What is Related Party Transactions?
Related Party Transaction is a transaction/ deal/ arrangement between two related parties for the transfer of resources, services or obligations, irrespective of whether a price is charged and it can have an effect on the statement of profit or loss and financial position of an entity. The requirement to disclose such transactions between related parties in Financial Statement is necessary. Also, Related parties may enter into transactions that unrelated parties may not.
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Source: Related Party Transactions (wallstreetmojo.com)
Types
- Transactions with the Subsidiary companySubsidiary CompanyA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company.read more, Associate, and Joint VentureJoint VentureA joint venture is a commercial arrangement between two or more parties in which the parties pool their assets with the goal of performing a specific task, and each party has joint ownership of the entity and is accountable for the costs, losses, or profits that arise out of the venture.read more;
- Transactions with Directors, Key Persons, Relatives of Directors, and Key Persons.
- Transactions with Relatives of Owner of Entity.
Related Party Transactions Examples
Example #1
ABC Ltd. has investment and holds 26% Shareholding of CDE Ltd. And CDE ltd. hold shares 51% of EFG ltd.
Solutions:
Company CDE ltd is an Associate Company of Company ABC ltd as it has more than 20% shareholding of Company CDE ltd. Transactions between these companies, i.e., ABC ltd and Associate Company, i.e., CDE ltd to be disclosed in the Financial Statement of CompanyFinancial Statement Of CompanyFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more ABC ltd. and at the time of preparation of consolidated Financial StatementsConsolidated Financial StatementsConsolidated Financial Statements are the financial statements of the overall group, which include all three key financial statements – income statement, cash flow statement, and balance sheet – and represent the sum total of its parents and all of its subsidiaries.read more.
All the related parties transactions among ABC ltd., CDE ltd. and EFG ltd. to be recorded in Financial Statement because of EFG ltd. is a subsidiary company of CDE ltd. and CDE ltd. is an associate company of ABC ltd.
Example #2
Company A has 70% Shareholding of Company B. Company A sold the goods $5 Million to Company B during the Financial Year.
Solutions:
Company A is holding Company of Company B as it has more than 51% Shareholding of Company B and Transactions between Holding Company, i.e., A and Subsidiary Company, i.e., B to be disclosed in Financial Statement of Company A and at the time of preparation of consolidated Financial Statement.
Above Example, Company A shall disclose the related party transaction in its financial statement and also disclose its nature.
Advantages
- The entity may benefit from such transactions if family relatives hold significant ownership of the entity. For example, a company that sells the finished goods to its related party at cost price may not sell on that price to another customer.
- It should be disclosed separately in Financial Statements for better representation.
- Related parties may enter into transactions that unrelated parties may not.
Disadvantages
- An entity can have losses from such transactions if family relatives do not hold significant ownership of the entity.
- Management can suppress such transactions and may gain in doing so.
- It should be disclosed separately in Financial Statements for better representation; otherwise, financial statements will provide an untrue and unfair view.
- These transactions could have an adverse effect on the Statement of profit or loss and financial position of an entity.
Limitations
- Private benefits of control are values enjoyed exclusively by the party in control, which is not shared among all the shareholders in the proportion of the shares owned.
- Management could not be able to control some related party transactions where parties have substatial control (More than 50%) on the board.
- These are driven by shared benefits only.
- These are driven by private benefits only.
Important Points
- Status of Relationships between Related Parties should be disclosed whether there have been transactions between them or not.
- If a company has had any related party transactions during the financial year, then all such transactions shall be disclosed in the financial statements.
- Related party transactions and their balances with another company in a group to be shown in a company’s financial statements. Intra-group transactions and balances are to be written -offWritten -offWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more at the time of accounting of consolidated financial statements of the group.
- It should be transacted at arm’s length price (This is the price on which goods to be sold to unrelated parties).
- An entity should disclose key management personnel compensation in total so that Shareholders can get all the relevant information about key management personnel compensation.
Conclusion
- It should be transacted at arm’s length transactionArm's Length TransactionAn arm's length transaction is one in which two parties operate independently and the price agreed between them (also known as the transfer price) is free of any influence.read more. An entity should disclose related party transactions between related parties and entities in the Financial Statement for better representation. Management of an Entity should follow the Accounting Standards and Policies issued by the Accounting Board/ Committee so that Frauds through such transactions can be identified and minimal such frauds.
- The group should prepare its consolidated financial statements after consideration of related party transactions as per issued accounting policies, guidelines, and standards. Consolidated financial statements as a whole can represent a better, true, and fair view of the company’s financial position. Since consolidated financial statements are also an integral part of an annual reportAn Annual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company's performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more, which too is shared with Shareholders, Stock exchanges, Government, Stakeholders, Management, Annual General Meeting, and display on the website of the group.
- It should be done on Arm length price between related parties to avoiding fraud.
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