Related Party Disclosures

Related party disclosures represent legally binding disclosure of relationships, transactions and outstanding balances between a reporting firm and its related parties. The related parties could be an entity individual having significant influence, control or joint control over the reporting entity. Additionally, transactions may include service agreements, loans and sales between them. Therefore, to make companies abide by the rule, various accounting standards have been formulated to increase accountability and transparency in financial statements, like ASC 850, AASB 124, AS 18, and FRS 8 related party disclosures.

Companies record and make all disclosures of related party transaction details appropriately reported in financial statements to induce transparency in data. The transaction details include outstanding balance, relationship and amount. Moreover, these transactions have to be scrutinized by auditors to find any earnings manipulation or inherent conflict of interest. It also helps to find any potential illegal benefit to parties or tax savings that may affect the company's finances and stability.

It has many implications for the reporting entity, stakeholders and investors alike. It stops making financial reporting misleading to all; otherwise, it may negatively affect investor confidence. More importantly, any unreported transaction can damage a company's financial results, resulting in potential financial and legal repercussions. Furthermore, any no-adherence to legal and mandatory reporting or disclosures may lead to reputational damage, criminal charges and even hefty fines. 

They have been used to highlight any potential risks related to third-party transactions, allowing creditors and investors to make wise decisions. It also helps companies to document every transaction properly. Thus, they act as a shield against fraud for investors and mismanagement of the companies for stakeholders.

Let us discuss the disclosure requirements of the related party disclosures with these points below:

• The existence of related or linked party relationships must be disclosed.
• Outstanding balance and nature of transactions with linked parties must be disclosed.
• Determine the lined parties as per the particular accounting standards put in use.
• Disclosure of all related-party transactions must comprise those happening during IPO process.

Let us use a few examples to understand the topic.

Example #1

An online article published on 15 May 2022 discusses the significance of disclosures of related parties in financial statements as necessitated by IAS 24 of IFRS. Such disclosures offer details on transactions and relationships amongst an organization with its related parties like key management staff, subsidiaries or associates. IFRS requires an entity to disclose all such material transactions having the ability to impact the financial position and performance of the entity and related party. 

Moreover, transactions such as sales between a subsidiary and its parent at cost or loans at lower than market rates come under these transactions. Furthermore, the article has raised the vitality of disclosures of related party pertaining stakeholders to evaluate non-financial & financial risks, effects on the performance and opportunities of the organization.

Example #2

Let us assume that Apexit Bank, based in Old York City, gives a loan to its subsidiary RetailingMart at a 2% interest rate much below the prevalent market interest rate of 5% for a similar loan. It is because Apexit Bank owns 65% of RetailingMart, so retailing mart profits by saving $200000 yearly in interest expense. However, Apexit Bank forgoes $200000 as potential income. 

Now, IAS 24 needs the bank and retailing company to disclose the related party transactions in their financial reports as it affects their financial performance. The said information helps stakeholders assess whether these transactions have been conducted at arm's length. Hence, the disclosure allows transparency and assists in evaluating the arrangements influencing Retailing Mart's and the bank's financial health and profitability.

It can have many consequences for firms as follows:

• Its non-compliance may lead to 20 years imprisonment and penalty of $500000.
• The Securities Exchange Commission can levy heavy fines for violating the disclosure norms.
• Any individual found in non-compliance with the disclosure rule can face severe legal outcomes, including criminal charges. 
• Any incomplete or misleading disclosure leads to civil lawsuits by loss-making investors.
• Loss of confidence in investors may happen because of non-compliance, leading to lower stock prices and decreased investment.
• Its non-compliance can result in fraud in financial statements, leading to $1 million as median loss per case and miscellaneous losses. 
• Any failure to disclose related party transactions warrants severe sanctions or even arrests from regulators like the U.S. Securities and Exchange Commission.

By virtue of its characteristics, it has many importance, as listed below:

• It enhances accountability and transparency of financial reporting. 
• It enables stakeholders to evaluate the potential conflicts of interest and the impact of the relationship on financial statements.
• Promotes comparability of entities and financial results throughout periods in the same sector.
• It helps investors make informed decisions regarding investment in a firm.
• It vividly shows opportunities and risks concerning transactions and linked parties.