Why related party disclosures in financial statements matter

Organisations enter commercial arrangements regularly in the ordinary course of business. These arrangements and transactions are part of the different relationships organisations form in society.

The IAS 24, related party disclosures, is one of the many financial reporting standards in IFRS that requires organisations to provide information on those relationships and transactions, the outstanding balances and commitments between the organisation and its related parties, the circumstances requiring these disclosures and the specific disclosure that are required.

The standard describes a related party as a person or entity linked to the organisation preparing its financial statements. It also explains a related party transaction as a transfer of resources, services or obligations between a reporting organisation and a related party, regardless of whether a price is charged.

While the scope and boundary of these disclosures are limited to financial reporting, its objective is to highlight the potential that an organisation’s financial performance and position may have been affected by related party transactions, outstanding amounts, and commitments.

The category of disclosures required by an organisation includes information on the organisation’s parent, subsidiaries, associates, joint ventures, entities that have joint-control or significant influence over the organisation, key management personnel of the organisation or its parent.

Organisations should ensure that only related party transactions that are material — quantitatively and qualitatively — to either the organisation, the related party or both are disclosed in the financial statements.

Organisations must recognise the importance of these disclosures to stakeholders in assessing the financial performance and position of the organisations.

Disclosing financial impact

An essential aspect of related party disclosures is regarding transactions organisations have within their group.

We have seen instances where organisations generate frequent transactions and commercial arrangements through subsidiaries, joint ventures and associates.

It is pertinent to understand that because the organisation can affect the financial and operating policies of the investee — subsidiary, joint venture, or associate — through its control, joint-control or significant influence, stakeholders will be keen to understand the nature of those arrangements.

Related party transactions could affect the performance and financial position of an entity. For instance, information on whether the transactions entered by an organisation and its subsidiary are on usual commercial terms or not is relevant to stakeholders.

An organisation that provides its subsidiary with a loan below the market interest rate will have forgone a higher return, impacting its performance. Likewise, the subsidiary would have benefited from paying an interest expense charge below-market rate.

Therefore, the financial performance and position of both the organisation and its subsidiary are affected by such an arrangement.

Providing information on these disclosures enables stakeholders to understand the impact of these commercial arrangements and transactions on the organisation.

Also, an organisation that sells goods to its parent at cost might decide not to sell on those same terms to another unrelated customer. Therefore, stakeholders would like to understand the degree of the impact of such an arrangement on the organisation.

Other non-financial effects

It is equally possible for the financial performance of an organisation to be affected by a related party relationship even in the absence of any transaction.

For example, a parent might exert control over its subsidiary by instructing its subsidiary to reduce its expenditure on research and development or other items that could impact the subsidiary's financial performance.

Related party disclosures also enable stakeholders to assess the risks and opportunities specific to the organisation. For instance, a situation where the only customer for an organisation's product is its subsidiary.

Many new non-financial reporting frameworks, including those on ESG, also include disclosure requirements on an organisation's relationships as the role of business in society evolves.

Awodumila is an Associate Director at PwC Kenya. An author who writes and speaks widely on corporate reporting topics

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