FRS 102: Related party transactions for small companies

Accounts and finance
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Steve Collings gets to grips with an issue that has caused confusion for practitioners: the disclosure of related party transactions for a small company.

This article discusses some of the points practitioners should consider, as the requirements in Section 1A Small Entities of FRS 102 are not as straightforward as they might first appear.

Section 1A requirements

Related party issues are dealt with in FRS 102, Section 1A in paragraphs 1AC.34 to 1AC.36. Paragraph 1AC.35 requires particulars to be disclosed of material transactions which the small entity has entered into which have not been concluded under ‘normal market conditions’.

FRS 102 does not define ‘normal market conditions’, and most practitioners interpret this as meaning the same as an ‘arm’s length basis’.

Where transactions have not been concluded under normal market conditions, the small company must disclose:

  1. the amount of the related party transactions;
  2. the nature of the related party relationship; and
  3. other information about the transactions necessary for an understanding of the financial position of the small entity.

There is no requirement to disclose the names of the transacting related parties, as FRS 102 instead requires the nature of the related party relationship to be disclosed.

Example

Peter and Susan are both directors and equal shareholders in a small company and both live in properties owned by the company. Peter pays a market rent of £9,000 per annum; Susan pays a peppercorn rent of £250 per annum.

The related party transaction between the company and Peter does not need to be disclosed as this transaction is being concluded under normal market conditions. However, the transaction between the company and Susan will require disclosure as a related party transaction because this is not being concluded under normal market conditions. The disclosure could be as follows:

During the year, the company rented a property to a member of key management personnel. Rents received amounted to £250 (2017: £250).

Directors’ remuneration

The Companies, Partnerships and Groups (Accounts and Reports) Regulations 2015 SI 2015/980 made amendments to the Companies Act 2006 in 2015 which repealed the requirements to disclose directors’ remuneration and other benefits in the financial statements of a small company.

Most automated accounts production software systems are defaulting to non-disclosure of directors’ remuneration. However, consideration must be given as to whether the directors’ remuneration is being concluded under normal market conditions.

It is not uncommon for a director-shareholder in a small company to be paid a salary up to the PAYE threshold, with the balance of their remuneration being paid by way of dividend.

Most practitioners agree that this is ‘normal market conditions’ and hence do not disclose it. However, if a director’s salary is not judged to be being paid under normal market conditions, then it will require disclosure.

This is causing a debate in the small companies arena because, while most practitioners agree that a remuneration structure of salary up to the PAYE threshold with the balance paid in dividends is ‘normal’, some do not. In such cases, it is advisable to document any conclusions drawn in this area.

Directors’ loans

When a small company receives a loan from a director-shareholder, or from someone within a director’s group of close family members when that group contains at least one shareholder, and that loan is below market rates of interest or at zero rates of interest, the loan will be caught under the related party disclosure rules.

The relief from discounting such loans to present value was introduced by the Financial Reporting Council as part of its first comprehensive review of current UK GAAP.

Example

Simon is a director-shareholder in Smallco Ltd and makes a loan to the company on 1 February 2018 amounting to £10,000, which is repayable on 31 January 2020. The rate of interest charged on the loan is 0%.  

The disclosure in Smallco’s financial statements could be as follows:

During the year, the company received a loan amounting to £10,000 from a member of key management personnel. The loan is to be repaid on 31 January 2020 and the rate of interest charged is 0%. At the balance sheet date, the loan was still outstanding and is presented within creditors: amounts falling due after more than one year.

The exemption from imputing a market rate of interest and discounting the loan to present value in a small company does not extend to loans made to a director from the company; nor does it extend to intra-group loans. Where a company makes a loan to the director, this will be caught by the section 413, Companies Act 2006 disclosure requirements.

Section 413 of the Companies Act 2006 requires the following disclosures to be made in respect of an advance or credit:

  1. its amount;
  2. an indication of the interest rate;
  3. its main conditions;
  4. any amounts repaid;
  5. any amounts written off; and
  6. any amounts waived.

Monetary amounts are required to be disclosed in respect of items (1), (4), (5) and (6).

Small companies which are members of a group

Paragraph 1AC.34 of FRS 102 states that if the small entity is a subsidiary, certain information is required to be disclosed in respect of the parent of the smallest group for which consolidated financial statements are drawn up of which the small entity is a member.

Where the group does not prepare consolidated financial statements (for example because the group is a small group under the Companies Act 2006), this information does not need to be disclosed.

Where the group does prepare consolidated financial statements, the following should be disclosed:

  1. the name of the parent which draws up the consolidated financial statements;
  2. the address of the parent’s registered office (whether in or outside the UK); or
  3. if it is unincorporated, the address of its principal place of business.

Conclusion

While the related party issues have been simplified for small companies, there will be more professional judgement required to determine whether or not transactions have been concluded under normal market conditions.

In subjective areas such as these, it is always advisable to document any conclusions reached – particularly in the case of a small company which is subject to statutory audit. 

*This article was amended on 8 May to add the word 'director' to Simon's job title in the second example*

About Steven Collings

collings

Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.

Replies

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08th May 2018 17:17

Why would the loan from Simon need to be disclosed under FRS1021A if he is not a director?

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to jon_griffey
08th May 2018 19:58

Oops - I did intend for Simon to be a director-shareholder not just a shareholder. Admittedly, I wrote this article in a hurry to meet the deadline! I've asked Sift's editor to add in director- to his shareholder status.

Thanks (1)
to Steve Collings
08th May 2018 21:19

That's done for you now.

Thanks (1)
to Steve Collings
09th May 2018 09:31

Steve - thanks for the clarification!

Thanks (2)
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09th May 2018 13:19

Re the director's salary issue, I've never considered £8424 salary for a full-time senior role, i.e. £4.05 per hour, to be "normal market conditions". But I guess in another few years it could well be...

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By Sial
09th May 2018 13:30

under your paragraph 'Directors' loan'Why would you need to consider close family members of the directors' making the loan for a small company disclosure under Section 1A? My understanding is that for Sec 1A family members and companies under common control are not related party.

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By Tim S
to Sial
09th May 2018 15:29

I was also going to raise this point. At the firm I work for there was initially a reluctance to not include connected companies or parties as related parties but the standard states as below.

1AC.35 Particulars must be given of material transactions the small entity has entered into that
have not been concluded under normal market conditions with:
(a) owners holding a participating interest in the small entity;
(b) companies in which the small entity itself has a participating interest; and
(c) the small entity’s directors [or members of its governing body].

So I believe transactions with connected parties, companies or otherwise, do not have to be disclosed under 1A. FRS 102 has the full connected party requirement we are all more familiar with, similar to FRSSE 15, but 1A appears to reduce the disclosure requirements, hence the difference between the full and small company standards.

What is everybody else doing?

(First time post btw, thanks.)

Thanks (3)
to Tim S
09th May 2018 18:46

Tim S wrote:

I was also going to raise this point. At the firm I work for there was initially a reluctance to not include connected companies or parties as related parties but the standard states as below.

1AC.35 Particulars must be given of material transactions the small entity has entered into that
have not been concluded under normal market conditions with:
(a) owners holding a participating interest in the small entity;
(b) companies in which the small entity itself has a participating interest; and
(c) the small entity’s directors [or members of its governing body].

So I believe transactions with connected parties, companies or otherwise, do not have to be disclosed under 1A. FRS 102 has the full connected party requirement we are all more familiar with, similar to FRSSE 15, but 1A appears to reduce the disclosure requirements, hence the difference between the full and small company standards.

What is everybody else doing?

(First time post btw, thanks.)

Given that the related parties note ends up on public record at Companies House, I can't imagine any client will thank you for disclosing more than is necessary. why not just stick to what S1A requires? Also 'normal market conditions' is so nebulous that to my mind it sets the bar quite high such that you can argue most transactions are covered by it.

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09th May 2018 16:01

The trouble is how far do you go, do you have to include Directors remuneration, mileage driven, items on expenses claims, assets introduced and at what terms /cost (purchased or transferred) ..... and on it goes

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to AndrewV12
09th May 2018 16:58

Accountants and auditors "go to" response when they can't be bothered with something is to say "it isn't material".

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09th May 2018 17:14

I really do not understand the comment that the "balance" (of a director's remuneration) can be paid by way of a dividend. It is something that is said all too often.
Dividends are paid to shareholders. If paid as remuneration for services, the courts have held that such would be remuneration (and chargeable to tax and NIC under PAYE).

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By Pukka
11th May 2018 12:32

Would you also need to consider disclosing directors dividends (if significant/material) in order for the accounts to show a 'true & fair' view?
That would presumably override the argument on whether it was at market rates?

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