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.

Related Party Transactions

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For eg:
Source: Related Party Transactions (wallstreetmojo.com)

Types

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

Conclusion

This article has been a guide to What is Related Party Transactions and its Definition. Here we discuss its types along with examples, advantages, and disadvantages. You can learn more about accounting from the following articles –

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