Related party transactions

Related party transactions refer to the transfer of resources, services, or obligations between a reporting entity and a related party. A related party is an entity or individual that has the ability to influence the financial and operating policies of another entity. This influence can arise due to a variety of relationships, including ownership, control, or common management. Proper accounting for related party transactions is important for transparency and to prevent potential conflicts of interest. Here are the key steps involved in accounting for related party transactions:

1. Identification of Related Parties:

   • Identify and disclose all related parties. This includes individuals or entities that have significant influence or control over the reporting entity, such as owners, key management personnel, and close family members.

2. Determination of the Nature of Transactions:

   • Clearly identify and understand the nature of the transactions with related parties. This includes transactions such as sales, purchases, loans, guarantees, leases, and contributions of assets or services.

3. Determination of the Transfer Price:

   • Determine the transfer price for goods, services, or other assets exchanged in related party transactions. The transfer price should be consistent with the principles of arm's length transactions, meaning it should be similar to what would be agreed upon between unrelated parties.

4. Recording the Transactions:

   • Record related party transactions in the accounting records at the agreed-upon or fair value. This involves debiting or crediting the relevant accounts based on the nature of the transaction, such as revenue, expense, or asset accounts.

5. Disclosures in Financial Statements:

   • Provide comprehensive disclosures in the financial statements regarding related party transactions. These disclosures should include the nature of the relationship, a description of the transactions, outstanding balances, and any terms and conditions. The goal is to provide users of the financial statements with a clear understanding of the related party relationships and their impact on the entity's financial position and performance.

6. Documentation and Substantiation:

   • Maintain proper documentation to substantiate the rationale behind the related party transactions. This documentation can include contracts, agreements, or any other supporting evidence that demonstrates the commercial substance of the transactions.

7. Compliance with Accounting Standards:

   • Ensure compliance with accounting standards applicable in your jurisdiction. International Financial Reporting Standards (IFRS) or Accounting Standards for Private Enterprises (ASPE) and Generally Accepted Accounting Principles (GAAP) provide specific guidance on the accounting treatment and disclosure of related party transactions.

8. Independence and Objectivity:

   • Ensure that the process for determining the terms and conditions of related party transactions is conducted with independence and objectivity. This helps prevent situations where related party transactions may be structured to the detriment of the reporting entity.

9. Review and Approval:

   • Establish a review and approval process for related party transactions. This may involve obtaining approval from independent directors or a committee to ensure that the transactions are in the best interest of the reporting entity and its shareholders.

10. Monitoring and Periodic Review:

    • Implement a system for monitoring related party transactions and conducting periodic reviews to assess their ongoing appropriateness. This is particularly important as circumstances may change over time.

Proper accounting for related party transactions is essential for maintaining the integrity of financial reporting and ensuring that financial statements accurately reflect the economic substance of an entity's transactions. If in doubt, seeking professional advice or guidance on specific accounting standards is advisable.