AC506 lecture 16

1. AC506 lecture 16 • Related party disclosures • Sources: • FRS 8 • Elliott and Elliott, chapter 8 • Alexander and Britton, Chapter 24 • Lewis and Pendrill, Chapter 13

2. Objective of FRS 8 • FRS 8 applies to material transactions =>their disclosure might reasonably be expected to influence decisions made by users • A basic assumption of accounting is that transactions are carried out at arm’s length between independent parties. • If they are not, users may be misled by the possibility that reported financial position and results may be affected by the existence of material related party transactions. • If related parties enter into transactions that unrelated parties would not undertake, it is considered useful to highlight these transactions and the existence of the relationship.

3. Definitions • Related party transaction: Transfer of assets or liabilities or the performance of services by, to or for a related party irrespective of whether a price is charged • Related party relationship exists if at any time during the financial period: (i) one party has direct or indirect control of the other party; or (ii) parties are subject to common control; or (iii) one party has influence over the financial and operating policies of the other party to the extent that the other party may be inhibited from pursuing at all times its own interest (iv) parties are subject to influence from the same source to such an extent that one party has subordinated its own separate interests

4. Explicit related parties of the reporting entity • Para. 2.5 (b) confirms the following: • Ultimate and intermediate parents, subsidiaries and fellow subsidiaries • Associates and JVs • Investor in respect of which reporting entity is an associate or joint venture • Directors of reporting entity as well as directors of ultimate and intermediate parent • Pension funds for the benefit of employees of the reporting entity

5. Presumption of relationship • Because of explicit relationships identified by FRS 8, the following are presumed related party relationships unless otherwise demonstrated: • Key management of reporting entity and key management of intermediate or ultimate parents • Person owing or controlling > 20% of the voting rights, directly or indirectly • Each person acting in concert to be able to exercise control or influence over the reporting entity • An entity managing or managed by the reporting entity under a management contract

6. Extension of presumption • Because of their relationship with certain parties that are, or are presumed to be related parties of a reporting entity, the following are also related parties: • members of the close family • partnerships, companies, trusts or other entities in which any individual or member of the close family has a controlling interest • List of identified related parties in FRS 8 is not an exhaustive list • Substance over form

7. Disclosure requirements • Financial statements should disclose material transactions undertaken by the reporting entity with a related party: • names of related parties • description of relationship • description of transactions • amounts involved • balances outstanding at period end • any amounts written off • any other elements of the transactions required for full understanding of financial statements

8. Examples • Assets and liabilities may be transferred between parties at values above or below market value • One party may make a loan to another at a beneficial interest rate or without taking into account the full risk involved • Services carried out by one party for another may be charged at a reduced rate

9. Materiality considerations • Para 20: The materiality of related party transactions is to be judged, not only in terms of their significance to the reporting entity, but also in relation to the other related party when that party is: • (a) a director, key manager or other individual in a position to influence, or accountable for stewardship of, the reporting entity; or • (b) a member of the close family of any individual mentioned in (a) above; or • (c) an entity controlled by any individual mentioned in (a) or (b) above

10. Example • Brian is a director of ABC Limited. He also owns a controlling interest in MTV Limited. • Jack is a regular supplier of goods to ABC Limited. • Jack makes a one off supply of goods to MTV Limited for a special price following representations from Brian. • Are there any related party transactions to disclose in the accounts of MTV Limited?

11. Example • Same details as the previous example except that there were several transactions throughout the year between MTV Limited and Jack. Only the original transaction was for a special price. All others were on normal commercial terms. • What disclosures are required in the accounts of MTV Limited?

12. Example • During the year ABC Group purchased €220,000 of goods at normal prices and a freehold property at an open market value of €5 million from XYZ Limited, an associated company. At financial year end, €20,000 was due in respect of the finished goods. • What disclosures, if any, required in the consolidated financial statements?

13. ABC Group disclosure • During the year, the group purchased from XYZ Limited, an associated company, €220,000 of finished goods at normal trade prices and a freehold property at an independent open market value of €5 million. At year end, €20,000 was due to XYZ Limited in respect of the finished goods. This amount is included in Creditors: Amounts falling due within one year.