IAS 24 Related Party Disclosures - Part 2

It's time to continue with Part 2 of IAS 24! (If you have not read Part 1, this is the link: https://tysonspeaks.blogspot.com/2019/08/ias-24-related-party-disclosures-part-1.html)

As a recap, under Paragraph 9 of IAS 24, part (a) of the definition deals with a person (i.e. when a person / real human being is related to an entity) and part (b) deals with an entity (i.e. when an entity is related to another entity). This post will focus on part (b) of the definition.

Let's look into Part (b)(i).

An entity is related to a reporting entity if 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).

The diagram above shows a group of company (parent with two subsidiaries and one sub-subsidiaries). All the four companies above are related to each other as they are in the same group.

Note: Subsidiary is a company that is controlled by the parent.

Part (b)(i) is quite simple. Let's look at Part (b)(ii) now.

An entity is related to a reporting entity 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).

According to IAS 28,

An associate is an entity over which the investor has significant influence.

According to IFRS 11,

A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Those parties are called joint venturers.

There are a few possible scenarios under part (b)(ii):

Scenario 1 - Associate or Joint Venture of the Other Entity

Generally, if a company is having an associate or joint venture, they are considered related (as shown below).

However, take note that the parent and Co A are not necessarily related party. More information are needed to assess whether they are related party.

Note: The associate and the joint venture are also related based on paragraph 9(b)(iv), which will be covered later.

Scenario 2 - A Group with Subsidiary, Sub-subsidiary, Associate and Joint Ventures

Let's now make some changes to the group structure in Scenario 1. Assuming that the parent is also having a subsidiary and sub-subsidiary as shown in the diagram below:

1. The parent, subsidiary and sub-subsidiary are in the same group. As such, they are related to each other.

2. As the parent also owns the associate and joint venture and the parent is in the same group with subsidiary and sub-subsidiary, the associate and the joint venture are also related to the subsidiary and sub-subsidiary.

Scenario 3 - Associate or Joint Venture of Subsidiary

Consider the following scenario:

1. The parent, subsidiary A and subsidiary B are in the same group. As such, the three companies are related to each other.

2. The associate or joint venture is related to Subsidiary A due to associate or joint venture relationship.

3. As subsidiary A is part of the group with Parent and Subsidiary B, the associate or joint venture is also related to parent and subsidiary B.

Scenario 4 - Associate's Subsidiary or Joint Venture's Subsidiary

IAS 24 also mentions that:

An associate includes subsidiaries of the associate and a joint venture includes subsidiaries of the joint venture. Therefore, for example, an associate’s subsidiary and the investor that has significant influence over the associate are related to each other.

As shown above, the parent is related to the subsidiary of the associate or joint venture.

That's all for Part (b)(ii). We can now look into Part (b)(iii).

An entity is related to a reporting entity if both entities are joint ventures of the same third party.

Consider the following scenario:

Joint Venture 1 and Joint Venture 2 are both jointly owned by Co A and Co B. As such, Joint Venture 1 and Joint Venture 2 are related.

However, take note that the Co A and Co B are not necessarily related party. More information are needed to assess whether they are related party.

Let's now look into Part (b)(iv).

An entity is related to a reporting entity if one entity is a joint venture of a third entity and the other entity is an associate of the third entity

For this part, we will refer back to Scenario 1 in part (b)(ii) above.

Refer to the purple arrow above, the associate and joint venture are related because they relate to the same company (i.e. the parent).

However, two associates of the parent are not related party (as shown below):

This is because common significant influence is not sufficiently strong to create a related party relationship. In other words, if you can only somehow influence the associates, you can't really have a strong power to force the two associates to be involved in certain transactions.

We can now look into Part (b)(v).

An entity is related to a reporting entity if 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. 

This paragraph deals with a post-employment benefit plan under IAS 19. Basically, the defined benefit plans are related to the company or related entities of the company.

Next, let's look at Part (b)(vi) and Part (b)(vii) together.

An entity is related to a reporting entity if the entity is controlled or jointly controlled by a person identified in (a).

An entity is related to a reporting entity if 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).

As a recap, part (a) of the definition talks about:

A person or a close member of that person’s family is related to a reporting entity if that person:  

(i) has control or joint control of the reporting entity;  

(ii) has significant influence over the reporting entity; or  

(iii) is a member of the key management personnel of the reporting entity or of a parent of the reporting entity. 

 As such, there are a few possible scenario under part (b)(vi) and part (b)(vii).

Scenario 1

When a person is having controls or joint controls over two entities, then the two entities are related.

Scenario 2

Let's change scenario 1 a bit by bringing in the close member of that person's family (i.e. the wife now appears!).

In this case, the two entities are also related to each other.

Scenario 3

Now let's look at the case where a person and his close family member jointly controls two entities.

In this case, the two entities are also related to each other.

Scenario 4

Let's look into the scenarios where a person has control or joint control over one entity and that person (or his close family member) has significant influence or is a key management personnel of the another entity.

or

For the two cases above, Co A and Co B are related to each other.

Scenario 5

For this scenario, we have one person who is having control or joint control over one entity (Co A) and that person (or his close family member) is the key management personnel of the parent (Co B) of the other entity (Co C).

or

In these cases, Co A and Co B are related. As Co B can also controls Co C, we can therefore say that Co A is also related to Co C.

Scenario 6

However, do take note that if one person is having significant influence over one entity and he (or his close family member) is also having significant influence over another entity, the two entities are not related, as shown below.

or

As mentioned previously, this is because common significant influence is not sufficiently strong to create a related party relationship.

Scenario 7

You should also take note that if two entities are having common director or common key management personnel, the two entities are not necessarily related party, as shown below:

Whether or not Co A and Co B are related would depend on whether the person has the power to control both companies or not.

Scenario 8

Same goes to the case where a person is a key management personnel of a entity and that person have significant influence over another entity, the two entities are also not related party, as shown below:

Finally, we can now look at the last point of the definition, part (b)(viii).

An entity is related to a reporting entity if 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.

Sometimes, an entity might be outsourcing their management services to a management company. This management company provides key management service to the entity. Such management company is considered related to the entity (as shown below, the management company is related to the parent).

If the management company provides key management personnel service to the parent of the subsidiary, the subsidiary is also considered as related to the management company.

Phew! Finally we come to an end of the definition! What a longgggggg post.

As a final note, I think I should highlight you on the scenarios where two entities are not related party according to paragraph 11 of IAS 24:

(a)

two entities simply because they have a director or other member of key management personnel in common or because a member of key management personnel of one entity has significant influence over the other entity. (highlighted in Scenario 7 and 8 of Part (b)(vi) and Part (b)(vii) above)

(b)

two joint venturers simply because they share joint control of a joint venture. (highlighted in Part (b)(iii) above)

(c)

(i) providers of finance,
(ii) trade unions,
(iii) public utilities, and
(iv) departments and agencies of a government that does not control, jointly control or significant influence the reporting entity, simply by virtue of their normal dealings with an entity (even though they may affect the freedom of action of an entity or participate in its decision‑making process).

(d) a customer, supplier, franchisor, distributor or general agent with whom an entity transacts a significant volume of business, simply by virtue of the resulting economic dependence.

Congratulations! You have reached the end of the post!

Wishing you have a nice day ahead of you and hope that you learnt something from these posts!

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IAS 24 Related Party Disclosures - Part 1

I remember when I was studying for P2 Corporate Reporting (one of the ACCA papers which is now known as Strategic Business Reporting or SBR), I can never fully understand the definition of related party under IAS 24. I was kinda hoping for some diagrams which can illustrate the related party definition in a simpler manner.

Yeah, this was the feeling that I was looking for.

But sadly I can't really find it!

Well, if you are looking for such diagrams, then today is your lucky day! I have drawn these diagrams myself and hopefully you will find them useful.

But before we go into the details, let us discuss briefly about what is this standard is all about.

Introduction

Basically, IAS 24 is a standard that requires an entity to disclose related party relationships, transactions and outstanding balances in their financial statements.

Think of this - when you are still young, your parent can somehow control you and your siblings. If your parent ask you to sell your toys to your siblings, your parent can force (I mean request) you to sell your toys at an extremely cheap (or extremely expensive) price. Well, sometimes they can even force you to sell this toys for free! But why?

This is why! I love you, you love me, we are happy family!

Just like fast and furious. We are family. Apa pun boleh~ (Anything is possible)

Anyway, imagine that instead of a family, what if such transactions are carried out by members of a group of companies? The members of the group can sell something to each other at an extremely cheap or expensive price, and this could result in one company having an extremely high profit and another company having an extremely high expense.

In other words, we can say that due to related party relationship, the financial performance and position of these company have been affected. Such high profit or high expense would not be possible if they trade with an independent party (i.e. if the transactions are arms length).

Arms length transactions - means transactions between independent and willing parties.

As such, it is important that the financial statements highlight / disclose such relationships to the users of financial statements. This is what IAS 24 is all about.

Definition

Thus, to comply with this standard, it is important for us to understand the meaning of related party. The definition of related party under paragraph 9 of IAS 24 is as follows (Note: You can skip these definitions for now, I will come back to these definitions again later):

A related party is a person or entity that is related to the entity that is preparing its financial statements (in this Standard referred to as the ‘reporting entity’). 

(a) A person or a close member of that person’s family is related to a reporting entity if that person: 

(i) has control or joint control of the reporting entity; 

(ii) has significant influence over the reporting entity; or 

(iii) is a member of the key management personnel of the reporting entity or of a parent of the reporting entity. 

(b) An entity is related to a reporting entity if any of the following conditions applies: 

(i) 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). 

(ii) 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). 

(iii) Both entities are joint ventures of the same third party. 

(iv) One entity is a joint venture of a third entity and the other entity is an associate of the third entity 

(v) 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. 

(vi) The entity is controlled or jointly controlled by a person identified in (a). 

(vii) 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). 

(viii) 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.

Wait, what? Why the definition is so long and so difficult to understand? 😩

If you are feeling that, I must say I feel you bro.

Don't worry, I believe that if you are really serious in wanting to learn something, then eventually you will understand them.

This is what I am going to do - I will guide you through the definitions and I will show you some diagrams for each of the points above, and hopefully you can understand them better. So are you ready?

Let's go!

Generally, if you look at the definition, part (a) deals with a person (i.e. when a person / real human being is related to an entity), and part (b) deals with an entity (i.e. when an entity is related to another entity). I will only talk about part (a) in this post. I will talk about part (b) in Part 2.

Let's look at (a)(i):

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 of the reporting entity.

This definition talks about two types of person, one is the person, another one is the "close member of that person's family". According to IAS 24, this means:

Those family members who may be expected to influence, or be influenced by, that person in their dealings with the entity and include: 

(a) that person’s children and spouse or domestic partner;
(b) children of that person’s spouse or domestic partner; and
(c) dependants of that person or that person’s spouse or domestic partner.

In short, IAS 24 believes this:

In other words, it is believed that if you are a close member of that person's family, you can influence that person. Something like how a guy can be influenced by his wife because:

Well, I am sure you have seen some real life examples / movies / dramas that shows a guy is scared of his wife, right?

I believe you know what I meant 😂 Anyway back to the definition in (a)(i):

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 of the reporting entity.

Generally a person has control over the reporting entity if that person owns more than 50% shares of that entity. According to IFRS 10 Consolidated Financial Statements, 

An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.  

Thus, an investor controls an investee if and only if the investor has all the following:

(a) power over the investee 

(b) exposure, or rights, to variable returns from its involvement with the investee; and

(c) the ability to use its power over the investee to affect the amount of the investor’s returns.

On the other hand, joint control generally means when two parties own a company and each of them owns 50% shareholding each. According to IFRS 11 Joint Arrangement, it is mentioned that joint control is:

The contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

Scenario 1

Let say, a person controls Company A, then the person is related to Company A.

Then, the wife of that person is also considered as related to Company A. This is because if the wife can "control" or "influence" his husband, then the wife can effectively control Company A also (i.e. wife controls husband, husband controls Company A, so wife also controls Company A). Same goes to other close member of that person's family.

Scenario 2

Now, let us consider another case: A person owns 50% of Company A. His wife also owns 50% of Company A.

In this case, we can say that the person has joint control over Company A together with his wife. This means that both the person and his wife are related to Company A. 

Scenario 3

Let us change scenario 2 a bit. Let's say the person is having joint control over Company A with his business partner. He and his business partner are considered as related to Company A.

That person wife (or other close family member) is also considered as related to Company A (i.e. if the wife can control his husband, and his husband has joint control over Company A, then the wife also can somehow exercise some control over Company A).

That's all for (a)(i). We can now look into (a)(ii).

A person or a close member of that person’s family is related to a reporting entity if that person has significant influence over the reporting entity.

Generally, significant influence means a person is holding 20% to 50% shares of a company. According to IAS 28,

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies.

This is quite simple. If a person has significant influence over Company A, that person is said to be related to Company A. Same goes for his close family member.

That's all for (a)(ii). Let's look at (a)(iii) now.

A person or a close member of that person’s family is related to a reporting entity if that person is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.

According to IAS 24, key management personnel are:

Those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity.

In short, if any person is involved in planning, directing and controlling the activities of an entity, that person is considered as key management personnel. Key management personnel can be board of directors, CEO, COO, CFO and etc.

What about UFO then? 😂😂😂

Anyway, as key management personnel can influence the company in a lot of way (well they can plan, direct and control the company), it is said that key management personnel is related to that company. Same goes to the close family member of the key management personnel.

Let us consider another scenario. Now we have a parent and subsidiary relationship (parent controls a subsidiary). If a person is the key management personnel of the parent, we can also say that the person is related to both the parent and the subsidiary. This is because if you are the key management personnel of the parent, you can control the parent, and if the parent can control the subsidiary, effectively you can also control control the subsidiary. Same goes to the close family member of the key management personnel.

That's all for part (a) of the definition!

I will explain about part (b) of the definition in the next post. Stay tuned!

Part 2 link: 

https://tysonspeaks.blogspot.com/2019/08/ias-24-related-party-disclosures-part-2.html

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