Chapter 4 Related Parties

TECHNICAL KNOWLEDGE

To understand the concept of related parties.

To identify related parties.
To know the requirements for disclosure of relates party relationship.
To know the requirements for disclosure of related party transactions.

DEFINITION
Related party - parties are considered to be related if one party has :

a. The ability to control the other party.

b. The ability to exercise significant influence over the other party.
c. Joint control over the entity.

Control​ is the ​power over the investee​ or the ​power to govern​ the financial and operating
policies of an entity so as to obtain benefits.

Control is ownership directly or indirectly through subsidiaries of ​more than half​ of the voting
power of the entity.

Significant influence is the ​power to​ ​participate​ in the financial and the operating policy
decision of an entity, but not control of those policies.

Significant influence may be gained by share ownership of 20% or more.

If an investor holds directly or indirectly through subsidiaries, 20% or more of the voting power
of the investee, it is presumed that the investor has significant influence , unless it can be clearly
demonstrated that this is not the case.

Beyond the mere 20% threshold of ownership, the existence of significant influence is usually
evidenced by the following factors :

a. Representation in the board of directors.

b. Participation in policy making process.

c. Material transactions between the investor and the investee.

d.Interchange of managerial personnel.

e Provision of essential technical information.

Joint​ Control is the contractually agreed sharing of control over an economic activity.

Examples of Related Parties

1. Entities that directly or indirectly through one or more intermediaries, controll or are
controlled by or under common control with reporting entity .

Such entities pertain squarely to ​affiliates,​ meaning the parent , the subsidiary and the fellow
subsidiaries.

2. Associates - These are the entities over which one party exercises significant influence .

The term associates includes the subsidiary or subsidiaries of the associate.

3. ​Venturer​ in a joint venture.

A joint venture includes the subsidiary or the subsidiaries of the joint venture.

4. ​Key management personnel​ are those persons having authority and responsibility for
planning, directing and controlling the activities of the entity , directly or indirectly, including
any executive director or nonexecutive director.

5. ​Close family members of an individual​ are those family members who may be expected to
influence or to be influenced by that individual in their dealings with the entity.

Close family members of an individual include :

a. The individual’s spouse and children.
b. children of the individual’s spouse.
c. Dependents of the individual or the individual’s spouse.

6. ​Individuals ​owning directly or indirectly an interest in the voting power of the reporting entity
that gives them significant influence over the entity , and close family members of such
individuals .
7. Postemployment benefit plans for the benefit of employees of an entity , or of any entity that is
a related party to that entity.

Example of Related Party Transaction

A related party transaction is a transfer of resources or obligations between related parties ,

regardless of whether a price is charged.

PAS 24, paragraph 20, provides the following examples of related party transaction:

1. Purchase and sale of goods

2. Purchase and sale of property and other asset
3. Rendering or receiving services
4. Leases
5. Transfer of research and development
6. License agreement
7. Finance arrangements, including loans, and equity contributions in cash or in kind
8. Guarantee and collateral
9. Settlement of liabilities on behalf of the entity or by the entity on behalf of another party

Related party disclosures

PAS 24, Paragraph 12 requires disclosure of related party relationships where control exist
irrespective of whether there have been transaction between the related parties.

In other words, relationships between ​parents​ ​and subsidiaries​ shall be disclosed ​regardless​ of
whether there have been transactions between those related parties.

An entity shall disclose the name of the entity’s parent and if different, the ultimate controlling
party.

If neither the entity’s parent nor the ultimate controlling party produces financial statements
available for public use, the name of the next most senior parent that does so shall also be
disclosed.

Disclosure of related party transaction

PAS 24, paragraph 17, provides that if there have been transactions between related parties, an
entity shall disclose the nature of the related party relationship as well as informations about the
transactions and outstanding balances necessary for an understanding of the financial statements
As a minimum, the disclosures of related party transaction shall include :

a. The amount of the transaction

b. The amount of outstandinv balance, terms and conditions, whether secured ir unsecured ,
and nature of consideration to be provided in settlement
c. The allowance for doubtful accounts related to the outstanding balance.
d. The expense recognized during the period in respect of doubtful accounts due from
related parties.

Disclosures that related party transaction were made on terms equivalent to those that prevail in
arm’s length transactions are made only if such terms can be substantiated.

Key management personnel compensation

PAS 24 , paragraph 16, provides that an entity shall disclose key management personnel
compensation in total and for each of the following categories :

a. Short-term employee benefits

b. Postemployment benefits, for example, retirement pensions
c. Other long-term benefits
d. Termination benefits
e. Share based payment transactions, for example, share options

Unrelated Parties

Unrelated parties include the following:

1. Two entities simply because they have a director or key management personnel in
common.
2. Providers of finance , trade unions , public utilities and government agencies in the
course of their normal dealings with an entity by virtue only of those dealings.
3. A single customer, supplier , franchisor or general agent with whom an entity transacts a
significant volume of business merely by virtue of the resulting economic dependence.
4. Two venturers simply because they share joint control over a jount venture.

Transactions with government- related entities

A reporting entity is ​exempted​ from providing the normal disclosures for transaction with:

a. A government that has control, joint control or significant indfluence over the entity.
 b. Other entitues controlled , jointly controlled or significantly influenced by the same
government .

In applying the exemption, the reporting entity is required to disclose only the following:

a. The name of the government and the nature of the relationship with the reporting entity .
b. The information on the nature and amount of each “individually” significant transaction
with the government.

Related party disclosures not required

PAS 24, paragraph 3, requires disclosures of related party transactions and outstanding balances
in the ​separate financial statements​ of a parent, subsidiary, associate or venturer.

However, paragraph 4 provides that ​intagroup​ related party transactions and outstanding
balances are eliminated in the preparation of ​consolidated financial statements​ of the group.

Pricing Policies

Accounting recognition of a transfer of resources is normally based on the price agreed upon
between the parties,Between unrelated parties, the price is an arm’s length price.

Between related parties, there may be a degree of flexibility in the price setting process that is
not present between unrelated parties.

PAS 24 did not provide for the measurement of related party transaction. However, a variety of
methods is used to price transactions between related parties.

1. Uncontrolled price method​ - This sets the price by reference to comparable goods sold
in an economically comparable market to a buyer unrelated to the seller.
2. ​Resale price method​- This method is often used where goods are transferred between
related parties before a sale to an independent party is made.

This reduces the resale price by a margin, representing an amount from which the reseller
would seek to recover costs and make an appropriate profit.

3. ​Cost plus method​ - This method seeks to add an appropriate markup to the suppliers
cost
 4. ​No price method​ - Literally, no price is charged, as in the case of free provision of
management services and the extension of free credit on a debt.

QUESTIONS

1. Define each of the following :

a. Related party
b. Related party transaction
c. Control
d. Significant influence
e. Joint control

2. Give examples of related parties.

3. Give examples of related party transactions.

4. Explain related party disclosures.

5. What are the minimum disclosures for related party transactions ?

6. Explain key management personnel compensation.

7. Give examples of unrelated parties.

8. What are the circumstances where related party disclosures are not required?

9. Explain disclosures of transactions with ​government related entities​.

10. Explain the pricing policies for related party transactions.

PROBLEMS

Problem 4-1 Multuple Choice (PAS 24)

1. Related Parties include all the following , ​except

a. Parent, subsiduary and fellow subsidiaries

b. Associates
 c. Key management personnel and close family members of such key management
personnel
d. Two ventures simply because they share joint control over a joint venture

2. A related party transaction is a transfer

a. Betweeb related parties when price is charged.

b. Between related parties, regardless of whether a price is charged.
c. Between unrelated parties when a price is charged.
d. Between unrelated parties , regardless of whether a price is charged.

3. Unrelated parties include which of the flowing ?

a. Providers of finance in the course of their normal dealings with an entity by virtue only
those dealings.
b. Government agencies
c. Single customer with whom an entity transacts a significant volume of business merely
by virtue of the resulting economic dependence.
d. All of these are unrelates parties

4. Close fmmily members of an individuall include all, ​except

a. The individual’s spouse and children

b. Children of the individual’s spouse
c. Dependents of the individual or individual’s spouse
d. Brothers and sisters of the individual

5. The minimum diaclosures about related party transactipnss include all of the following, ​except

a. The amount of transaction

b. Amount of outstanding balance
c. Allowance for doubtful accounts related to the outstanding balance
d. Nature of the relationship