P2 - Related party

I d e n t i f i c a t i o n o f t h e r e l a t e d p a r t i e s :

Control: → Parent
→ Sole director
→ > 50% of share-holder
Control is the power to govern the financial and operation policies of an entity so as to obtain benefits
from its activities.

Significant influence: → > 20% shareholding

→ Associate
→ Any director
- including NED
- including key member of management
Significant influence is the power to participate in the financial and operating policy decisions of the
entity but is not control over those policies. Significant influence may be gained by share ownership,
statue or agreement.

Common control: → Sibling company i.e. same parent

→ Same sole director
→ Same majority shareholding
IAS 24 states that entities are not necessarily related parties because they have a director in common.
Some directors practice more influence than others. A related party relationship exists if this director
actually exercises control or significant influence over the policies of the companies in practice.

Related party relationship could be extended to the close family members of persons mentioned
above. But the definition of close family members is more subjective rather straightforward.

Why it is important to disclose related party transaction:

Related party relationships can lead to transactions through rightful or unduly influence which would
not normally be undertaken otherwise. For example, company may sell a large proportion of its
production to its parent company because it cannot and/or could not find a market elsewhere.

Related parties’ has ability to manipulate decisions taken by the counterpart even by not undertaking
any transaction. A newly acquired subsidiary may be forced by parent to end relationship with a
particular supplier to give more access to the market of a sibling company.

Related parties can agree in a contract terms which may not acceptable to unrelated parties. A parent
company may lease an asset to a subsidiary on very flexible terms which is irrelevant to the market.

Related party transactions are part of the normal business process. But, in the absence of contrary
information it is assumed that the financial statements of an entity reflect transactions carried out on
arm’s length basis and that the entity has independent discretionary power over its actions and
pursues its activities independently.

Transactions with related parties can never be on arm’s length basis. Even if the transactions with the
related parties are at arm’s length, the disclosure is important because it is likely that future
transactions may be affected by such relationships.

Information about related parties has paramount importance in terms of any investment decision.
Related party identification helps to understand the company’s future.

In most jurisdictions regulatory authorities, e.g. stock exchanges, tax authorities etc, made it
compulsory to report on related parties.

D i s c l o s u r e s :
- nature of the transaction - write offs
- amount - anything else!
- nature of the related party - fair view
- balances

Relevant practice questions: Egin Group (June 06), Engina (Pilot)

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