IAS 24 Related parties

A set of financial statements tells you what an entity earned and what it owns. It does not, on its face, tell you whom it was dealing with. IAS 24 Related Party Disclosures fills that gap. It changes no number — nothing is recognised, remeasured or reclassified because of it — but it requires the entity to say who its related parties are and what passed between them, so that a user can judge the reported performance and position knowing how much of it came from dealings that may not have been at arm's length.

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1 Why related party disclosures matter

Related party relationships are a normal part of everyday business. Groups of companies are often built around a trading relationship, and a group that buys and sells within itself is doing nothing improper.

The relationship can nevertheless have a direct effect on reported performance, because of the special terms that can arise between related parties. An entity may sell to a fellow group company at a smaller mark-up than it would charge anyone else. The transaction is not at arm's length, and the margins of both companies then reflect the relationship rather than the trading.

The same is true of balances. An entity may allow a related party an extended credit period it would refuse an ordinary customer, which flatters the related party's liquidity and distorts the reporting entity's own receivables collection period.

A transaction may also fail to happen because of a relationship — a company stops buying from its usual supplier because its parent tells it to buy from a fellow subsidiary instead. That is why IAS 24 requires the relationship between a parent and its subsidiaries to be disclosed even when there have been no transactions at all.

If users know about the relationships, the transactions and the balances, they can take them into account when assessing the entity's performance, position and prospects. That is the whole purpose of the standard.

2 Who is a related party

IAS 24 defines a related party as a person or an entity that is related to the reporting entity — the entity preparing the financial statements. Both limbs turn on the same three ideas: control, joint control and significant influence, which section 3 defines.

One question decides most cases: is there an unbroken chain of control or influence between the reporting entity and the other party? If there is, they are related. If the chain breaks, they are not — however much commercial leverage the other party may have.

2.1 The person limb

A person, or a close member of that person's family, is related to the reporting entity if that person:

• has control or joint control of the reporting entity;

• has significant influence over the reporting entity; or

• is a member of the key management personnel of the reporting entity, or of a parent of the reporting entity.

So a director of the parent is a related party of every company in the group — and so is that director's spouse, who has no shareholding, no job with the group and no dealings with it. That is the whole of Example 1 below.

2.2 The entity limb

An entity is related to the reporting entity if any of the following applies:

• the two are members of the same group — so a parent, each of its subsidiaries and each fellow subsidiary are all related to one another;

• one is an associate or a joint venture of the other, or of a member of the same group as the other;

• both are joint ventures of the same third party;

• one is a joint venture of a third entity and the other is an associate of that same third entity;

• the entity is a post-employment benefit plan for the benefit of employees of the reporting entity, or of an entity related to it;

• the entity is controlled or jointly controlled by a person identified in the person limb, or a person who controls or jointly controls the reporting entity has significant influence over it or is a member of its key management personnel;

• the entity, or any member of a group of which it is part, provides key management personnel services to the reporting entity or to its parent.

Read the left panel through the chain rule. The parent controls the subsidiary and has significant influence over the associate, so each is related to the parent. And because the parent controls the subsidiary and can influence the associate, the subsidiary and the associate are related to each other as well — the chain runs through the parent and is never broken. Nobody has to transact for the relationship to exist.

The right panel is the case students miss. Two venturers who together have joint control of a joint venture are each related to the joint venture, but they are not related to each other. Neither controls, jointly controls or significantly influences the other, and each takes its own decisions independently. IAS 24 says so explicitly.

2.3 Who is not a related party

IAS 24 names four cases that are not related party relationships. They are the standard's own examples, and objective questions are built out of them, because each one looks like influence until the definition is applied.

3 The definitions the tests turn on

Three of the five terms below are defined by other standards, and IAS 24 uses them as those standards define them. Get the source right and the definition follows.

4 What has to be disclosed

IAS 24 is a disclosure standard: it adds notes, not numbers. There are three separate requirements, and the first of them applies whether or not anything has been bought or sold.

4.1 The relationship itself

Relationships between a parent and its subsidiaries are disclosed irrespective of whether there have been transactions between them. The entity discloses:

• the name of its parent; and

• if different, the name of the ultimate controlling party.

If neither of those produces consolidated financial statements available for public use, the entity also names the next most senior parent that does — so that a user can always find a set of accounts in which the group is presented as a whole.

4.2 Key management personnel compensation

Compensation of key management personnel is disclosed in total and separately for each of five categories:

• short-term employee benefits;

• post-employment benefits;

• other long-term benefits;

• termination benefits; and

• share-based payment.

Compensation means all employee benefits, including those to which IFRS 2 Share-based Payment applies, and it includes amounts paid by a parent on the entity's behalf in respect of the entity's own employees.

4.3 Transactions and outstanding balances

Where there have been transactions between related parties, the entity discloses the nature of the relationship together with enough information about the transactions and the outstanding balances for a user to understand their potential effect on the financial statements. Disclosure is required whether or not a price was charged.

As a minimum it discloses:

• the amount of the transactions;

• the amount of the outstanding balances, including commitments, together with their terms and conditions, whether they are secured, and the nature of the consideration to be given in settlement;

• any allowance for doubtful debts on those outstanding balances; and

• the expense recognised in the period in respect of bad or doubtful debts due from related parties.

That information is given separately for each of the following categories:

• the parent;

• entities with joint control of, or significant influence over, the entity;

• subsidiaries;

• associates;

• joint ventures in which the entity is a joint venturer;

• key management personnel of the entity or of its parent; and

• other related parties.

Transactions to be disclosed if they occur include purchases and sales of goods, property or services; leases; transfers of research and development; licence agreements; the provision of finance, including loans and equity contributions; guarantees given or received; commitments; and the settlement of the entity's liabilities by a related party on its behalf.

One partial exemption exists. An entity controlled, jointly controlled or significantly influenced by a government need not give the full detail for transactions with that government, or with other entities related to it through the same government. Instead it names the government, describes the relationship, and discloses the nature and amount of any individually significant transaction together with a qualitative indication of the extent of the rest. Know that the exemption exists and why: without it, a state-controlled entity in an economy where the government owns much of the industry would be listing thousands of related parties to no useful purpose.

4.4 Where the disclosure bites in a group

This is the point that makes IAS 24 a group topic. Intra-group related party transactions and balances are eliminated on consolidation, so they do not appear in the consolidated financial statements and there is nothing about them left to disclose there. The parent–subsidiary relationship is still disclosed — that requirement is unconditional — but the transactions themselves have gone.

The disclosure of intra-group transactions therefore bites in the separate financial statements of each individual group company (IAS 27 Separate Financial Statements), where a subsidiary's sales to its parent are real revenue and its balance with the parent is a real receivable. A student who only ever looks at consolidated accounts will not see why the requirement matters.

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