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:
- the amount of the related party transactions;
- the nature of the related party relationship; and
- 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.
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).
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and Groups (Accounts and Reports) Regulations 2015 SI 2015/980 made amendments to the Companies Act 2006 in 2015 which repealed the requirements to disclose directors’ remuneration and other benefits in the financial statements of a small company.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.
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.
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:
- its amount;
- an indication of the interest rate;
- its main conditions;
- any amounts repaid;
- any amounts written off; and
- 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:
- the name of the parent which draws up the consolidated financial statements;
- the address of the parent’s registered office (whether in or outside the UK); or
- if it is unincorporated, the address of its principal place of business.
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
Steve Collings, FMAAT FCCA is the audit and technical partner at Leavitt Walmsley Associates Ltd where Steve trained and qualified.