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Essential guide to FRS 8 : Reporting related parties

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9th Oct 2009
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Steve Collings offers a clarification of the financial reporting requirements governing related party disclosures.

The standard governing related party issues, FRS 8 Related Party Disclosures, often causes confusion with preparers of financial statements because of its subjective nature. This article will look at some of the core areas of FRS 8, notably control, common control, influence and common influence.

Related party transactions can take many forms but are usually confined to transactions undertaken in the normal course of business (this is mostly the case with companies in the SME sector). The overall objective of FRS 8, its international counterpart IAS 24, and FRSSE (April 2008) section 15 is to draw attention to the fact that reported financial information may have been influenced by the existence of related parties and material transactions between those related parties which could undermine the financial statements if disclosure of them is not made. 

For example: Company A has provided an interest free loan to another company which was owned by the operations director of Company A. This transaction would need disclosure under FRS 8, not only because the operations director would be considered ‘key management’, but also because it would be extremely unusual for one company to provide another unrelated company with an interest free loan.

FRS 8 and its counterparts (IAS 24 and FRSSE equivalent) apply to all financial statements which are required to give a true and fair view.  For the purposes of those preparing accounts for clients in the SME sector, these financial statements are the full, unabbreviated, financial statements.

Who is a ‘related party’?

A related party can be an individual or a corporate entity, whether incorporated or a sole trader, a partnership or LLP. A related party can also be a group of individuals, for example where a group of directors act ‘in concert’. For the purposes of financial reporting, there are four criteria for ascertaining whether two or more parties are related parties. The criteria are as follows:

  • One party has direct or indirect control of the other party.
  • The parties are subject to common control from the same source.
  • One party has influence over the other party.
  • The parties are subject to influence from the same source.

The above points could therefore be headed up as:

  • Control
  • Common control
  • Influence
  • Common influence

Control
Control is the ability to influence the financial and operating policies of an entity. The controlling party will have a view to gaining economic benefit from such control. More often than not (especially for companies in the SME sector), control is obtained when more than 50% of the voting rights in the company are obtained. 

For example, where a director holds 75% of the shares of Company A, then by virtue of his/her shareholding, the director has control of Company A. This ‘ultimate control’ should be disclosed in the financial statements.

Common control
Common control can arise, for example, where two companies are subject to common control by the same individual. 

Figure 1.

In Figure 1, Company A is a related party of Company B. Company A is also a related party of Company C. Both Company B and Company C are also related parties because they are subject to common control.

Influence
Influence is essentially where one party has influence over another company’s financial and operating policies to such an extent that the other party could be inhibited from pursuing, at all times, its own separate interests. To some extent, it can be unclear whether or not one party influences another party to the extent that it inhibits the subject party from pursuing its own interests at all times. This is a ‘grey’ area, and open to interpretation. 

However, I am of the opinion that the fact one party has the ability to influence the other party, and thus has the power to prevent it from pursuing its separate interests at all times, is generally a trigger for all transactions between the two parties to become disclosable.

Common influence
Common influence is where parties essentially enter into a transaction and are subject to influence from the same source. 

In the scenario described in figure 1, if Company A merely had influence over Companies B and C, then both B and C could be inhibited from pursuing their own separate interests at all times because Company A would have influence over B and C’s financial and operating policies.

Transactions become disclosable under FRS 8 where influence is actually exerted, i.e. one party has placed its own interests after the other’s in entering into the transaction. Therefore, it is necessary to look at the facts of the transaction to establish whether (or not) influence has been exerted.  If either party has put its own interests after the other party (or parties), in entering into that transaction, then disclosure is required of that transaction, and all other transactions undertaken in the year.

One director in common

Figure 2

In figure 2, assume that the director does not control Alpha Limited or Beta Limited. The question in this case is ‘are Alpha and Beta related parties?’

Under the provisions of FRS 8, two companies are not related parties just because they have a director in common. More often than not, a director can have influence over the running of the company but this does not necessarily give rise to Alpha and Beta becoming related parties, as Alpha and Beta would be expected to go about their own business for the benefit of their respective shareholders.

However, consider a scenario where Alpha Limited had pledged security for Beta’s borrowings. This would mean that Alpha has put Beta’s interests before its own. In this case Alpha and Beta would be related parties for the entire accounting period in question.

Another example would be if Alpha Limited and Beta Limited had a controlling nucleus of six directors each, five of whom were directors of both companies.  In this case, Alpha Limited and Beta Limited would be related parties because they would be under common control.

Persons acting in concert
The term ‘acting in concert’ is referred to when directors of a company actively co-operate to exercise control or influence over a company. Where this occurs, control is obtained and disclosure in the financial statements is required. A typical disclosure in the full financial statements of a reporting entity is:

‘The directors are regarded as controlling parties by virtue of their ability to act in concert in respect of the operations of the company’.

Key management
With effect from 6 April 2008, FRS 8 defines key management as:

“Those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity.”  (Para 2.3 FRS 8 - revised).

Key management includes people who are not on the board of directors but whose duties include directing and controlling an entity’s activities. 

For example, consider a plant hire company that has two divisions, one in the North of England and one in the South. Each division has a branch manager who is not a director. The branch managers would be considered ‘key management’ because they are responsible for directing and controlling half of the company’s principal activities.

Disclosures
The disclosures required under FRS 8 are as follows:

  • The name of the party who controls the entity and (if different), the name of the ultimate controlling party. This disclosure is required regardless of whether or not transactions have taken place between these parties.
     
  • A description of the relationship.
     
  • Details of material transactions entered into between the reporting entity and its related parties together with details of the amounts involved and balances due to or from each related party at the balance sheet date together with any other additional information which will enable a better understanding of related party transactions.
     
  • Details of any amounts written off in the period.

Related parties are renowned for causing a lot of confusion because of the subjective nature of related parties. Hopefully this article clears up some of the ambiguity associated with this. Auditors of companies who could have material related party transactions should comply with the requirements laid down in ISA 550 ‘Related Parties’.  Auditors should note ISA 550 has been revised and redrafted for audits of periods beginning on or after 15 December 2009.

Steve Collings FMAAT ACCA DipIFRS is audit and technical manager at Leavitt Walmsley Associates Ltd and a partner in AccountancyStudents.co.uk. He is also the author of ‘The Core Aspects of IFRS and IAS’ and lectures student accountants on financial reporting and auditing issues.

 

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By User deleted
09th Oct 2009 13:26

Non Uk registered related parties?

This is a really useful document, thank you. One question, does it still apply if the related party is a company not registered in the UK?

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collings
By Steven Collings
09th Oct 2009 14:31

Non UK registered related party

Hi,

 If your non UK registered related party meets the definition of a related party under the framework you are reporting under (e.g. FRS/FRSSE) then it does not matter where your related party is situated, it will still be caught under the related party provisions and all material transactions between the reporting entity and its overseas related party will be disclosable.

 Kind regards,

Steve

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By User deleted
09th Oct 2009 14:50

Related Party Example

Hi,

I have two companies, one owned by the husband (sole director & 100% shareholder) and the other by the wife (sole director & 100% shareholder).

The husbands company manufactures items and sells them on to various retailers one of which is his wife's company. All of the transactions are of a commercial nature with no 'special' terms. The wife also has other suppliers but around 80% is from her Husbands Company.

I am planning not to disclose these as related party transactions as this information may not sit well with the Husbands other customers and therefore prejudice his ability to trade.

15.7 of the FRSSE also states that disclosure of a related party transaction is not required of (c) transactions with the parties listed below simply as a result of their role as (iv) a customer, supplier etc.

Is non-disclosure of these transactions acceptable?

 

Many thanks

 

 

 

 

 

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collings
By Steven Collings
09th Oct 2009 15:12

Husband/wife run companies

Hi,

I think in your example above, where husband has 100% in his company and wife 100% in hers and both enter into commercial transactions, then you need to be looking at the "close family" provisions (which are quite grey - para 2.1 FRS 8).  The definition of a related party can also apply to close family where those family members could influence the other family member in their dealings with the company. For example, the wife could ask (or maybe demand!!) the husband to supply goods to her at a discount which he would not normally offer other customers in the normal course of business.  In this instance, the wife has influenced the husband and as such would trigger a related party disclosure.

So in answer to your question, you need to establish whether husband and/or wife can (or could be expected to) influence (or be influenced by) one another in their dealings. 

Kind regards,

Steve

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By joanne lewisham
10th Oct 2009 00:37

A fantastic article
A fantaastic article once again from Steve. This has helped me clear a number of problems I knew were not right in the firm I work for.

Thanks for this. It's what we come here for!

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