Getting related party disclosures right

Related parties have often caused problems for practitioners, and this is largely due to their subjective nature.  In this article I will cover some of the typical issues concerning related party disclosures and incorporate some of the more commonly asked questions.

Related parties and related party transactions

Most of us know what constitutes a related party and FRSSE states that two or more parties are related when, at any time during the financial period:

• one party has direct or indirect control of the other party;
• the parties are subject to common control from the same source; or
• one party has significant influence over the financial and operating policies of the other party, to an extent that the other party might be inhibited from pursuing its own separate interests.

FRS 8 Related Party Disclosures defines a ‘related party transaction’ as:

‘the transfer of assets or liabilities or the performance of services by, to or for a related party irrespective of whether a price is charged.’ [FRS 8 paragraph 2.6]

The FRSSE (effective April 2008) states that related parties of a reporting entity including the following:

• parent undertakings, subsidiary and fellow subsidiary undertakings;
• associates and joint ventures;
• investors with significant influence and their close families; and
• directors of the reporting entity and of its parent undertakings.

Disclosures required

When related parties enter into transactions, disclosures must include:

• the names of the transacting related parties;
• a description of the relationship between the parties;
• a description of the transactions;
• the amounts involved;
• any other elements of the transactions necessary for an understanding of the accounts;
• amounts due to or from related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and
• amounts written off in the period in respect of debts due to or from related parties.

Materiality

When the term ‘materiality’ is mentioned, it is quite common for accountants to go into autopilot and judge items in relation to percentages of turnover, profit before tax and gross assets (audit materiality).  However, FRS 8 defines the term ‘material’ in the following way:

‘Transactions are material when their disclosure might reasonably be expected to influence decisions made by the users of general purpose financial statements.’ [FRS 8 paragraph 20]

This definition does appear to exempt those transactions which clearly would be of no interest to users of the financial statements.

It is fair to say that judging materiality can be somewhat problematic for practitioners.  In FAQ 2 it was fairly obvious what is and what is not material.  However, there are many occasions when such transactions are not as clear cut and become ‘borderline’.  FRS 8 does not provide prescriptive benchmarks for materiality and the facts of each case needs to be considered in isolation.  In some instances, key management personnel could well enter into several small transactions and these transactions will all need to be aggregated to see if they are material from the individual’s point of view when applying FRS 8 requirements.  Should the items become material when aggregated then disclosure will be required.

When considering the definition of materiality, you do so having regard to the users’ needs of general purpose financial statements.  If you look to Chapter 1 of the ASBs Statement of Principles, this details various users including investors, employees, banks and financiers, trade creditors and such like.  It also sets out their various needs as well as acknowledging that general purpose financial statements cannot meet the information needs of all types of users mentioned in Chapter 1 of the Statement of Principles, but does acknowledge that there are needs that are common to all users.  Therefore, when considering whether disclosure of a particular related party is material you should consider the needs of the users.

Transactions with directors: disclosures

I have covered the issue about transactions with directors in previous articles, but it still seems to rear its head within the profession, hence it seemed sensible to incorporate it in this article.  The FRSSE (effective April 2008) is now based on the disclosure requirements contained in Section 413 Companies Act 2006.  This particular section requires disclosure of information relating to directors’ benefits which include advances, credits and guarantees.  For the purposes of this particular section, you must make disclosure in the notes to the financial statements of:

• Advances and credits which have been made to the director; and
• Guarantees of any kind entered into on behalf of the directors.

In respect of advances and credits, disclosure needs to be made concerning:

• The amount.
• An indication of the interest rate.
• The main conditions.
• Any amounts repaid.

In respect of guarantees, disclosure is to be made concerning:

• The main terms.
• The amount of the maximum liability that may be incurred by the company (or its subsidiary).
• Any amount paid and any liability incurred by the company (or its subsidiary) for the purpose of fulfilling the guarantee.

It is fair to say that the disclosures in Section 413 concerning directors advances and credits has caused a bit of unrest because of how it could be defined, but professional bodies have acknowledged that there has to be some degree of common sense in this approach, as opposed to producing what would otherwise look like a shopping list in the notes to the financial statements.  A suggested disclosure approach is as follows:

• Balance b/fwd
• Plus advances in the year
• Plus private transactions
• Less amounts repaid
• Less undrawn remuneration
• Less dividends
• Balance c/fwd

Any individual advances or repayments considered material should be disclosed separately.  It is also worth pointing out that auditors may well challenge the disclosures if they consider them inadequate for the purposes of giving a true and fair view.

Controlling parties

Companies are invariably controlled by another party.  This can either be the shareholders or another company.  Where the company is controlled by another party, disclosure must be made of:

• the name of the controlling party; and
• if different, the name of the ultimate controlling party

It is also worth pointing out that these disclosures are required regardless of whether there have been any transactions between the parties.  In situations when the controlling party of the reporting entity is unknown, you must disclose that fact.  You need only make disclosure, however, when there is control, not when there is merely significant influence.

When transactions don’t need to be disclosed as related party transactions

There is no need to make disclosure of:

• pension contributions paid into a pension fund; nor
• payroll costs in respect of services as an employee of the reporting entity.

There are also exemptions from disclosing the relationship and transactions between the reporting entity and:

• providers of finance in the ordinary course of their business;
• utility companies;
• government departments and their sponsored bodies; or
• a customer, supplier, franchiser, distributor or general agent.

Companies Act 2006 disclosures

There are many disclosures which are required under FRSSE and FRS 8 which are not required under Companies Act and hence can be ignored for the purposes of abbreviated financial statements.  Here is a summary of the main disclosure requirements under Companies Act 2006.

For group companies the disclosure requirements in the notes under Companies Act 2006 are as follows:

Category: Accounting and standards, Audit