Related Parties

Practice Areas

By Judith Terre

Investors, analysts, bankers and owners, needs to know if an entity’s financial statements are free of biases and material misstatements. One of the areas that could pose a risk of material misstatements in the financial statements is the related party relationships and transactions. Even though related party transactions occur in the normal course of business, related parties are said not to be acting at arm’s length, because of the special inherent relationship between them.

To understand this, Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC), defines related parties to include:

  1. Affiliates of the entity;
  2. Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825–10–15, to be accounted for by the equity method by the investing entity;
  3. Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management;
  4. Principal owners of the entity and members of their immediate families;
  5. Management of the entity and members of their immediate families;
  6. Other parties with which the entity may deal if one party controls or can significantly influence
  7. the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests; and
  8. Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests. The FASB ASC glossary also defines the terms affiliate, control, immediate family, management, and principal owners.

Examples of transactions between and among related parties include:

  • Sales, purchases, or transfers of property;
  • Accounting, management, engineering, and legal services or similar services received or furnished;
  • Use of property and equipment by lease or otherwise;
  • Borrowings, lendings, and guarantees;
  • Maintenance of compensating bank balances for the benefit of related parties;
  • Intra-entity billings based on allocations of common costs; and
  • Filings of consolidated tax returns.

Due to the special inherent relationship between related parties that can create a conflict of interest that can benefit related parties as opposed to when transaction is between unrelated entities, withholding related party transactions would make the financial statements unreliable and not represents the true picture of the entity. Thus, related party disclosure is required for material related party transactions so financial statements user can evaluate the significance of these transactions and make an informed decision. Moreover, based on FASB ASC 850-10-05-5, “transactions between related parties are related party transactions even though they may not be given accounting recognition. For example, an entity may receive services from a related party without charge and not record receipt of the services. While not providing accounting or measurement guidance for such transactions, FASB ASC 850 requires their disclosure nonetheless.”

Per FASB ASC 850, following is the required disclosure for material related party transactions:

  • The nature of the relationships involved.
  • A description of the transactions, including transactions where no amounts or nominal amounts are involved, for each of the reporting periods where income statements are presented; additionally, other information deemed necessary to gain an understanding of the effects of the transactions on the financial statements should be disclosed.
  • The dollar amounts of the transactions for each of the reporting periods where income statements are presented along with the effects of any change in the method of establishing the terms of the transactions when compared to the method used in the preceding reporting period.
  • Amounts due to or from related parties as of each financial statement date and, if not otherwise apparent, the terms and manner of settlement related to those amounts.