Impact on the financial statements

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1 Impact on the financial statements

A user of financial statements will normally expect the financial statements to reflect transactions that have taken place on normal commercial terms (‘at arm’s length’).

The user of the financial statements would want to be informed if Transactions have taken place that were not at ‘arm’s length’; or There are parties that could enforce transactions on the entity that are not on an ‘arm’s length’ basis.

For example, in a group of companies, an entity might sell goods to its parent or fellow-subsidiaries on more favorable terms than it would sell to other customers. In this situation, the financial performance or financial position reported by the financial statements would be misleading.

In each situation there is a special relationship between the parties to the business transactions.

This is referred to as a ‘related party relationship’.

The objective of IAS24 The objective of IAS 24 is to ensure that an entity’s financial statements contain sufficient disclosures to draw attention to the possibility that the entity’s financial position, or profit or loss may have been affected by:  the existence of related parties; and  transactions and outstanding balances with related parties. IAS 24 is a disclosure standard. It does not require the redrafting of financial statement

 

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Related party transaction
Related party:

A party is related to an entity (it is a related party) in any of the following circumstances:

The party controls the entity, or is controlled by it: (e.g. parent and subsidiaries’ relationship);

It has significant influence over the entity: (e.g. investor and associate relationship);  It has joint control over the entity: (e.g. joint ventures' relationship);

The parties are under common control. (e.g. fellow subsidiaries’ relationship);

The party is a member of the key management personnel of the entity or its parent; and

The party is a close family member of any of the above.

A parent entity is related to its subsidiary entities (because it controls them) and its associated entities (because it exerts significant influence over them). Fellow subsidiaries are also related parties, because they are under the common control

 

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In considering each possible related party relationship,

the entity must look to the substance of the arrangement, and not merely its legal form.

Although two entities that have the same individual on their board of directors would not meet any of the above conditions for a related party, a related party relationship would nevertheless exist if influence can be shown.

Some examples are given by IAS 24 of likely exemptions, where a related party relationship would usually not exist. However, the substance of the relationship should always be considered in each case. Examples of entities that are usually not related parties are:

Two ventures that simply share joint control over a joint venture;

Providers of finance (such as a lending bank or a bondholder); Trade unions; Public utilities; Government departments and agencies; and Customers, suppliers, franchisors, distributors or other agents with whom the entity transacts a significant volume of business.

 

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Related party transaction
A related party transaction is:

A transfer of resources, services, or obligations between related parties; and Whether or not a price is charged. The following examples of related party transactions are given in IAS 24.

(These are related party transactions when they take place between related parties):

Purchases or sales of goods; Purchases or sales of property and other assets;

Rendering or receiving of services; Leases; Transfer of research and development costs;

Finance arrangements (such as loans or contribution to equity); Provision of guarantees; and Settlement of liabilities on behalf of the entity or by the entity on behalf of another party.

 

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Disclosure requirements

IAS 24 requires disclosure in the notes to the financial statements of the following,

whether or not transactions have taken place between those related parties: the name of the entity’s parent; and if different, the name of the ultimate controlling party.

Where transactions have taken place between the related parties, irrespective of whether a price was charged, or price charged is at arm’s length, the following should be disclosed:

The nature of the related party relationship;

The amount of the transactions; In respect of outstanding balances:

the amount; their terms and conditions; any guarantees given or received; any provision for doubtful/irrecoverable debts; and

The expense recognized in the period in respect of irrecoverable debts due from related parties

 

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DISCLOSURES

The disclosures should be given separately for each of the following categories of related party:

The parent; Entities with joint control or significant influence over the entity;

Subsidiaries; Associates; Joint ventures in which the entity is a venture;
Key management personnel of the entity or its parent; and

Other related parties. In addition, IAS 24 requires disclosure of compensation to key management personnel, in total, and for each of the following categories:

Short-term employee benefits; Post-employment benefits; Other long-term benefits; Termination benefits; and Share-based payments. Sales to related parties Purchases from related parties Amount

All this disclosures are very pertinent to business.

 

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The impact of the new accounting rules will be a significant change to the financial statements. The impact on the income statement is expected to be minimal, while the impact on the balance sheet and cash flow is expected to be substantial.

The primary effect of the new rules will be a reduction in reported earnings, which may require a change in accounting policies and procedures for certain companies. This will be particularly relevant for companies with a high level of debt and/or high levels of Net Operating Losses (NOLs).

In addition, the new rules will require all businesses to adopt IFRS as their primary source of financial reporting. This means that any company that currently uses American Accounting Standards Board (ASB) standards or International Financial Reporting Standards (IFRS) must convert to those standards by 2020.