Related Party

Definition

A related party is broadly defined as any person or entity that has a significant influence on the reporting entity during a specific reporting period, although this influence does not necessarily equate to control. Detailed criteria on identifying related parties are provided in Section 33 of the Financial Reporting Standard (FRS) applicable in the UK and the Republic of Ireland.

Importance in Financial Reporting

Entities must disclose the existence of related parties when their presence has a material effect on the balance sheet or profit and loss account during the reporting period. This ensures transparency and helps users of financial statements understand potential biases in financial performance or condition.

Listed companies are specifically required to adhere to International Accounting Standard (IAS) 24, Related Party Disclosures.

Examples

Parent-Subsidiary Relationships: A parent company and its subsidiaries are considered related parties. Any transactions between them, such as loans or sales, must be disclosed in the financial statements of both entities.
Key Management Personnel: Senior executive officers and directors are related parties due to their influence over significant decisions affecting the entity’s financial standing.
Shareholders with Significant Influence: Shareholders who hold substantial voting power in an entity can be considered related parties.

Frequently Asked Questions

What constitutes a significant influence?

Significant influence is the power to participate in the financial and operating policy decisions of an entity but not to control those policies. Typically, holding 20% or more of the voting power of an investee may be indicative of significant influence.

Disclosure of related party transactions is crucial for ensuring transparency in financial statements. It helps stakeholders understand the relationships and transactions that could impact the entity’s financial results and condition.

Not all related party transactions need to be disclosed. Only those transactions that are material and have a significant impact on the financial statements should be disclosed.

Entities must include disclosures about related party relationships, transactions, and outstanding balances to provide a comprehensive view of the potential impact on their financial statements.

Significant Influence

Significant influence refers to the power to participate in the financial and operating policy decisions of an entity, which is typically demonstrated through holding a significant share of voting power or through statutory means.

Control

Control is the power to govern the financial and operating policies of an entity to benefit from its activities.

Financial Reporting Standard (FRS)

The FRS is a set of accounting standards used to prepare and present financial statements, aimed at ensuring transparency, reliability, and comparability of financial information.

Balance Sheet

The balance sheet is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.

Profit and Loss Account

The profit and loss account, also known as the income statement, summarizes the revenues, costs, and expenses incurred during a specified period.

International Accounting Standard (IAS) 24

IAS 24 outlines the disclosure requirements for related party relationships, transactions, and outstanding balances in financial statements to ensure transparency and avoid conflicts of interest.

References

Suggested Books for Further Studies

“Wiley IFRS 2021: Interpretation and Application of IFRS Standards” by PKF International Ltd.
“Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott
“International Financial Statement Analysis” by Thomas R. Robinson et al.
“Accounting for Managers: Interpreting Accounting Information for Decision Making” by Paul M. Collier and Samuel Agyei-Ampomah

### What is considered significant influence in the context of a related party? - [ ] Holding any amount of shares - [ ] Holding a management position - [x] Holding 20% or more of the voting power - [ ] Owning a percentage of non-voting stock > **Explanation:** Significant influence is typically demonstrated by holding 20% or more of the voting power, allowing for participation in the financial and operating policy decisions of the entity. ### Which financial statement typically shows the effects of related party transactions? - [ ] Statement of Cash Flows - [x] Balance Sheet and Profit and Loss Account - [ ] Notes to the Financial Statements alone - [ ] Statement of Changes in Equity > **Explanation:** The balance sheet and the profit and loss account usually show the effects of related party transactions, supplemented by detailed disclosures in the notes. ### Do related party transactions need to be disclosed if they are not material? - [ ] Yes, all transactions must be disclosed - [ ] Disclosures are optional in this case - [x] No, only material transactions are disclosed - [ ] Only transactions approved by the board need to be disclosed > **Explanation:** Only material related party transactions that could impact the financial statements need to be disclosed to ensure relevance and avoid unnecessary clutter. ### Which accounting standard provides guidelines on related party disclosures for listed companies? - [x] IAS 24 - [ ] IFRS 9 - [ ] GAAP 12 - [ ] FRS 102 > **Explanation:** IAS 24 (International Accounting Standard) provides guidelines specifically for the disclosure of related party relationships, transactions, and balances. ### Why must entities disclose related party transactions? - [x] To ensure financial transparency - [ ] To comply with audit requirements - [ ] To increase shareholder value - [ ] To reduce operational costs > **Explanation:** Disclosure of related party transactions is crucial for financial transparency, helping stakeholders understand the implications and potential conflicts of interest such transactions might entail. ### What influence does a parent company have over its subsidiary in terms of related party? - [x] Control - [ ] No control but significant influence - [ ] Minor influence - [ ] Financial interest only > **Explanation:** A parent company typically has control over its subsidiary, making them related parties that must disclose mutual transactions and relationships. ### Are key management personnel classified as related parties? - [x] Yes - [ ] No - [ ] Only in certain jurisdictions - [ ] Only if they hold equity in the company > **Explanation:** Key management personnel are classified as related parties due to their ability to influence significant decisions affecting the entity’s financial performance and condition. ### What aspects of related party transactions should be disclosed? - [x] Nature of relationship, transaction details, and outstanding balances - [ ] Only monetary value of transactions - [ ] External audit results of transactions - [ ] Managerial commentary on transactions > **Explanation:** Comprehensive disclosures must include the nature of the relationship, transaction details, as well as any outstanding balances to fully inform stakeholders of the potential impact. ### True or False: A company must disclose related party transactions even if there is no significant influence. - [ ] True - [x] False > **Explanation:** Disclosure is only required if there is significant influence or control by the party involved, as this could materially affect the financial statements. ### What financial reporting standard in the UK and Republic of Ireland outlines related party definitions and disclosures? - [ ] GAAP - [ ] IFRS 16 - [x] Section 33 of the Financial Reporting Standard (FRS) - [ ] ASBE 23 > **Explanation:** Section 33 of the Financial Reporting Standard (FRS) applicable in the UK and Republic of Ireland provides detailed guidelines on identifying and disclosing related parties and their transactions.

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