re-exposure draft

PUBLIC SECTOR ACCOUNTING BOARD PROPOSED ACCOUNTING STANDARDS

Related Party Transactions

June 2013

COMMENTS MUST BE RECEIVED BY SEPTEMBER 4, 2013

This Re-exposure Draft reflects proposals made by the Public Sector Accounting Board (PSAB). Individuals, governments and organizations are invited to send written comments on the Re-exposure Draft proposals. Comments are requested from those who agree with the Re-exposure Draft as well as from those who do not. Comments are most helpful if they are related to a specific paragraph or group of paragraphs. Any comments that express disagreement with the proposals in the Re-exposure Draft should clearly explain the problem and include a suggested alternative, supported by specific reasoning. All comments received by PSAB will be available on the website shortly after the comment deadline, unless confidentiality is requested. The request for confidentiality must be stated explicitly within the response.
To be considered, comments must be received by September 4, 2013, addressed to: Tim Beauchamp, Director Public Sector Accounting 277 Wellington Street West Toronto, Ontario M5V 3H2 A PDF response form has been posted with this document to assist you in submitting your comments. Alternatively, you may send comments by email (in Word format), to: ed.psector@cpacanada.ca

Highlights
The Public Sector Accounting Board (PSAB) proposes, subject to comments received following re-exposure, to issue a new Section on related party transactions. This Section would apply to all governments and government organizations that base their accounting policies on the CICA Public Sector Accounting Handbook. The following documents accompany this Exposure Draft: An issues analysis that summarizes PSABs considerations by providing background information and discussing alternatives evaluated. A plain language document that explains the proposals in non-technical language. Main features of the Exposure Draft The main features of the Re-exposure Draft are as follows: A related party exists when one party has the ability to exercise control or shared control over the other. Two or more parties are related when they are subject to common control or shared control. Related parties also include individuals that are members of key management personnel and close family members. Disclosure of key management personnel compensation arrangements, expense allowances and other similar payments routinely paid in exchange for services rendered is not required. Disclosure is only required when transactions and events between related parties have or could have a material financial effect on the financial statements. Determining which related party transactions to disclose is a matter of judgment based on assessment of : the terms and conditions underlying the transactions; the financial materiality of the transactions; the relevance of the information; and the need for the information to enable users understanding of the financial statements and for making comparisons. A related party transaction, with the exception of contributed goods and services, should be recognized by both a provider organization and a recipient organization on a gross basis. An entity may either: disclose information about contributed goods and services; or recognize a revenue and expense if those goods and services would otherwise have been purchased. Related party transactions should be recorded at the carrying amount unless: they are undertaken in the normal course of operations; or a recipient organization's future economic benefits or service potential is expected to change significantly as the result of the transaction. In these cases, the transactions should be measured at the exchange amount. An entitys policy, budget practices or accountability structures may dictate the exchange amount. Using fair value may be appropriate. It may not be necessary or practical for the provider organization or recipient organization to disclose information about transactions undertaken by an entity in the normal course of operations.

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Implications of the proposals The new Section requires disclosure only when related party transactions have a material financial effect on the financial statements. Knowledge of an entitys transactions with related parties and their terms and conditions is necessary to provide users with an understanding of an entity's financial results and position. The effect of this Section on the government reporting entity is expected to be minimal. Related party transactions with members of key management personnel and their close family members would generally not be financially material at the government reporting entity level. This Section does not deal with transactions that are eliminated upon consolidation or with those with entities accounted for under the modified equity method by the entity reporting. Those government organizations that were previously using pre-changeover accounting standards in Part V of the CICA Handbook Accounting may have to adjust their current disclosures because this Re-exposure Draft does not include significant influence. Comments requested PSAB welcomes comments from individuals, governments and organizations on all aspects of the Re-exposure Draft. When comments have been prepared as a result of a consultative process within an organization, it is helpful to identify generically the source of the comment in the response. This will promote understanding of how the proposals are affecting various aspects of an organization. Comments are most helpful if they relate to a specific principle, paragraph or group of paragraphs. Any comments that express disagreement with the proposals in the Exposure Draft should clearly explain the problem and include a suggested alternative, supported by specific reasoning, for alternative wording. Supporting reasons for your comments are most valuable when they demonstrate how the Exposure Draft proposals, or your alternatives: produce more relevant information for accountability and decision-making by external users; improve the representation of the substance of the underlying transaction or event; contribute to improved measures and understanding of financial position and annual results; facilitate enhanced comparability; and provide sufficient information for external users to understand the financial statements.

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Please respond to the following questions: 1. Do you agree that entities may be related when individuals that are members of the key management personnel or close family members of the entity reporting are also members of key management personnel of the another entity? 2. Do you agree that related party transaction should be measured at the carrying amount except when: (a) they are undertaken in the normal course of operations; or (b) a recipient organization's future economic benefits or service potential is expected to change significantly as the result of the transaction? 3. Do you agree that in the case of 2(a) and 2(b) above, related party transactions should be measured at the exchange amount? 4. Do you agree with the transitional provisions? For your convenience, a PDF response form has been posted with this document. You can save the form both during and after completion for future reference. You are not restricted by the size of the interactive comment fields in the response form and there is also a general comments section. Alternatively, you may send written comments by email in Word format to: ed.psector@cpacanada.ca

RELATED PARTY TRANSACTIONS

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Related Party Transactions

TABLE OF CONTENTS
PARAGRAPH

Purpose and scope............................................................................... .01-.09 Definitions.............................................................................................. .10 Reportable transactions....................................................................... .11-.13 Identifying a related party..................................................................... .14-.21 Key management personnel........................................................................... .18-.19 Close family members of key management personnel................................... .20-.21 Recognition............................................................................................ .22-.32 Cost allocation and recovery.......................................................................... .24-.26 Contributed goods and services..................................................................... .27-.32 Measurement......................................................................................... .33-.41 Disclosure.............................................................................................. .42-.50 Unrecognized transactions............................................................................. .48-.50 Transitional provisions......................................................................... .51-.52 PURPOSE AND SCOPE .01 This Section establishes standards for the recognition, measurement and disclosure of related party transactions. .02 Generally, it is presumed that transactions and events are recognized in financial statements at the amount of cash or cash equivalents paid or received or the fair value ascribed to them when they took place. Conversely, as related parties do not deal at arms length, a transaction between related parties cannot be presumed to have been recognized on the same basis. .03 Disclosing sufficient information about the terms and conditions of related party transactions and the relationship underlying them is important. It enables users to assess the effect that they have or may have on an entitys financial position and changes in financial position reported in financial statements. .04 Not all related party relationships nor are all transactions occurring between related parties required to be disclosed. Disclosure is generally required when transactions between related parties have occurred at a value different from that which would have been arrived at if the parties were unrelated. However, not all of these transactions are reportable under this Section. Only those transactions that have or could have a material financial effect on the financial statements are disclosed. .05 In some cases, it may be difficult to determine whether transactions occurring between related parties have or could have a material financial effect on the financial statements. In these cases, judgment may be needed to determine whether information about these transactions would be disclosed. .06 This Section requires that reasonable efforts are made to identify related party transactions that have or could have a material financial effect on the financial statements. This may involve adopting policies and procedures designed

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to ensure that these transactions are appropriately identified, measured and disclosed in the financial statements. .07 This Section identifies: (a) which parties are related; (b) the extent to which related party transactions are recognized in the financial statements of both the provider and recipient organizations; (c) the appropriate basis of measurement for recognized transactions; and (d) disclosure requirements for transactions including those that have not been given accounting recognition. .08 This Section does not deal with: (a) amalgamations and restructurings; (b) transactions between governments that are separate financial reporting entities (see GOVERNMENT REPORTING ENTITY, Section PS 1300); (c) for consolidated financial statements, transactions that are eliminated and those with entities accounted for under the modified equity method; and (d) disclosure of key management personnel compensation arrangements, expense allowances and other similar payments routinely paid in exchange for services rendered. .09 Financial disclosure and conflict of interest legislation or, if applicable, procurement and governance policies, may require certain disclosures in other public reports. The objectives of these reports are not the same as the objective of this Section. In addition, the disclosure requirements in this Section are not intended to replicate or be a substitute for these other reporting requirements. DEFINITIONS .10 The following terms are used in this Section with the meaning specified: (a) Carrying amount is the amount of an item transferred, or cost of services provided, as recorded in the accounts of the provider organization, after adjustments, if any. (b) Exchange amount is the amount of the consideration as established and agreed to by the related parties. (c) Fair value is the amount of the consideration that would be agreed upon in an arms length transaction between knowledgeable and willing parties who are under no compulsion to act. (d) Key management personnel are those individuals having authority and responsibility for planning, directing and controlling the activities of the entity. (e) A related party exists when one party has the ability to exercise control or shared control over the other. Two or more parties are related when they are subject to common control or shared control. Related parties also include key management personnel and close family members. (f) A related party transaction is a transfer of economic resources or obligations between related parties, or the provision of services by one party to a related party. These transfers are related party transactions whether or not there is an exchange of considerations or transactions have been given accounting recognition. The parties to the transaction are related prior to the transaction. When the relationship arises as a result of the transaction, the transaction is not one between related parties.

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(g) Shared control occurs when two or more entities are bound by a contractual arrangement establishing shared control over another entity and specifies the agreed sharing of the ongoing power to determine the entitys financial and operating policies. REPORTABLE TRANSACTIONS .11 Governments commonly conduct activities necessary for different aspects of their responsibilities and for achieving their objectives through separate entities. These entities may prepare financial statements intended to provide users with relevant and reliable information for decision-making purposes and to demonstrate the entitys accountability for the resources entrusted to it. .12 Governments can also establish different relationships between entities that allow them to operate together to achieve the overall objectives of the government. Governments establish individual policies regarding the terms and conditions for inter-organization transactions that reflect a governments policy objectives, accountability structures and budgetary practices. .13 Determining which transactions between an entity and its related parties to disclose is a matter of professional judgment. For example, it may be necessary to disclose information about contributed goods and services and other unrecognized transactions for users to understand the environment within which the entity operates. Factors to consider in assessing users needs include, but are not limited to, the following: (a) whether the transactions are undertaken on different terms and conditions that would be expected to have been adopted if the parties were dealing at arms length in the same circumstances; (b) the materiality of the effect the transactions have or could have on the entitys financial position and changes in financial position reported in financial statements; (c) the relevance of the information to the decisions of users and their evaluation of the financial effect or potential financial effect of the transactions on the financial statements of the entity; (d) the contribution the information would have to users understanding of the operating environment and the financial statements of the entity; and (e) the need for the information to enable users to compare the entitys financial position and changes in financial position reported in financial statements with that of other entities. IDENTIFYING A RELATED PARTY .14 A related party is an entity or an individual that is related to the entity that is reporting on its financial position and changes in financial position. Related parties have one of the following characteristics: (a) an entity that controls or is controlled by another entity; (b) an entity that is subject to common control; (c) an entity that has shared control over, or is subject to shared control of, another entity; (d) an individual that is a member of key management personnel of an entity and a close family member of that individual; (e) an entity controlled by, or under shared control of, a member of key management personnel of the entity reporting or a close family member of that individual; and

RELATED PARTY TRANSACTIONS

(f) an entity when a member of key management personnel of the entity reporting or a close family member of that individual is a member of key management personnel of that entity. .15 The determination of whether an entity controls another entity would be made by reference to the definition of control set out in GOVERNMENT REPORTING ENTITY, Section PS 1300. Reference would also be made to the characteristics of shared control set out in GOVERNMENT PARTNERSHIPS, Section PS 3060. .16 Parties to a contractual arrangement that establish shared control of an entity would not automatically be related parties. The determination of whether parties to a shared control arrangement are related would be made giving consideration to the definition and characteristics of a related party. For example, if all parties to a shared control arrangement are under common control, they would be related parties. Similarly, when two or more entities are under the shared control of the same entity, each is a related party. .17 When a member of key management personnel or a close family member of that individual is also a member of key management personnel of another entity, the degree of influence the individual is able to exert over that entity is considered in determining whether the entities are related. For example, a member of key management personnel of the entity reporting may serve as a board member of a local not-for-profit organization. This individual, in his or her role as a board member, would participate in the financial and operating policy decisions of the organization, but as a single board member, would not have control over those decisions. In such a case, it may be determined that the two entities are unrelated. Key management personnel .18 The determination of whether an individual is included in key management personnel requires judgment. Key management personnel could include: (a) directors or members of the governing body of the entity, where that body has authority and responsibility for planning, directing and controlling the activities of the entity; and (b) senior management of the entity, including the chief executive or permanent head and senior management group who have the day-to-day responsibility for managing the entitys activities and operations, and who have been delegated authority and executive powers to implement the planning, directing and controlling decisions and initiatives of the governing body. .19 In addition, an entity may be related to the entity reporting if a member of its key management personnel: (a) has control or shared control over the other entity; (b) holds an ownership interest that allows the individual to participate in the financial and operating decisions of the other entity; or (c) is a member of key management personnel of the other entity, and has authority and responsibility for planning, directing and controlling the activities of that entity.

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Close family members of key management personnel .20 A related party includes individuals that are close family members of an individual who is a member of key management personnel of the entity reporting. Close family members normally include an individuals spouse and those dependent on either the individual or the individuals spouse. The determination of whether an individual would be identified as a close family member requires judgment. .21 Similarly, an entity may be a related party if a close family member of an individual that is a member of key management of the entity reporting: (a) has control or shared control over the other entity; (b) holds an ownership interest that allows the individual to participate in the financial and operating decisions of the other entity; or (c) is a member of key management personnel of the other entity, and has authority and responsibility for planning, directing and controlling the activities of that entity. RECOGNITION .22 A related party transaction, with the exception of contributed goods and services, should be recognized by both a provider organization and a recipient organization. .23 An entity would recognize assets and liabilities in its financial statements when an item satisfies the definitions and meets the recognition criteria in FINANCIAL STATEMENT CONCEPTS, Section PS 1000. Therefore, if a related party transaction involves the transfer of an asset or liability, both the provider organization and recipient organization would recognize the transaction. Cost allocation and recovery .24 When there is a policy of allocating costs for the provision of goods and services: (a) the provider organization should report all revenues and expenses on a gross basis; and (b) the recipient organization should report all expenses on a gross basis. .25 A government may have established an organizational structure whereby a central agency provides goods and services to other entities under common control. The provider organization may be subject to a policy requiring that the related costs are allocated to the recipient organization(s). For example, a central agency may be responsible for provision of information services to other entities. It recognizes all revenues and expenses, on a gross basis, associated with the provision of information services. Showing the gross revenues and costs of providing goods and services helps users to understand the full extent of the provider organizations operations. .26 Under the policy of allocating costs, a recipient organization would recognize the expense in its financial statements. Expenses would be identified and reported at gross amounts in arriving at surplus or deficit for the period.

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Contributed goods and services .27 It is not unusual that certain activities are undertaken by a central entity to support the activities of other departments and agencies. For example, a central entity may be responsible for the debt management, pension administration, procurement and other shared services that apply across all government entities. .28 The provider organization may have a policy of funding expenses related to these common services through appropriations or other revenue sources and not allocating the costs to recipient organizations. Contributed goods and services between entities are a related party transaction. .29 An entity may recognize contributions of goods and services when those goods and services would otherwise have been purchased. The entity may, or be required by policy, to: (a) disclose information about the transaction; or (b) recognize a revenue and expense. .30 Whether related party transactions involving contributed goods and services would be recognized or disclosed in the financial statements of the recipient organization requires judgment. Factors to consider include, but are not limited to: (a) the needs of users; (b) the nature of operations; and (c) the legislative authorities. .31 To demonstrate accountability for the resources, obligations and financial affairs for which an entity is responsible and to assist users assess whether resources were administered in accordance with the limits established by legislative authorities, it may not be necessary to recognize contributed goods and services. Alternatively, measuring the cost of resources consumed in the period for assessing the performance of an entity may require the recognition of contributed goods and services. .32 If recognized, the recipient organization reports the contributed goods and services in the statement of operations as an expense. It also recognizes an equivalent amount as a credit in the statement of operations. For guidance on measurement, refer to paragraph .41. MEASUREMENT .33 Related party transactions should be recorded at the carrying amount except as specified in paragraphs .35 and .38. .34 Generally, when a transaction that occurs between entities under common control involves the transfer of an asset or liability or the provision of a service, a substantive change in the consolidated interest in the item does not occur. This may not justify a change in the measurement of the item. In this case, the carrying amount may be appropriate as it retains the amount attached to the item transferred or the cost of the service provided. .35 Related party transactions should be recorded at the exchange amount when they are undertaken in the normal course of operations on similar terms and conditions to those adopted if the parties were dealing at arms length.

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.36 Individual policies regarding related party relationships that reflect policy objectives, accountability structures and budgetary practices may result in transactions that would not take place between unrelated parties or would be subject to different terms and conditions. In other instances, one related party may transact with both unrelated and related parties under a normal business relationship on similar terms and conditions. These transactions are commonly considered to occur in the normal course of operations. .37 For the purposes of this Section, a related party transaction, in the normal course of operations, occurs within a normal business relationship and on terms and conditions that are similar to those of transactions with unrelated parties. Whether or not a transaction is in the normal course of operations is a question of fact. Matters to be taken into account when determining whether the operations are normal include, but are not limited to: (a) type and scope of operations of the provider organization; (b) characteristics of the industry; (c) operating policies of the public sector entity; (d) nature of products and services; and (e) the environment in which the provider and recipient organizations operate. A related party transaction is presumed not to be in the normal course of operations if it is not usually, frequently or regularly undertaken by the entity. .38 When a recipient organizations future economic benefits or service potential is expected to change significantly as the result of the related party transaction, it should be measured at the exchange amount. .39 When, as result of a related party transaction, the recipients future cash flows, or its capacity, both in terms of quality and efficiency, to provide goods and services is expected to change significantly, using fair value may be appropriate. For example, a local government may transfer a parking facility to a parking authority that charges commercial rates for parking. Using fair value of the facility as the exchange amount could be justified since the transfer may significantly change the risk, timing and amount of future cash flows of the parking authority. .40 When there is a difference between the exchange amount and the carrying amount, a gain or loss should be reported in the statement of operations for the period. .41 If contributed goods and services are recognized, an entitys policy, budget practices or accountability structures may determine how the transactions would be measured. In the absence of such, they would be measured at: (a) carrying amount; or (b) fair value. DISCLOSURE .42 An entity should disclose: (a) adequate information about the nature of the relationship with related parties involved in related party transactions; (b) the types of related party transactions that have been recognized; (c) the amounts of the transactions recognized classified by financial statement category; (d) the basis of measurement used;

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(e) the amount of outstanding balances and the terms and conditions attached to them; (f) contractual obligations with related parties, separate from other contractual obligations; (g) contingent liabilities involving related parties, separate from other contingent liabilities; and (h) the types of related party transactions that have occurred for which no amount has been recognized. Items of a similar nature should be disclosed in aggregate.

.43 An entity would disclose sufficient information about related party transactions and the underlying relationships necessary for users to understand the effect of those transactions on its financial position and changes in financial position. Knowledge of transactions with related parties and their terms and conditions is necessary for accountability purposes and to allow users to assess the cost of services and the management of resources. .44 Judgment is required to determine the level of detail to be disclosed. Factors that would be considered in making the determination include, but are not limited to: (a) the significance of the transactions in terms of size; and (b) whether the transactions were carried out on non-market terms. .45 Items of a similar nature may be disclosed in aggregate except when separate disclosure is necessary for an understanding of the effects of related party transactions on the financial statements of the entity. Judgment is required to determine whether it is necessary to disclose information that is already reported on the face of the financial statements or in other notes to the financial statements. It may be necessary to disclose information about these transactions for users to understand their effect on an entitys financial position and changes in financial position. .46 It may not be necessary or practical for the provider organization or recipient organization to disclose information about related party transactions undertaken in the normal course of operations on similar terms and conditions to those adopted if the parties were dealing at arms length. For example, disclosure of information about transactions involving the sale or purchase of electricity between related parties may not be necessary when the terms and conditions are the same as those for unrelated parties. .47 On the other hand, if a significant portion of an entitys revenues are derived from related parties, it may be necessary to disclose information about these transactions for users to understand their effect on the entitys financial position and changes in financial position. Unrecognized transactions .48 An entity should disclose the nature of related party transactions that have not been given accounting recognition. .49 An exchange of goods or services between related parties that has not been given accounting recognition is a related party transaction. Such transactions could have a material effect on the financial position and changes in financial position reported in financial statements. An entity would disclose information

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about related party transactions that have occurred for which no amount has been recognized in sufficient detail to enable users of its financial statements to understand the operating environment. .50 The information would include either a qualitative or quantitative indication of the extent of unrecognized related party transactions. When only qualitative information is disclosed about unrecognized related party transactions, it may be difficult for users to determine the terms and conditions under which they might have been transacted had the parties been unrelated. However, an explanation about the transactions helps users of financial statements detect and explain possible differences or evaluate their significance to the changes in financial position reported in the financial statements of the entity. TRANSITIONAL PROVISIONS .51 This Section applies to fiscal years beginning on or after April 1, 2016. Earlier adoption is permitted. .52 This Section may be applied retroactively or prospectively. If applied prospectively, restatement of assets or liabilities is not required when the related party transaction occurred prior to the date of adoption.

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CONSEQUENTIAL AMENDMENT New text is denoted by underlining. TANGIBLE CAPITAL ASSETS, Section PS 3150 .14 Governments may receive contributions of tangible capital assets. The cost of a contributed asset is considered equal to its fair value at the date of contribution. Fair value of a contributed tangible capital asset may be estimated using market or appraisal values. In unusual circumstances, where an estimate of fair value cannot be made, the tangible capital asset would be recognized at nominal value. When a contributed tangible capital asset is received from a related party, refer to RELATED PARTY TRANSACTIONS, Section PS XXXX.

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