Related parties

IAS 24
The objective of IAS 24
The objective of IAS 24 Related party disclosures is to ensure that an entity’s financial
statements contain sufficient disclosures to draw attention to the possibility that the entity’s
financial position, or profit or loss may have been affected by:
◦ the existence of related parties, and
◦ transactions and outstanding balances with related parties.
IAS 24 is a disclosure standard. It does not require the redrafting of financial statements.
Such redrafting would be difficult as without the related party relationship the transactions
might never have taken place, and even if they had, it may not be possible to determine at
what amount.
Introduction
Related party relationships and transactions are a normal feature of business. However, there
is a general presumption that transactions reflected in financial statements have been carried
out on an arm's length basis, unless disclosed otherwise.
Arm's length means on the same terms as could have been negotiated with an external party,
in which each side bargained knowledgeably and freely, unaffected by any relationship
between them.
Even if a transaction with a related party is at market value, the shareholders need to know if
it is not at arm's length, because the relationship could influence future transactions.
Related party transaction
A related party transaction is defined as 'the transfer of resources, services or obligations
between related parties, regardless of whether a price is charged' (IAS 24, para 6).
The following examples of related party transactions are given in IAS 24.
◦ Purchases or sales of goods
◦ Purchases or sales of property and other assets
◦ Rendering or receiving of services
◦ Leases
◦ Transfer of research and development costs
◦ Finance arrangements (such as loans or contribution to equity)
◦ Provision of guarantees
◦ Settlement of liabilities on behalf of the entity or by the entity on behalf of another party.
Example
Company A owns 75% of the equity shares of B. A sells goods to B at prices significantly above
market rate. As a result, the profit of Company A is higher than if it had sold all of its goods to
a third party.
Company A's financial statements are not comparable with those of similar companies. Its
performance has been distorted as a result of trading with an entity that it controls.
Companies A and B are related parties. Users of the financial statements, such as investors
and banks, need to be made aware of the transactions that have occurred between these two
companies to enable them to make a proper assessment of the financial statements.
Related party - Criteria
Related party (IAS 24): a person or entity that is related to the entity that is preparing its
financial statements (the 'reporting entity').
a) A person or a close member of that person's family is related to a
reporting entity if that person:
i. Has control or joint control over the reporting entity;
ii. Has significant influence over the reporting entity; or
iii. Is a member of the key management personnel of the reporting entity or of a parent
of the reporting entity.
Related party - Criteria
b) An entity is related to a reporting entity if any of the following conditions
apply:
i. The entity and the reporting entity are members of the same group (which means that each
parent, subsidiary and fellow subsidiary is related to the others).
ii. One entity is an associate* or joint venture* of the other entity (or an associate or joint
venture of a member of a group of which the other entity is a member).
iii. Both entities are joint ventures* of the same third party.
iv. One entity is a joint venture* of a third entity and the other entity is an associate of the third
entity.
v. The entity is a post-employment benefit plan for the benefit of employees of either the
reporting entity or an entity related to the reporting entity.
vi. The entity is controlled or jointly controlled by a person identified in (a).
vii. A person identified in (a)(i) has significant influence over the entity or is a member of the key
management personnel of the entity (or of a parent of the entity).
viii. The entity, or any member of a group of which it is a part, provides key management
personnel services to the reporting entity or the parent of the reporting entity.
Close members of the family of a person
Close members of the family of a person are defined (IAS 24: para. 9) as 'those family members
who may be expected to influence, or be influenced by, that person in their dealings with the
entity and include:
◦ That person's children and spouse or domestic partner; Children of that person's spouse or
domestic partner; and
◦ Dependents of that person or that person's spouse or domestic partner.' In considering each
possible related party relationship, attention is directed to the substance of the relationship,
and not merely the legal form.
Key management personnel
Key management personnel are defined as 'those with authority and responsibility for
planning, directing and controlling the activities of the entity, including any director (whether
executive or otherwise) of that entity' (IAS 24, para 9).
Test your understanding 1 – Group
structures
Consider the following structure:

Required: Identify the related party relationships within the above structure.
Solution
Entity A:
◦ Entities that are within the same group are related to one another. Entities B and C are therefore related
parties of A.
◦ D is an associate of C. C is a member of A's group. This means that D is a related party of A.
Entity B:
◦ Entities that are within the same group are related to one another. Entities A and C are therefore related
parties of B.
◦ D is an associate of C. C is a member of the same group as B. This means that D is a related party of B
Entity C:
◦ Entities that are within the same group are related to one another. Entities A and B are therefore related
parties of C.
◦ Entities are related if one is an associate of another. C and D are therefore related parties.
Entity D:
◦ Entities are related if one is an associate of another. D and C are therefore related parties.
◦ Entities are related if one is an associate of a member of a group of which the other entity is also a member. D
is an associate of C. Companies A and B are in the same group as C. This means that D is also a related party of
A and B.
Test your understanding 2 – Individual
shareholdings
Consider each of the following situations:

Mr P controls entity A and is able to exert significant influence over entity B.

Mr P is able to exert significant influence over entity A and entity B.
Required:
◦ For each situation explain whether or not entity A and entity B are related parties.
Solution
Situation A:
◦ Mr P is a related party of both entity A and entity B as he is able to exercise either control
or significant influence over each entity.
◦ Mr P controls entity A and has significant influence over entity B. Therefore, A and B are
related parties.
Situation B:
◦ Mr P is a related party of both entity A and entity B as he is able to exercise significant
influence over each entity.
◦ Mr P does not control either entity A or entity B. Therefore, A and B are not related
parties.
Test your understanding 3 – Key
management personnel
Consider the following situation:

Mr P owns all of the issued share capital of entity A. He also is a member of the key management
personnel of entity B which, in turn, owns all of the issued share capital of entity C.
Required:
Discuss the related party relationships arising from the above structure.
Solution
Mr P has control over entity A, meaning that Mr P is a related party of A.
Mr P is a member of key management personnel of B, so is a related party of B.
A and B are related parties, because Mr P controls A and is a member of key management
personnel of B.
Entity B controls entity C so B and C are related parties.
Mr P is a member of key management personnel of the parent of C, so Mr P and C are
related parties.
This means that entities A and C are also related parties (Mr P controls A and is a member
of key management personnel of the parent company of C).
Test your understanding 4 – Family
members
Consider the following situation:

Mr T controls entity A. His spouse, Mrs T, exercises significant influence over entity B.
Required: Discuss the related party relationships arising from the above.
Solution
Mr T and Mrs T are close family. Mr T controls entity A. Mr T and Mrs T are related parties of
entity A.
Mrs T has significant influence over entity B. Mrs T and Mr T are related parties of entity B.
Mr and Mrs T control entity A and have significant influence over entity B. A and B are related
parties.
Test your understanding 5 – Picture and
Frame
Joanne Smith has owned 60% of the equity shares of Picture and 70% of the equity shares of
Frame for many years. On 1 January 20X4, Picture entered into a lease agreement with Frame.
Under the terms of the lease, Picture would lease one of its unused warehouses, with a
remaining useful life of 20 years, to Frame for five years. Consideration payable by Frame would
be $10,000 a year in arrears. Market rentals for similar sized warehouses tend to be around
$100,000 per year.
Required:
◦ Discuss the correct treatment of the above transaction in Picture's financial statements for the year
ended 30 June 20X4.
Solution
According to IFRS 16 Leases, a finance lease is a lease where the risks and rewards of
ownership transfer to the lessee. The lease between Picture and Frame is only for a fraction
of the asset’s remaining useful life and the lease payments are insignificant. The lease is
therefore an operating lease. Picture should recognise lease income on a straight line basis
over the lease term. Therefore, $5,000 ($10,000 × 6/12) should be recognised in the current
year’s statement of profit or loss, as well as a corresponding entry to accrued income on the
statement of financial position.
Picture and Frame are under joint control of Joanne Smith, so this means that they are
related parties. Disclosure is required of all transactions between Picture and Frame during
the financial period. Picture must disclose details of the leasing transaction and the income
of $5,000 from Frame during the year.
Disclosures that related party transactions were made on terms equivalent to an arm’s
length transaction can only be made if they can be substantiated. The lease rentals are only
10% of normal market rate meaning that this disclosure cannot be made.
Government-related entities
If the reporting entity is a government-related entity (ie a government has control, joint
control or significant influence over the entity), an exemption is available from full disclosure
of transactions, outstanding balances and commitments with the government or with other
entities related to the same government.
However, if the exemption is applied, disclosure is required of:
a) The name of the government and nature of the relationship
b) The nature and amount of each individually significant transaction (plus a
qualitative or quantitative indication of the extent of other transactions which are
collectively, but not individually, significant).
Disclosure - Parent and subsidiary
relationships
IAS 24 requires that relationships between parents and subsidiaries should always be disclosed.
The name of the parent and, if different, the ultimate controlling party should be given. This
applies regardless of whether or not any transactions have taken place between the parties
during the period.
Disclosure - Key management personnel
Total compensation granted to key management personnel should be disclosed. IAS 24 says
that this should also be broken down into the following categories:
◦ short-term benefits
◦ pension benefits
◦ termination benefits
◦ share-based payment schemes.
Disclosure of transactions and balances
If there have been transactions between related parties, and if there are balances
outstanding between the parties, the following should be disclosed:
◦ 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 was charged.

IAS 24 specifies that an entity may only disclose that related party transactions were made
on terms equivalent to those that prevail in arm’s length transactions if such terms can be
substantiated.