Related party transactions and disclosures
/What are Related Party Transactions and Disclosures?
Related party transactions are conducted with other parties with which an entity has a close association. The disclosure of related party information is considered useful to the readers of a company’s financial statements, particularly in regard to the examination of changes in its financial results and financial position over time, and in comparison to the same information for other businesses. The users of financial statements want to understand related party transactions, since they can indicate the presence of favoritism in an organization’s business dealings that may negatively impact profits.
Examples of Related Parties
Examples of related parties are affiliates, other subsidiaries under common control, owners of the business, its managers, and their families, the parent entity, and trusts for the benefit of employees.
Types of Related Party Transactions
There are many types of transactions that can be conducted between related parties, including the following:
Sales to related parties. A company may sell goods or services to a subsidiary, affiliate, or key executive at terms that differ from market conditions. These transactions must be disclosed to ensure transparency and prevent manipulation of revenue or earnings.
Loans to or from related parties. Organizations may issue loans to directors, executives, or affiliated entities, often at preferential rates. Such loans pose a risk of conflicts of interest and may affect the fair presentation of financial statements.
Lease agreements. A business might lease office space or equipment from a company owned by an executive or family member. These arrangements must be scrutinized for fair market terms to avoid inflated expenses or hidden benefits.
Purchase of goods or services. A company may buy raw materials or consulting services from a related business owned by a board member. This can influence cost structures and should be evaluated for fairness and proper disclosure.
Transfers of assets. Assets may be transferred between related parties, such as moving property between a parent and its subsidiary. These transfers can be used to shift profits or liabilities and must be recorded at arm’s length value.
Employment of family members. Hiring relatives of executives or board members is a related party transaction if their compensation or role may not reflect merit. Disclosure helps assess whether compensation policies are equitable and free from favoritism.
Guarantees or collateral for loans. A company might guarantee a loan for a related party or offer its assets as collateral. These commitments increase the company’s risk exposure and must be fully disclosed in financial statements.
Advisory agreements. A related entity might be contracted to provide strategic advice or operational support. If pricing or scope is not market-based, it could distort expense reporting and benefit insiders.
Joint ventures. A business might enter into a joint venture with a related individual or company, creating shared financial interests. These arrangements should be disclosed to ensure stakeholders are aware of potential conflicts.
Equity transfers. Shares may be issued or transferred to related parties under special terms, such as discounted pricing or vesting conditions. Such actions can impact ownership structure and require thorough explanation in the notes to the financial statements.
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Related Party Disclosures
In general, any related party transaction should be disclosed that would impact the decision making of the users of a company’s financial statements. This involves the disclosures noted below. Depending on the transactions, it may be acceptable to aggregate some related party information by type of transaction. Also, it may be necessary to disclose the name of a related party, if doing so is required to understand the relationship.
General Disclosures
Disclose all material related party transactions, including the nature of the relationship, the nature of the transactions, the dollar amounts of the transactions, the amounts due to or from related parties and the settlement terms (including tax-related balances), and the method by which any current and deferred tax expense is allocated to the members of a group. Do not include compensation arrangements, expense allowances, or any transactions that are eliminated in the consolidation of financial statements.
Control Relationship Disclosures
Disclose the nature of any control relationship where the company and other entities are under common ownership or management control, and this control could yield results different from what would be the case if the other entities were not under similar control, even if there are no transactions between the businesses.
Receivable Disclosures
Separately disclose any receivables from officers, employees, or affiliated entities.
When disclosing related party information, do not state or imply that the transactions were on an arm’s-length basis, unless you can substantiate the claim.