Related parties under FRS 102by
Steve Collings digs into the common questions concerning related parties and their disclosure when preparing financial statements.
Arguably, queries relating to related party disclosures in a small company which is applying the presentation and disclosure requirements of FRS 102 seem to be more common than others.
All entities have related parties and most will enter into transactions with those related parties. The overarching objective of related party disclosures is to draw attention to the fact that an entity’s financial position and profit or loss may have been affected by the existence of related parties and transactions with them.
For micro-entities choosing to report under FRS 105 related parties are not in scope. However, micro-entities are required to disclose transactions with directors and the disclosure requirements of s413, Companies Act 2006 Information about directors’ benefits: advances, credit and guarantees are mandatory.
As well as FRS 102, The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 (SI 2008/410) requires disclosures to be made in respect of transactions with directors and disclosure of related party transactions.
Small companies need not disclose directors’ remuneration and other benefits following an amendment to company law by The Companies, Partnerships and Groups (Accounts and Reports) Regulations 2015 (SI 2015/980).
However, small companies may need to provide this disclosure in certain situations – for example, if the remuneration structure is not carried out under ‘normal market conditions’ which will involve professional judgement.
FRS 102, para 33.1A says that details need not be given in respect of transactions entered into between two or more members of a group, provided that any subsidiary which is a party to the transaction is wholly-owned by such a member.
Reference is made to the term ‘wholly-owned’ in FRS 102, para 33.1A. This term is defined in s1159(2), Companies Act 2006 as follows:
A company is a “wholly-owned subsidiary” of another company if it has no members except that other and that other’s wholly-owned subsidiaries or persons acting on behalf of that other or its wholly-owned subsidiaries.
Related parties defined
The definition of a related party is set out in FRS 102, para 33.2 and is split into related parties that are natural persons and related parties that are entities as follows:
A related party is a person or entity that is related to the entity that is preparing its financial statements (the reporting entity).
- A person or a close member of that person’s family is related to a reporting entity if that person:
- has control or joint control over the reporting entity;
- has significant influence over the reporting entity; or
- is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.
- An entity is related to a reporting entity if any of the following conditions apply:
- 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 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).
- a person identified in (a)(i) 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).
- the entity, or any member of a group of which it is a part, provides key management personnel services to the reporting entity or to the parent of the reporting entity.
When looking at the term ‘key management personnel’ keep in mind that this does not just relate to the directors of the business as the term itself is quite broad. Managers and supervisors may also be regarded as key management personnel if they have the authority and responsibility for planning, directing and controlling the activities of the entity either directly or indirectly.
Example – Identifying related parties
Michelle has an investment in Sunnie Ltd and Dexter Ltd. Michelle is the controlling party in Sunnie Ltd and has significant influence over Dexter Ltd.
In Sunnie’s financial statements, Dexter will be a related party because Michelle has significant influence over Dexter. This would also be the case if Michelle had control or joint control over Dexter.
In Dexter’s financial statements, as Michelle has control over Sunnie, Sunnie is related to Dexter because Michelle has significant influence over Dexter.
If Michelle had significant influence over both Sunnie and Dexter, this would not be enough to mean the entities were related.
Example – Husband and wife run two separate companies
Mr and Mrs Breary have a controlling interest in two companies. Mr Breary controls Company A and Mrs Breary controls Company B. Mr and Mrs Breary are close members of the family of each other (as they are married to each other) and they have control over each reporting entity (hence meeting the definition in FRS 102, para 33.2(a)) and in terms of each entity it is controlled by a person identified in (a) (i.e. either Mr or Mrs Breary) hence meeting the definition in FRS 102, para 33.2(b)(vi).
As Mr and Mrs Breary both have control over each of their respective companies, both companies are related to each other. Transactions among each company would therefore be disclosed as related party transactions as they are not part of the same group and so the 100% subsidiary exemption will not apply.
On the other hand, if Mr and Mrs Breary only had significant influence over each of their respective businesses, their companies would not be related to each other.
Small entities which choose to apply FRS 102, Section 1A are only legally required to make limited related party disclosures in their financial statements. Additional disclosures beyond the legally required minimum would be required if doing so enables a true and fair view to be given.
FRS 102, para 1AC.35 provides a much narrower definition of related parties and only requires a small entity to provide particulars of material related party transactions, not concluded under normal market conditions, entered into with:
- owners holding a participating interest;
- companies in which the entity has a participating interest; and
- directors (or members of the entity’s governing body).
The particulars required are:
- the amount of such 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 are two points to consider:
- FRS 102 does not define the term ‘normal market conditions’ but it should be taken to mean the transactions have not been undertaken on an arm’s length basis.
- The names of the transacting related parties do not need to be disclosed. As with full FRS 102, the standard only requires the nature of the related party relationship to be disclosed.
Example – Related party disclosures
Janet and John are both directors of Heaton Ltd. John owns 80% and the other 20% is owned by John’s wife. Janet is not related to John and owns no shares in the business. Both directors live in houses that are provided by the company. John pays a peppercorn rent of £1,000 per year and Janet pays full market rent of £24,000. All rents were up to date by the balance sheet date.
Disclosure under FRS 102, Section 33 (full disclosure)
During the year the company rented two properties to key management. One property attracted a below market rate rent charge and the other property attracted a commercial rent. Total rents received in the year to 31 December 2020 were £25,000 (2019: £24,000). No amounts are outstanding (2019: £nil).
[Technically, FRS 102, para 33.5 would require the ultimate controlling party to be disclosed if the company were a member of a group – ie if Heaton Ltd had a parent company. In this example, John is the shareholder with ultimate control as he owns 80%, but disclosing this is not strictly necessary.]
Disclosure under FRS 102, Section 1A (small entity disclosure)
During the year the company rented a property to a director. A below market rate rent was charged amounting to £1,000 (2019: £1,000).
[Note, that under FRS 102, Section 1A, only material transactions that have not been concluded under normal market conditions need to be disclosed. However, if the company chose to make full disclosure per FRS 102, Section 33, it would still be compliant with the law.]
Disclosure under FRS 105
No disclosure is required.
Disclosures under FRS 102, Section 33
FRS 102, Section 33 requires the following to be disclosed:
- Parent-subsidiary relationships
- Key management personnel compensation
- Related party transactions
Regard must be had to FRS 102, paras 33.5 to 33.14 for details of what needs to be disclosed. The disclosures are quite comprehensive and there is insufficient room available in this article to cover them all.