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.
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.
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| Yeah, this was the feeling that I was looking for. |
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
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| This is why! I love you, you love me, we are happy family! |
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| Just like fast and furious. We are family. Apa pun boleh~ (Anything is possible) |
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).
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| Arms length transactions - means transactions between independent and willing parties. |
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? đŠ
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;In short, IAS 24 believes this:
(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 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 đ 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.
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| What about UFO then? đđđ |
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:
