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.
Why is related party disclosure important?
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.
Are all related party transactions required to be disclosed?
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.
How should related party transactions be reported?
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.
Related Terms
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
Accounting Basics: “Related Party” Fundamentals Quiz
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