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IAS 24 - Related Party Disclosures

This document discusses the disclosure requirements for related party transactions according to IAS 24. It defines a related party as one that can influence or be influenced by the other party. Parent-subsidiary relationships are considered related parties. Related party transactions may affect consolidated financial statements if not conducted at arm's length. IAS 24 requires disclosures of the nature and amount of related party transactions, as well as compensation for key management personnel. These disclosures provide transparency about potential unfair advantages between related parties.

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Anesu Nathan Chiwaridzo
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51 views21 pages

IAS 24 - Related Party Disclosures

This document discusses the disclosure requirements for related party transactions according to IAS 24. It defines a related party as one that can influence or be influenced by the other party. Parent-subsidiary relationships are considered related parties. Related party transactions may affect consolidated financial statements if not conducted at arm's length. IAS 24 requires disclosures of the nature and amount of related party transactions, as well as compensation for key management personnel. These disclosures provide transparency about potential unfair advantages between related parties.

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Anesu Nathan Chiwaridzo
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Related Party

Disclosures
IAS 24
Background
• The qualitative characteristic of financial reports known as faithful
representation, implies, inter alia, that the information contained in
the reports faithfully represents that which it purports to represent.
• It means that the financial reports represent the result of transactions
between independent parties on a normal arm’s length basis, unless
the opposite is stated.
• If transactions take place other than on a normal arm’s length basis,
this should be disclosed in the financial statements.
What is a related party?
• A related party transaction is a transfer of resources, services or
obligations between related parties, regardless of whether a price is
charged.
• IAS 24 Related Party, in its definition of related party, lists all possible
cases by which a party can be related to another.
• Parent companies and subsidiaries are considered to be related
parties in accordance with the definition of related parties. Since the
parent company controls the subsidiary, it can use this control to its
advantage and benefit.
Effect of related party relationship on
group financial statements
• According to the definition in IAS 24 Related Party, the parent and subsidiary
are related parties. Related party relationship may affect the consolidated
income statement and the statement of financial position, since the parent
and the subsidiaries may enter into certain transactions, such as:
1. transactions of sale of goods between parent and subsidiaries at more
favourable terms; the price may not be an arm’s length price
2. providing finance to subsidiaries at favourable interest rates, which are
lower than the market rates
3. sale of assets by the parent to its subsidiary at an amount in excess of its
carrying amount - such transactions may be designed to transfer profit to
the parent
• In order to provide the users of financial statements with information
about such related party transactions, IAS 24 mandates disclosures for
transactions between the group entities. IAS 24 requires that:

1. Relationships between parents and subsidiaries shall be disclosed


irrespective of whether there have been transactions between those
related parties.
Example
• Black Co is a parent of White Co.
• They have no transactions with each other. In spite of that, in its
financial statements, Black Co has to disclose the fact that White Co is
its parent company.
• In its financial statements, White Co has to disclose the fact that Black
Co is its subsidiary.
2. If there have been transactions between related parties, then for an understanding of
the potential effect of the relationship on the financial statements, an entity shall
disclose:

a) The nature of the related party relationship;


b) Information about the transactions;
c) The amount of the transactions;
d) The amount of outstanding balances and;
• their terms and conditions, including whether they are secured;
• the nature of the consideration to be provided in settlement;
• details of any guarantees given or received;
e) The provisions for doubtful debts related to the amount of outstanding balances; and
f) The amounts written off as bad or doubtful debts due from related parties.
Example
• America Co is a subsidiary of India Co and sells goods amounting to $4,000 to India Co.
The amount outstanding as at the reporting date is $500.
• In the financial statements of America Co, the following disclosures must be made:
• Sales to India Co (parent company) during the year amounted to $4,000 of which the
amount outstanding as at the end of reporting period was $500. The provision for
doubtful debts and amount of bad debts written off during the year does not include
any amount due from India Co.
• In the financial statements of India Co, it becomes necessary to make the following
disclosure:
• Purchases from America Co (subsidiary company) during the year amounted to $4,000
of which the amount
• to be paid as on end of reporting period amounted to $500.
3. The entity shall also disclose key management personnel compensation in
total and for each of the following categories.

a) Short-term employee benefits;


b) Post-employment benefits;
c) Other long-term benefits;
d) Termination benefits; and
e) Share-based payment.
Who constitutes key management
personnel?
• 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 director (whether
executive or otherwise) of that entity.
• The disclosure in the financial statements of the subsidiary as well as
of the parent will include any compensation paid by the subsidiary on
behalf of the parent. The disclosure in the financial statements of
• the parent as well as of the subsidiary will include any compensation
paid by the parent on behalf of the subsidiary.
The need for related party disclosures
(a) Related party disclosures help outsiders ascertain whether the
related parties exploit their relationship to give each other an unfair
advantage compared to arm’s length transactions with third parties.
Example
• Black Inc is engaged in the business of producing television sets. It
procures printed circuit boards (PCBs) for these sets from its parent,
White Inc, at $1 per PCB.
• White Inc is one of the major producers of PCBs.
• White Inc sells PCBs to all other companies at $1.5 per PCB.
• This unfair price advantage is one reason why Black Inc is the market
leader in the television industry. It is also the reason why the parent
company is earning lesser profits than its potential.
(b) Related party disclosures help shareholders of group companies
assess the impact of related party transactions on the financial status of
their respective entities.

(c) Related party disclosures help the non controlling shareholders decide
whether any unfair advantage has been given to group companies. They
can also assess how this has been advantageous / disadvantageous to
their own entity.
(d) Related party disclosures help government agencies decide whether
there have been any transactions specifically meant to avoid taxes or to
bypass regulations.
Example
• Willy Co owns 90% shares in Nelly Co.
• Nelly Co enjoys a tax holiday for 10 years. (This means that Nelly Co
does not have to pay any tax for 10 years). In order to reduce its tax
liability, Willy Co shows its own sales as if they were made by Nelly Co
(by showing intra-group sales).
• The concerned government department will come to know of these
intra-group transfers only because of the related party disclosures.
b) Related party disclosures help financial institutions, banks etc. decide
whether there has been a misuse of loans given to group entities.
Example
• Pretty Co approaches Citybank for a loan. Pretty Co does not satisfy the
parameters of the bank and the loan is rejected.
• Witty Co, the parent of Pretty Co, approaches Citybank for a loan.
Citybank advances the amount of loan to Witty Co.
• Witty Co then makes an inter company advance to Pretty Co from the
funds it receives from the bank.
• Loans advanced to one group entity are re-advanced to other group
entities, to which the banks would not have allowed loans.
• This is a common business practice and the bank will come to know of
this transaction only because of the related party disclosures.
The effect that the related party relationship between a parent
and subsidiary may have on the
consolidated financial statements

• It is essential to eliminate all intra-group balances on consolidation


because:
(a) If such transactions are not eliminated, then the consolidated
financial statement will show an inflated picture of the financial
status of the group, which would be misleading.

(b) It will also be against the very definition of consolidated financial


statements, which states that the group is to be considered as one single
economic unit and one single economic unit cannot transact with itself.
• Hence, the intra-group components of related party transactions will
not be present in the consolidated financial statements as they are
cancelled during the consolidation procedure.
• However, consolidated financial statements disclose key management
personnel compensation in the same manner as it is disclosed in the
individual statements of the parent and the subsidiary company.
Practice Questions

• Check your Study Module


The End

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