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Related parties and small entities: Get the details right

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Steve Collings considers some of the main issues that get flagged up where related party disclosures are concerned for small and micro-entities.

9th Aug 2022
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Related party disclosures have long-since been a contentious issue and over the years accounting standards have invariably been expanded to ‘catch all’ related party transactions.

FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland, Section 1A Small Entities only requires limited related party disclosures to be made in the financial statements and this also seems to cause an element of confusion to a certain extent.

Micro-entities

Micro-entities can choose to apply FRS 105 The Financial Reporting Standard applicable to the Micro-entities Regime when preparing their financial statements.

FRS 105 is an optional standard, and a micro-entity need not apply FRS 105 if it does not wish to. Instead, it can apply FRS 102 including the presentation and disclosure requirements of Section 1A if it wishes. Section 1A is also optional and the micro-entity could report under full FRS 102 (although it is uncommon to see this in practice).

Under FRS 105, there is no specific section that deals with related party disclosures. Indeed, the term ‘related party’ is not defined in the glossary to FRS 105 and so micro-entities preparing financial statements under FRS 105 do not have to disclose transactions they may enter into with a related party.

Micro-entities are, however, required to disclose directors’ advances, credit and guarantees in accordance with s413, Companies Act 2006.

For advances and credits, the micro-entity must disclose:

a) its amount;b) an indication of the interest rate;

c) its main conditions;

d) any amounts repaid;

e) any amounts written off; and

f) any amounts waived.

Monetary amounts must be disclosed for items under a), d), e) and f) above.

The details required of a guarantee are:

  • a) its main terms;
  • b) the amount of the maximum liability that may be incurred by a micro-entity;
  • c) any amount paid and any liability incurred by a micro-entity for the purpose of fulfilling the guarantee (including any loss incurred by reason of enforcement of the guarantee).

Monetary amounts must be disclosed for items under b) and c).

If a micro-entity decides to prepare their financial statements under FRS 102 (including Section 1A) instead of FRS 105, then it is within scope of related party disclosures.

It is incorrect to assume that because the entity could apply FRS 105, but chooses not to, it still does not need to disclose related party transactions. If the entity chooses not to apply the presentation and disclosure requirements of Section 1A, then it must comply with the full disclosure requirements of Section 33 Related Party Disclosures.

FRS 102, Section 1A

FRS 102, Section 1A deals with related party disclosures in paragraphs 1AC.34 to 1AC.36. FRS 102, para 1AC.35 states:

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].

Particulars must include:

  • the amount of such transactions;
  • the nature of the related party relationships; and
  • other information about the transactions necessary for an understanding of the financial position of the small entity.

Professional judgement will be called upon to establish whether, or not, a transaction (or series of transactions) has been concluded under normal market conditions. FRS 102 does not define the term ‘normal market conditions’, although in many cases it will be clear when a transaction has, or has not, been concluded under normal market conditions.

In addition, the disclosure requirements in FRS 102, para 1AC.35 above are the legally required minimum. It must be borne in mind that directors of small entities have a legal duty to ensure that the financial statements give a true and fair view and hence directors must consider whether additional related party disclosures need to be made to achieve this. To that end, FRS 102, para 1AC.35 goes on to state:

Although disclosure is only required of material transactions with the specified related parties that have not been concluded under normal market conditions, small entities disclosing all transactions with such related parties would still be compliant with company law.Transactions with directors, or members of an entity’s governing body, include directors’ remuneration and dividends paid to directors.

Using an example, the detail of related party disclosures under full FRS 102, FRS 102 Section 1A and FRS 105 can be seen as follows:

Example – Related party disclosures

Ben Currie and Danny Walker are both directors of C&W Enterprises Ltd which is a small company preparing its financial statements under FRS 102, including Section 1A. Ben owns 80% of the shares with the remaining 20% being owned by Ben’s wife. Danny is unrelated to Ben and is not a shareholder. Both directors live in houses provided by the company. Ben pays a peppercorn rent of £150 per annum and Danny pays full market rent of £18,500 per annum. There are no amounts of rent outstanding or prepaid at the balance sheet date.

Disclosure under full FRS 102

During the year the company rented two properties to key management. One property attracted a peppercorn rent, and the other property a commercial rent. Total rents received in the year to 30 June 2022 were £18,650 (2021: £18,100). No amounts are outstanding (2021: £nil).

Note – technically FRS 102, para 33.5 only requires the ultimate controlling party disclosures in respect of a group (i.e. where the reporting entity has a parent entity). In this scenario, Ben Currie is the shareholder with ultimate control, but disclosing this is not strictly necessary.

Disclosure under FRS 102, Section 1A

During the year the company rented a property to a director. A peppercorn rent of £150 was charged (2021: £100).

Note – under FRS 102, Section 1A only material transactions that have not been concluded under normal market conditions need disclosure. If the small entity were to make all the related party disclosures, the standard notes that the company would still be compliant with the law.

Disclosure under FRS 105

Nothing.

The examples above show how the disclosure requirements would reduce the further down the regimes you go. You will also note that nowhere in the disclosures are the names of the transacting related parties. This is because neither FRS 102, nor FRS 102, Section 1A requires disclosure of the names of the transacting related parties. Instead, FRS 102 requires the nature of the related party relationship to be disclosed.

Conclusion

FRS 102, Section 1A only requires limited related party disclosures to be made to comply with the legally required minimum. Keep in mind that additional disclosures beyond those required by Section 1A may be needed to provide a true and fair view.

If the small entity is audited, the auditor must consider whether transactions with related parties have been concluded under normal market conditions or not. If they have not, they become disclosable. The auditor must also devise specific audit procedures to ensure the disclosures in the financial statements enable a true and fair view to be given and reduce audit risk (the risk that the auditor expresses an incorrect opinion on the financial statements) to an acceptable level.

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