Disclosures and Analysis Overview
As you have learned, the accounting and financial reports are essential to a firm's stakeholders. In this chapter, you will see what actions a firm takes to ensure that the reports presented to the stakeholders are a true and accurate representation of their financial status. Pay particular attention to the discussion on disclosure issues.
4. Disclosure Issues
4.2. Related Party Transactions
One area in particular where full disclosure is important is in the case of related parties.The accounting issue with related parties is that transactions with these parties may occur on a non-arms-length basis. Because the transactions may occur in a manner that is not consistent with normal market conditions, it is important that readers are alerted to their presence. IAS 24 provides guidance to the appropriate treatment of related party transactions and balances. IAS 24 provides a detailed definition of related parties, as follows:
a. A person or a close member of that person’s family is related to a reporting entity if that person:ii. has significant influence over the reporting entity; or
iii. is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.
ii. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).
iii. Both entities are joint ventures of the same third party.
iv. One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
v. The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If there porting entity is itself such a plan, the sponsoring employers are also related to the reporting entity.
vi. The entity is controlled or jointly controlled by a person identified in (a).
vii. A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).
viii. The entity, or any member of a group of which it is a part,provides key management personnel services to the reporting entity or to the parent of the reporting entity. (CPA Canada, 2016, Part I, Section IAS 24.9)
The standard further defines close family members as the children, dependents, and spouse or domestic partner of the person in question. However, the definition leaves some room for interpretation as it suggests that a close family member is any family member who is expected to influence, or be influenced by, the person in question.
In cases where complex corporate structures exist, it may be helpful to draw organization charts or other visual representations to determine who the related parties are. Correct identification of the related parties is important, as this will determine the disclosures that are required.
The key feature of IAS 24 is that it requires additional disclosures when related parties exist. Specifically, all related party relationships must be disclosed, even if there are no transactions with those parties. When transactions with related parties do occur, the amount of the transactions and outstanding balances must be disclosed, along with a description of the terms and conditions of the transaction, any commitments, security, or guarantees with the related party, the nature of the consideration used to settle the transactions, and the amount of any provision or expense related to bad debts of the related party. Additionally, the standard requires disclosure of details of compensation paid to key management personnel. The disclosure requirements are designed to help readers understand the potential effects of the related party transactions on the entity’s results and financial position.
ASPE takes related party disclosures one step further by also requiring different measurement bases for the transaction, depending on the circumstances. In summary, related party transactions are normally reported at the carrying amount of the item or services transferred in the accounts of the transferor. This means that the transaction may need to be remeasured at a different amount than what was agreed upon by the parties. The only circumstances where the exchange amount (i.e., the amount agreed upon by the related parties, is used to measure the transaction is if the transaction is:
- a monetary exchange in the normal course of operations
- a non-monetary exchange in the normal course of operations which has commercial substance
- an exchange not in the ordinary course of business where there is a substantive change in ownership, the amount is supported by independent evidence, and the transaction is monetary or has commercial substance.
These rules are intended to prevent related parties from reporting transactions at amounts that may not be representative of fair values. By requiring most related party transactions to be reported at the carrying amount, the standard may prevent gains or losses from being reported that represent the result of bargaining between arm’s length parties. Only where the transaction is monetary, has commercial substance, or is the result of a substantial change of ownership interests, can the negotiated price be used.
Other disclosure requirements under ASPE for related parties are similar to those of IFRS, except ASPE does not specifically require the disclosure of key management compensation.