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FRS 102: Related Party Disclosures

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18th Nov 2014
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Section 33 of FRS 102 dealing with related party disclosures has been posing some headaches for early preparers. Steve Collings offers some guidance on how to tackle them.

Most companies will undertake some form of transactions with related parties that are usually undertaken in the normal course of business and at market values. But there are occasions when a significant related party transaction is entered into which can be at fair value or at an amount that differs from market prices.

Reporting on related parties 

Section 33 requires an entity to include necessary disclosures to inform users that the entity’s profit or loss and balance sheet position have been affected by the existence of related parties, as well as transactions with those related parties together with balances outstanding with such parties. This article works through the following aspects of these disclosures:

A point worthy of note in Section 33 is that paragraph 33.1A does not require transactions entered into between two, or more, members of a group.

There is a provision however within this paragraph covering such transactions stipulating that any subsidiary which is a party to the transaction must be wholly owned (this issue is discussed later in the article).

Identifying a related party

A related party may be a person, a company or an unincorporated entity. The definition contained within Section 33 is in two parts. Part (a) sets out the criteria which would result in a person, or a close family member of that person being a related party. 

Part (b) of the definition sets out the criteria which would result in an entity being related to the reporting entity. Within the definition is the term ‘close member of that person’s family’ and the glossary to FRS 102 defines this as:

‘Those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity including:

(a)        That person’s children and spouse or domestic partner

(b)        Children of that person’s spouse or domestic partner

(c)        Dependants of that person or that person’s spouse or domestic partner

Paragraph 33.2 says that a related party is a person, or entity, which is related to the entity that is preparing its financial statements (the entity in this case being the ‘reporting entity’).

Where ‘persons’ are concerned for the definition of a related party, step-children are also included within the definition. In addition, the term ‘dependants’ would also include foster children and other relatives where they are dependant on the related party or the related party’s spouse or domestic partner.  

A person or a close member of that person’s family becomes related to the reporting if he/she:

(i)         Has control or joint control over the reporting entity

(ii)        Has significant influence over the reporting entity

(iii)       Is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.

Example – husband and wife

Fred is married to Michelle. Fred owns 100% of Company A and Michelle owns 40% of Company B.

In this example, the husband has control of Company A and the wife has significant influence over Company B. 

For Company A’s financial statements, a close family member of the person who controls the company has significant influence over Company B and so the two companies are related by virtue of paragraphs 33.2(a)(i) and 33.2(b)(vii).

For Company B’s financial statements, a close family member of a person who has significant influence over Company B controls Company A and hence the two companies are related by virtue of paragraph 33.2(b)(vi).  

Example – branch managers who are not directors

The principal activity of Company A is that of a plant hire company. Company A consists of a head office based in the North of England and has five branches spread across the UK. 

Each branch is run by a branch manager but each branch manager is not a director of Company A. The branch managers are all responsible for the running of each branch including the planning, directing and controlling of the branch’s activities and must report on the performance of their branch on a regular basis to the board of directors.

Whilst the branch managers are not directors, they would fall under the definition of key management personnel within FRS 102 and hence would be considered to be a related party for the purposes of Section 33.

The term ‘key management personnel’ is defined in the Glossary to FRS 102 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.’

The definition above would therefore include those who are not appointed as directors (as in the example above). 

Part (b) of the definition refers to entities being related to the reporting entity and paragraph 33.2(b) outlines seven conditions which will mean that an entity is related to a reporting entity as follows:

  • The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others)
  • 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)
  • Both entities are joint ventures of the same third party
  • One entity is a joint venture of a third party and the other entity is an associate of the third party
  • 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 the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity
  • The entity is controlled or jointly controlled by a person identified in (a). [See above]
  • A person identified in (a)(i) [see above] 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).

Parties who are not related

The following are not considered to be related parties for the purposes of Section 33:

  • Two entities simply because they have a director or other member of key management personnel in common or because a member of key management personnel of one entity has significant influence over the other entity.
  • Two venturers simply because they share joint control over a joint venture.
  • Any of the following simply by virtue of their normal dealings with an entity (even though they may affect the freedom of action of an entity or participate in its decision-making process):

o    Providers of finance

o    Trade unions

o    Public utilities

o    Government departments and agencies

  •  A customer, supplier, franchisor, distributor or general agent with whom an entity transacts a significant volume of business, merely by virtue of the resulting economic dependence

Notwithstanding the fact that Section 33 recognises the above as parties who are not related, it is crucial to consider the substance of the relationship.  In the first bullet, two entities are not considered related simply because they have a director or other member of key management personnel in common

This phrase indicates that whilst the two entities might have a director or other member of key management personnel in common, there is still a need to consider whether they are, in fact, related because paragraph 33.3 does require entities to assess the substance of the related party relationship rather than the legal form. 

Transactions with group members

Paragraph 33.1A of FRS 102 says that disclosures need not be given of transactions that have taken place between two or more members of group, provided that any subsidiary which is a party to the transaction is wholly owned by such a member.

Example – intra-group trading

Consider the following group structure:

During the year Entity B and Entity C trade with Entity D. Despite B and C being wholly-owned subsidiaries of Entity A, Entity D is not wholly-owned by any member of the group and hence the intra-group transactions in B, C and D’s financial statements must be made as related party disclosures. 

The same would also apply if Entity A were to trade with Entity D. 

However, any transactions between A, B and C would be covered by the exemption from disclosure in paragraph 33.1A of FRS 102.

If, on the other hand, Entity C owned the remaining 30% shares in Entity D, then any transactions between each company in the group would be exempt from disclosure in the individual financial statements of each company.

Disclosure requirements

Section 33 deals with the disclosures concerning related party transactions in paragraphs 33.5 to 33.14.  Disclosures in respect of related party transactions are considered in a lot of detail in paragraphs 33.8 to 33.14.  Paragraph 33.9 outlines the disclosures required when an entity has related party transactions. 

In addition to disclosing the nature of the related party relationship and information about the transactions, outstanding balances and commitments necessary for an understanding of the effect of the related party relationship on the financial statements, a reporting entity is also required to disclose:

a.     The amount of the transactions

b.    The amount of outstanding balances and:

i.        Their terms and conditions, including whether they are secured, and the nature of the consideration to be provided in settlement

ii.        Details of any guarantees given or received

c.     Provisions for uncollectible receivables related to the amount of outstanding balances

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

FRS 8 'Related party disclosures' at paragraph 6(a) requires the names of the transacting related parties to be disclosed.  Section 33 is silent on disclosing the names of the transacting related parties

Key management personnel

Paragraph 33.6 requires disclosure of key management personnel compensation. 

Under FRS 8 no disclosure is necessary for emoluments in respect of services as an employee of the reporting entity (FRS 8.3(e)). Notwithstanding this exemption, the Companies Act 2006 does require disclosure of directors’ remuneration in the financial statements.

The key issue here concerns the definition of ‘key management personnel’. FRS 102 takes a wider view of key management personnel and does not simply regard such personnel as being confined to those who are a director (see earlier in the article). 

As a result compensation to key management personnel will include all employee benefits (the definition of which are contained in Section 28 Employee Benefits) and will include share-based payments and all forms of consideration paid, payable and provided by the entity (or on behalf of the entity) in exchange for services rendered to the entity.  All such compensation must be disclosed in total.

Conclusion

The underlying principles involved where related parties are concerned remain largely unchanged from FRS 8.  However, there are a couple of notable differences in Section 33 compared to FRS 8 including:

  • No specific requirement to name transacting related parties
  • Slight differences in the wording exempting subsidiary undertakings from disclosing related party transactions with each other where they are wholly-owned (although the meaning is essentially still the same)
  • Disclosure of key management personnel is not required under FRS 8 whereas FRS 102 requires such disclosure under paragraph 33.6
  • No exemption from disclosure in FRS 8 for state-controlled entities.
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By Nick7
29th Jul 2016 12:55

A company with 4 equal director/shareholders outsources its finance function to an accountancy partnership with 2 50/50 partners.

Total fees in the year are circa £100k

One of the partners in the accountancy firm is the sister of one of the company directors.

Do these transactions require a RPT disclosure under FRS102?

Thanks

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