Why you should pay attention to related party transaction disclosure?
What is a related party transaction?
As per Indian Accounting Standard 24, a related party transaction is a transfer of resources, services, or obligations between related parties, irrespective of whether a price is charged. In simple terms, when a company undertakes a transaction with another company with whom management personnel of the former is associated, it is known as a related party transaction.
For example,
Suppose there is an infrastructure company X and A is its managing director. For its operations, amongst other key materials, company X requires cement. It procures this cement from company Y, whose CEO is the brother of A. This transaction will be deemed as a related party transaction.
What is to be included in the disclosures?
- Relationship between parents and subsidiaries irrespective of whether there has been a transaction.
- Compensation of key management personnel in total and for each of the following categories- short-term employee benefits, post-employment benefits, other long-term benefits, termination benefits, share-based payment benefits.
If there have been transactions, then the company should disclose the following separately for each category of related parties
- The amount of the transactions.
- The amount of outstanding balances, including terms and conditions and guarantees.
- Provisions for doubtful debts related to the amount of outstanding balances.
- Expense recognised during the period in respect of bad or doubtful debts due from related parties.
What is the objective of these disclosures?
Related party transactions, which are guided by the Indian Accounting Standard 24 or IND 24, requires companies to make disclosures of related party relationships, transactions and outstanding balances with their related entities in their financial statements. The main objective of this standard is to draw attention to the possibility that the company’s financial position and profit or loss may have been affected by the existence of related parties and by transactions and outstanding balances, including commitments, with such parties.
Bottom line:
Simply put, the disclosures aim to help the investors, aka the stakeholders to assess whether a company’s performance has been affected adversely due to related party transactions.