is different from the actual value) any amounts due to or from related parties at the year end (including any doubtful debts) any amounts written off related party receivables any other information necessary for an understanding of the transaction and its effect on the financial statements. It is assumed that all the related party transactions are material. Ace: Deuce Trey Consolidat ed financial statement s (i Sale of Disclose ) machine by intra-group Ace to Deuce profit on sale of $5,000. Otherwise sale eliminated on consolidatio Disclose purchase of machine from parent at $25,000 and depreciation charge of $5,000. No amounts outstanding at year end

Expandable text - UK syllabus focus directly, or indirectly through one or more intermediaries, the party: (i) controls, is controlled by, or is under common control with, the entity (this includes parents, subsidiaries and fellow subsidiaries); (ii) has an interest in the entity that gives it significant influence over the entity; or (iii) has joint control over the entity; (b) the party is an associate (as defined in FRS 9, Associates and joint ventures) of the entity; (c) the party is a joint venture in which the entity is a venturer (as defined in FRS 9, Associates and joint ventures); (d) the party is a member of the key management personnel of the entity or its parent; (e) the party is a close member of the family of any individual referred to in subparagraph (a) or (d); (f) the party is an entity that is controlled, jointly controlled or significantly influenced by, or for which significant voting power in such entity resides with directly or indirectly, any individual referred to in (d) or (e); or (g) the party is a retirement benefit scheme for the benefit of employees of the entity, or of any entity that is a related party of the entity. 4 Chapter summary