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.
Types
- Transactions with the Subsidiary company, 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
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 Company ABC ltd. and at the time of preparation of consolidated Financial Statements.
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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 -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.
Conclusion
- It should be transacted at arm’s length transaction. 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 report, 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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