IAS 24 - Related Party Disclosures (detailed review)
This Standard purports to ensure that financial statements of the entity include
the disclosures which are essential to bring the attention of the users, to the likelihood that the financial performance of the entity may have been influenced because of the related party relationships and by transactions, outstanding balances, and any contractual or non-contractual commitments with such parties.
Therefore, this standard requires the disclosures, in the financial statements of the entity, in respect of any entity’s related party relationships, irrespective of whether there have been transactions between those related parties.
- The requirements of this standard are applicable to identify the:
a) Entity’s related party relationships
b) Any transactions including any outstanding balances and any contractual or non-contractual commitment with such related parties
c) The circumstances requiring the disclosure of such related party relationships
d) The nature of disclosures required for such related party relationships
- The requirements of this standard are applicable in the consolidated and individual financial statements of the parent for the disclosure of related party relationships including any transactions, outstanding balances, and any contractual or non-contractual commitments with such parties. However, related party transactions and outstanding balances at reporting date with other entities in the same group are disclosed in the financial statements of the entity only, as intra-group transactions and outstanding balances with related party are cancelled out in the preparation of consolidated financial statements of the group.
Reason of Related Party Disclosures:
- Related party relationships are the normal part of business and economic activities. As entities usually conduct part of the business operations through different arrangements which may be established in the form of subsidiaries, joint ventures or associates. In such circumstances, the entity has the ability to influence the financial performance of the investee by having control, joint control of or significant influence over such arrangements.
- This raises the issue that related parties may agree to the transactions that are not considered to be at arm’s length basis, such as an entity may sell goods to its parent at an artificial low selling price, which it cannot offer to the unrelated party.
- The financial performance of the entity may be influenced because of the related party relationships even if no transaction takes place between the entity and related party.
- The presence of influence in related party relationships can individually affect the transactions of the entity with other parties, such as trade restrictions on a subsidiary placed by its parent or not to engage in certain activities.
- These apprehensions raise the concern for the disclosure of entity’s related party relationships to bring to the attention of the users the likelihood that the financial performance of the entity may have been influenced because of the related party relationships and by transactions, outstanding balances, and any contractual or non-contractual commitments with such parties.
It is referred to the entity which prepares financial statements.
It may be a person or an entity, and will be considered as related party with the reporting entity in the following circumstances:
(a) If the person or entity:
- Controls or has joint control of the reporting entity
- has significant influence over the reporting entity
- is a member or part of the key management personnel of the reporting entity or of its parent
- is a close family member of the person who controls, or has joint control, or has significant influence over the reporting entity
(b) Two or more entities of the same group, that means that each parent, subsidiary and fellow subsidiary is related to the others
(c) The entity which is an associate or joint venture of the other entity
(d) The entity subject to control, or joint control, or significant influence by the person referred to in a (iii), (iv) above
(e) The entity is a post-employment benefit plan which is established for the benefit of employees of either the reporting entity or an entity related to the reporting entity.
- The entity is required to consider the substance of the related party relationship not just the legal form.
- The associate’s subsidiary and the investor that has significant influence over the associate are related to each other.
- Following are not considered as related parties:
(a) Two entities having a director or key management personnel in common or because a member of key management personnel of one entity has significant influence over the other entity.
(b) Two joint venturers having joint control of a joint venture
(c) Finance Providers
(d) Trade unions
(e) Public utility Providers
(f) Government departments and agencies that does not have control, joint control or significant influence on the reporting entity
(g) It also includes customer, supplier, franchisor, distributor or general agent which is the part of trading activities
Key Management Personnel
The persons who have power to directly or indirectly direct the relevant activities of an entity.
Close family Member
It includes those members of the family who may have the ability to persuade that person in respect of transactions with the reporting entity and it includes:
- Children of that person and spouse or domestic partner of that person
- Children of spouse or domestic partner of that person
- Individuals who are dependants on that person, person’s spouse or person’s domestic partner.
Compensation entails all the employee benefits which are covered under IAS 19 and IFRS 2. And it includes all types of compensation given to employee, in exchange for services provided to the entity. It includes:
- Employee benefits which are classified as Short term benefits, such as salaries, wages, compensated annual leaves and annual profit-sharing or bonuses which are payable within 12 months from the relevant year end
- Employee benefits which are classified as Post employment benefits such as pensions or other retirement benefits
- Employee benefits which are classified as Other long term benefits, such as sabbatical leave, or other long-term benefits which are payable after 12 months from the year end
- Termination benefits
- Benefits in the form of share-based payment.
The definition of ‘control’, ‘joint control’ and ‘significant influence’ are prescribed as per the IFRS 10, IFRS 11 Joint Arrangements and IAS 28 Investments in Associates and Joint Ventures with the meaning specified in such standards.
To enable the users of financial statements to analyze the effects of related party relationships on the financial performance of the entity, it is required to give the disclosure of such relationships, regardless of whether any transactions take place between entity and the related parties. The entity is required to give disclosures in respect of each of the following related parties:
(a) The parent which controls an entity
(b) The entity having joint control of or significant influence over an entity
(c) Any subsidiary or associate of the entity
(d) The joint ventures in which the entity is a joint control;
(e) The key management personnel of the entity or its parent; and
(f) Any other related parties as per the definition.
If the entity has had a transaction with related party during the current accounting period, which is included in financial statements, the entity will disclose the following:
(a) The nature of transaction
(b) Amount of the transactions
(c) Any balance amount outstanding at reporting date
(d) The terms and conditions of the transaction, indicating if they are secured
(e) The mode of the consideration in settlement
(f) Any contractual or non-contractual commitments with such related parties
(g) Any doubtful debts related to the outstanding balances at reporting date
(h) Any balance recognized in the form of bad debts with such related parties.
In respect of key management personnel the entity will disclose the following:
(a) Employee benefits which are classified as short term benefits, such as salaries, wages, compensated annual leaves and annual profit-sharing or bonuses which are payable within 12 months from the relevant year end
(b) Employee benefits which are classified as Post employment benefits such as pensions or other retirement benefits
(c) Employee benefits which are classified as Other long term benefits, such as sabbatical leaves, or other long-term benefits which are payable after 12 months from the year end
(d) Termination benefits
(e) Benefits in the form share-based payment.
The nature of transaction with the related party which needs to be disclosed as per the requirements of this standard may include the following:
(a) Any transaction involving the sales or purchases of goods or other assets
(b) Any transaction involving the rendering or receiving of services;
(c) Any lease arrangements between the entity and the related party;
(d) Any provision of technical and essential services
(e) Any contractual or non-contractual commitments with such related parties
(f) Any funding arrangements between the entity and the related parties
(g) Any provision of guarantees or collateral;
(h) Any settlement of liabilities on behalf of the entity or by the entity on behalf of that related party.
The related party transactions also include, transaction by the parent or subsidiary with its group defined benefit plan that shares risks between group member entities
The entity can disclose about the related party transactions that these are conducted at arm’s length terms only, if such terms can be demonstrated.
An entity is exempt from the disclosure requirements of this standard in respect of transactions with the government who controls, or has joint control, or significant influence over, that reporting entity. However, in such a case the entity will give disclosure about the name of government and nature of relationship with such government and details about the significant transactions.
On 1 December 2011, AB Ltd a public limited company underwent a fundamental reorganization for its group of companies including foreign operations. The directors of AB Ltd require advice on implications of the IAS 24 Related Party Disclosures, and the disclosure of related party information but they feel that related party transactions are a regular part of the business and need not be disclosed.
Under the newly formed structure of the group, AB Ltd owns 85% of Body, 65% of Fit, and 25% of Eagle. The directors of AB Ltd are also directors of Body and Fit, but AB Ltd is represented by only one director on the management board of Eagle. However, AB Ltd has significant influence over Eagle. The Eagle has five directors on its management board.
At formation the group was formed by five companies but the fifth company, Triangle was sold on 30 June 2011 which was a 65% subsidiary of AB Ltd. There were no transactions between AB Ltd and Triangle during the current year.
Identify the related party relationships and transactions which exist within the AB Ltd Group and needs to be disclosed in the financial statements of the entity for the year ended 31 December 2011. Also explain why it is important to disclose related party relationships and transactions with such parties.
Nature of Relationship within the AB Ltd Group
Body and Fit are related parties with AB Ltd because these are controlled by same parent i.e. AB Ltd. And as Body and Fit are fellow subsidiaries, these are also related parties of each other. Eagle is also a related party with AB Ltd because it is an associate of AB Ltd as it has significant influence over Eagle.
Body and Fit may be treated as related parties to Eagle. Although AB Ltd, Body, Fit, and Eagle have director in common, however IAS 24 states that entities are not necessarily related parties simply because they have a director or other member of key management personnel in common.
Although Triangle was sold before the year end, but it will be treated as related party of AB Ltd, Body and Fit up to the date of disposal. Therefore Triangle will also be disclosed as related party in the current year, even though there is no transaction with the Triangle during the period.