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. A related party transaction can have an effect on the statement of profit or loss and financial position of an entity. The requirement to disclose related party transactions between related parties in Financial Statement is necessary. Also, Related parties may enter into transactions that unrelated parties may not.
Related Party Transactions Types
There are many types of related party transactions, some of them are as follows, and the same can be understood after having knowledge of the definition of related party transactions:-
- Transactions with Subsidiary, Associate and Joint Venture.
- Transactions with Directors, Key Persons, Relatives of Directors and Key Persons.
- Transactions with Relatives of Owner of Entity.
Related Party Transactions Examples
Below are examples of related party transactions.
Example #1
ABC Ltd. has investment and holds 26% Shareholding of CDE Ltd. And CDE ltd. hold shares 51% of EFG ltd.
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Solutions:
Company CDE ltd. is an Associate Company of Company ABC ltd. as it has more than 20% Shareholding of Company CDE ltd. and Transactions between these Company i.e. ABC ltd. and Associate Company i.e. CDE ltd. to be disclosed in the Financial Statement of Company ABC ltd. and at the time of preparation of consolidated Financial Statements.
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.
In Above Example, Company A shall disclose the related party transaction in its financial statement and also disclose the nature, information of related party transactions.
Advantages
- The entity can have benefited from related party transactions if major ownership of the entity is held by family relatives. For example, a company that sells the finished goods to its related party at cost price may not sale on that price which was sold 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 related party transactions if major ownership of the entity is not held by family relatives.
- Management can suppress related party transactions and can have gained.
- This should be disclosed separately in Financial Statements for better representation otherwise financial statements will provide an untrue and unfair view.
- A related party transaction 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 strong 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 that all the related party transactions shall be disclosed in the financial statements. Also the nature of Related Party transactions, all information about such transactions and relationships shall be disclosed in the financial statement.
- Related party transactions and their balances with another company in a group to be shown in a company’s financial statements. Intra-group related party transactions and balances are to be written -off 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.
- Related party Transaction is a general element of the business.
Conclusion
- It should be transacted at arm’s length price. An entity should disclose related party transactions between related parties and entity 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 related party transactions can be identified and minimal such frauds.
- Group should prepare its consolidated financial statements after consideration of related party transactions as per issued accounting policies, guidelines and standards so that consolidated financial statements as a whole can be represented better, true and fair view of company’s financial position since consolidated financial statements are also integral part of annual report which too is shared with Shareholders, Stock exchanges, Government, Stakeholders, Management, Annual General Meeting and display on website of group.
- This should be done on Arm length price between related parties to avoiding frauds.
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