AC506 lecture 16

1
AC506 lecture 16

• Related party disclosures
• Sources
• FRS 8
• Elliott and Elliott, chapter 8
• Alexander and Britton, Chapter 24
• Lewis and Pendrill, Chapter 13

2
Objective of FRS 8

• FRS 8 applies to material transactions
• their disclosure might reasonably be expected
  to influence decisions made by users
• A basic assumption of accounting is that
  transactions are carried out at arms length
  between independent parties.
• If they are not, users may be misled by the
  possibility that reported financial position and
  results may be affected by the existence of
  material related party transactions.
• If related parties enter into transactions that
  unrelated parties would not undertake, it is
  considered useful to highlight these transactions
  and the existence of the relationship.

3
Definitions

• Related party transaction Transfer of assets or
  liabilities or the performance of services by, to
  or for a related party irrespective of whether a
  price is charged
• Related party relationship exists if at any time
  during the financial period
• (i) one party has direct or indirect control of
  the other party or
• (ii) parties are subject to common control or
• (iii) one party has influence over the financial
  and operating policies of the other party to the
  extent that the other party may be inhibited from
  pursuing at all times its own interest
• (iv) parties are subject to influence from the
  same source to such an extent that one party has
  subordinated its own separate interests

4
Explicit related parties of the reporting entity

• Para. 2.5 (b) confirms the following
• Ultimate and intermediate parents, subsidiaries
  and fellow subsidiaries
• Associates and JVs
• Investor in respect of which reporting entity is
  an associate or joint venture
• Directors of reporting entity as well as
  directors of ultimate and intermediate parent
• Pension funds for the benefit of employees of the
  reporting entity

5
Presumption of relationship

• Because of explicit relationships identified by
  FRS 8, the following are presumed related party
  relationships unless otherwise demonstrated
• Key management of reporting entity and key
  management of intermediate or ultimate parents
• Person owing or controlling 20 of the voting
  rights, directly or indirectly
• Each person acting in concert to be able to
  exercise control or influence over the reporting
  entity
• An entity managing or managed by the reporting
  entity under a management contract

6
Extension of presumption

• Because of their relationship with certain
  parties that are, or are presumed to be related
  parties of a reporting entity, the following are
  also related parties
• members of the close family
• partnerships, companies, trusts or other entities
  in which any individual or member of the close
  family has a controlling interest
• List of identified related parties in FRS 8 is
  not an exhaustive list
• Substance over form

7
Disclosure requirements

• Financial statements should disclose material
  transactions undertaken by the reporting entity
  with a related party
• names of related parties
• description of relationship
• description of transactions
• amounts involved
• balances outstanding at period end
• any amounts written off
• any other elements of the transactions required
  for full understanding of financial statements

8
Examples

• Assets and liabilities may be transferred between
  parties at values above or below market value
• One party may make a loan to another at a
  beneficial interest rate or without taking into
  account the full risk involved
• Services carried out by one party for another may
  be charged at a reduced rate

9
Materiality considerations

• Para 20 The materiality of related party
  transactions is to be judged, not only in terms
  of their significance to the reporting entity,
  but also in relation to the other related party
  when that party is
• (a) a director, key manager or other individual
  in a position to influence, or accountable for
  stewardship of, the reporting entity or
• (b) a member of the close family of any
  individual mentioned in (a) above or
• (c) an entity controlled by any individual
  mentioned in (a) or (b) above

10
Example

• Brian is a director of ABC Limited. He also owns
  a controlling interest in MTV Limited.
• Jack is a regular supplier of goods to ABC
  Limited.
• Jack makes a one off supply of goods to MTV
  Limited for a special price following
  representations from Brian.
• Are there any related party transactions to
  disclose in the accounts of MTV Limited?

11
Example

• Same details as the previous example except that
  there were several transactions throughout the
  year between MTV Limited and Jack. Only the
  original transaction was for a special price.
  All others were on normal commercial terms.
• What disclosures are required in the accounts of
  MTV Limited?

12
Example

• During the year ABC Group purchased 220,000 of
  goods at normal prices and a freehold property at
  an open market value of 5 million from XYZ
  Limited, an associated company. At financial
  year end, 20,000 was due in respect of the
  finished goods.
• What disclosures, if any, required in the
  consolidated financial statements?

13
ABC Group disclosure

• During the year, the group purchased from XYZ
  Limited, an associated company, 220,000 of
  finished goods at normal trade prices and a
  freehold property at an independent open market
  value of 5 million. At year end, 20,000 was
  due to XYZ Limited in respect of the finished
  goods. This amount is included in Creditors
  Amounts falling due within one year.