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Accounting Standard 18 Related Party Disclosures

Amit Majmudar April , 2009


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AS - 18 - Contents
Scope Specified Related Party Transactions Parties not to be treated as Related Parties Definition of control, significant influence and Key management personnel Examples of Related Parties Disclosure requirements Provisions of Clause 49 Corporate Governance Key Issues

AS 18
Scope:

- should be applied in reporting related party relationships


and transactions between a reporting enterprise and its related parties

- the requirements of this Statement apply to the financial statements of each reporting enterprise as also to consolidated financial statements presented by a holding company

AS 18
The statement deals only with specific related party transactions as specified below:
(a) enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise (this includes holding companies, subsidiaries and fellow subsidiaries). (b) associates and joint ventures of the reporting enterprise and the investing party or venturer in respect of which the reporting enterprise is an associate or a joint venture. (c) individuals owning, directly or indirectly, an interest in the voting power of the reporting enterprise that gives them control or significant influence over the enterprise, and relatives of any such individual.

AS 18
(d) Key management personnel (KMP) and relatives of such personnel

(e) enterprises over which any person described in (c) or (d) is able to exercise significant influence. This includes enterprises owned by directors or major shareholders of the reporting enterprise and enterprises that have a member of key management in common with the reporting enterprise

AS 18
The following are deemed not to be related parties:
- two companies simply because they have a director in common (unless the director is able to affect the policies of both companies in their mutual dealings)
- a single customer, supplier, franchiser, distributor, or general agent with whom an enterprise transacts a significant volume of business merely by virtue of the resulting economic dependence - the parties listed below, in the course of their normal dealings with an enterprise by virtue only of those dealings (although they may circumscribe the freedom of action of the enterprise or participate in its decision-making process): Providers of finance Trade unions Public utilities Government departments and government agencies including government sponsored bodies
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AS 18
Control
Own more than voting power Control over composition of board Substantial interest in voting power and power to direct financial and/or operating policies

Significant Influence (participation in the financial and/or operating policy decisions of an enterprise, but not control of those policies)
Representation on board Participation in policy making Material inter-company transactions Sharing of managerial personnel Dependence on technical information Ownership of 20% or more

AS 18
Key management personnel
Those persons who have the authority and responsibility for planning, directing and controlling the activities of the reporting enterprise.

AS 18
Enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise (includes holding companies, subsidiaries and fellow subsidiaries);
60% A Ltd 60% A Ltd

B Ltd

15%

B Ltd

15%

40%

Reporting Enterprise

40%

Reporting Enterprise Related Party

AS 18
Related parties include associates and joint ventures

60% Reporting Enterprise

Company H 55%

Company F

21%

50% Company SI

Company S Related Party

AS 18
Associate joint ventures of the enterprise and investing party or venturer in respect of whom the reporting entity is an associate or joint venture
Company I 2 Company I 60% 40% Reporting enterprise 40% JV 5% with an agreement for management Company A Associate

Company CV

60%

JV

Company JV

Related Party

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AS 18
Enterprises over which controlling individuals/relatives or KMPs/relatives are able to exercise significant influence. This includes enterprises owned by directors or major shareholders of the reporting enterprise and enterprises that have a member of key management in common with the reporting enterprise
Example 1
Individual 1:1 PSR and capital

Example 2
MD of Reporting Enterprise

MD of Company D Company D

25%

Reporting enterprise

80% Company S Related Party

Partnership firm

AS 18
Disclosure requirements:
Where control exist: Name of the related party and nature of the related party relationship should be disclosed irrespective of whether or not there
have been transactions between the related parties. If there have been transactions between related parties, during the existence of a related party relationship, the reporting enterprise should disclose the following:
Name of transacting related party Description of relationship

Nature of transaction
Volume of transactions Other key elements Outstanding balances & provision for doubtful debts

Amounts written off or written back

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AS 18
Para 26 of AS 18: Items of a similar nature may be disclosed in aggregate by type of related party except when separate disclosure is necessary for an understanding of the effects of related party transactions on the financial statements of the reporting enterprise.

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AS 18
Provisions relating to Related Party Transactions in Clause 49 of the listing agreement Corporate Governance
A statement in summary form of transactions with related parties in the ordinary course of business shall be placed periodically before the audit committee. Details of material individual transactions with related parties, which are not in the normal course of business, shall be placed before the audit committee. Details of material individual transactions with related parties or others, which are not on an arms length basis should be placed before the audit committee, together with Managements justification for the same.

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AS 18 Key issues
ASI 13
Paragraph 26 and 27 of AS 18 provides for disclosure of items of similar nature in aggregate by type of related party except when the separate disclosure is required for understanding the effects of the transaction. However, this is not done in such a way as to obscure the importance of significant transactions. Nor a material related party transaction with an individual party is clubbed in an aggregated disclosure.

Issue: How the test of materiality should be applied.

Depending on the circumstances, either the nature or the size of the item could be the determining factor. As regards size, ordinarily a related party transaction, the amount of which is in excess of 10% of the total related party transactions of the same type (such as purchase of goods), is considered material.

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AS 18 Key issues
ASI 19 Interpretation of the term intermediaries
The term intermediaries should be confined to mean enterprises which are subsidiaries as defined in AS 21, Consolidated Financial Statements.

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AS 18 Key issues
ASI 21 Non executive directors on the board whether related parties A non executive director should not be considered as key management person unless he has a authority and responsibility for planning, directing and controlling the activities of the enterprise.

The requirements of AS 18 should not be applied in respect of non executive director even if he participates in the financial and / or operating policy decisions unless he falls in any categories in para 3 of AS 18 (the specified related party transactions).
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AS 18 key issues
Issue: What are the connotations to "planning, directing and controlling the activities of the reporting enterprise"? Whether it is at strategic, functional or micro level? Resolution: Since key management personnel needs to have all the three authorities and responsibilities of planning, directing and controlling the activities, such person will be at strategic levels (with functional responsibility) for the reason that employee at functional level will have the authority (& also responsibility) only to execute, direct and control the activities as already decided at strategic level. He will not be involved in planning stage per se. The planning of activities which he does is not planning as such but a functional plan to execute a broader strategic plan. Further the directing and controlling of activities will be at much lower levels (micro or functional) and therefore such persons should not be deemed as key personnel for AS 18 purposes.

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AS -18 Key issues


Further, AS 18 examples also talk about Managing Director, Whole Time Director, manager or any person according to whose instructions Board of Directors is accustomed to act. The employee at functional level will not have any powers per se to influence the Board of Directors or their activities ( but may in a limited way influence them from time to time by presenting a proper case or path).

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AS 18 Key issues
Issue:
In case of Joint Ventures entered into by the Company with other parties, there is controlling interest of more than 20% (in most of the cases the interest is 50%). There is joint management in all such joint ventures. Under the definition of Control, para (c) states a substantial interest in voting power and the power to direct, by statute or agreement, the financial and/or operating policies of the enterprise. Whether as per this definition, the reporting enterprise will also be deemed to exercise control over the joint venture within the meaning of para 3 (a) of the AS, irrespective of the fact that it will still be a related party within the meaning of para 3 (b) of the AS. In case it is deemed to exercise control, then as per para 21 of the AS, names of the related parties are to be given irrespective of whether or not there are any transactions.

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AS 18 Key issues
Resolution:
For purposes of consolidation, AS 21 defines control as: (a) own more than 1/2 of voting power (b) controls the composition of the board For purposes of AS 18, related party transactions, control includes the above two factors plus 'a substantial interest in voting power and the power to direct, by statute or agreement, the financial and/or operating policies of the enterprise'. Therefore a related party may exercise control over another enterprise, which is not subject to consolidation. The relationship with the joint venture will fall under the definition of 'control', names of such related parties should be given irrespective of whether there is any transaction or not.

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AS 18 Key issues
Issue: The Company is a joint venture of X and Y (50:50). Z is the 100% holding company of X. Are the following transactions required to be disclosed as related party transactions? (a) The Company pays 8% sales commission to Z for the sales promoted by them on company's behalf.

(b)

The Company is required as per the agreement to pay license fee and sales commission to X which is not paid and a certificate of waiver has been received for the year.

Resolution: (a) X is a 50% Venturer and accordingly Z has the joint control over joint venture through X. Joint control does not give the power to direct financial/operating policies to any one Venturer as decisions are taken jointly. Therefore paragraph 3(a) of AS 18 cannot be said to be applicable. Waiver of income/expense is a related party transaction. A transaction under AS 18 is defined as ' a transfer of resources or obligations between related parties, regardless of whether or not price is charged'. Therefore waiver would be a transaction.

(b)

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AS 18 Key issues
Issue: The Company has transformed the application money paid to Y Ltd (which is a related party) for Deep Discount Bond (DDB) in to security deposits for a property taken on lease from Y Ltd. Application money was given in the previous year. In the current year, the DDB allotment is cancelled and the refund money is transformed into security deposit. Whether the disclosure should be specifically made stating that amount in the form of application for DDB converted in to Security deposit during the year?

Resolution:
All related party transactions are required to be disclosed. Related party transactions are any transfer of resources or obligations between related parties regardless of whether or not a price is charged.

AS 18 requires the disclosure for nature of the transaction. Accordingly, the transaction with Y should be disclosed by way of giving the description. In the given example, the description should state that application money for DDB being converted into security deposit. It will not be correct to show only outstanding amount as security deposit at the year end, since the transaction of transforming refund money into security deposit has taken place during the year, which needs to be disclosed.

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AS 18 Key issues
Issue:
The Company has been provided with the technical information and formulation by Z Ltd. Z Ltd is the owner of the product brand which is manufactured and marketed by the Company. The Company pays royalty to Z Ltd as per the license agreement and also the raw materials are imported from Z ltd. Whether the disclosure of Z Ltd is required in the event they are considered to have a significant influence?

Resolution: Paragraph 13 of AS 18 states that significant influence may be exercised in several ways. One of the examples given in this paragraph is by way of dependence on technical information. However, definition of related parties as per paragraph 3 of AS 18, does not include as related parties the enterprises which have significant influence over the reporting enterprise. It includes only individuals having significant influence over the enterprise. In the present case, Z Ltd, not being an individual, will not be covered by the related party definition.
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AS 18 Key issues
Issue:
A listed Company , has made donations to a trust formed for charitable and social development purposes. The settler of the trust is the Managing Director of the Company. The three trustees are heads of the finance and certain business divisions of the Company. MD as the settler of the trust , has only initiated the formation of the trust as an one time action( like initial subscriber to the memorandum in case of companies). He has no role to play in the functioning and activities of the trust which are driven by the trust deed and monitored by the board of trustees. The trustees are not key management personnel of the company as they are only the business unit heads. Hence the trust does not fall into the category of the enterprises directly or indirectly controlled by the reporting entity Whether the donations made need to be disclosed as a related party transactions?

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As 18 Key issues
Resolution:
As per the definition of related party in para 3 (a) of AS 18, which includes indirect control, the enterprise is able to exercise significant influence on the trust. If it was not the intention of the enterprise to control the trust, why would it not appoint independent trustees. In many cases of the trusteeship the employee holds expires with the termination of his employment itself. Even by virtue of the corpus of the trust being funded by the enterprise, it would have control over the trust. The trust would also be a related party based on definition in para 3 (e) of AS 18 if the MD is able to exercise significant influence on the trust. In the present case, one needs to see the function of the MD in the trust and what powers are given to him and whether he can influence the operations of the trust. Given that the divisional heads report to the MD, the MD would be in a position to influence the working of the trust though he may have been titled only as a settler.

The fact that the trust is a charitable trust should in no way influence judgement on AS 18. One needs to look at the trust deed and the minutes of the meeting to get more clarity. The bottom line is that if as an enterprise it can exercise significant influence or control over another enterprise, then it is a related party. The trust is a related party under AS 18.
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AS 18 Key issues
Issue:
Under para 3(b) of the AS - 18, related party includes associates and joint ventures of the reporting enterprise and the investing party or venturer in respect of which the reporting enterprise is an associate or a joint venture. Whether, as per this definition, the other parties in the Joint Ventures of the reporting enterprise will also be construed as related party. For example, reporting enterprise A has formed a joint venture C with another enterprise B. Whether enterprise B will also be falling within the definition of related party for the purpose of reporting enterprise A.

Resolution:
A co-venturer is not a related party, though a venturer and the joint venture are related parties. Between co-venturers there does not exist any significant influence or control. However co-venturers may be otherwise related, for example if they otherwise exercise significant influence or control over each other.

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AS 18 Key issues
Issue:
Whether disclosure under AS 18 on Related Party Transactions require auditor's opinion on the measurement of such transactions?

Resolution:
AS 18 does not deal with measurement issues. But that does not exempt auditors from looking at related party pricing. After all auditors give the opinion that the accounts are true and fair, and it would be difficult for auditors to escape from this responsibility should something major go wrong. Auditors also report specifically on these issues in the CARO.

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AS 18 Key issues
Issue:
The Company is a subsidiary of ABC International BV, a company incorporated in the Netherlands, which holds 74 percent of the equity shares. The balance 26 percent shares are held by ABC (Mauritius) Limited, a company incorporated in Mauritius. All of these companies are part of the ABC Group of France, which is a leading independent Company. The ABC Group is very closely held and privately owned. The Company is principally engaged in marketing of finished dosage forms, based on active pharmaceutical ingredients imported from XYZ Laboratories ABC (XYZ), France and ABC Egypt Industries (AEI), Egypt; both these companies are also part of the ABC Group.

During the current year, the companys turnover has exceeded Rs 50 crores, and consequently certain accounting standards including AS 18 on Related Party Disclosures have become applicable to the Company.

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AS 18 Key issues
Issue (continued)
Paragraph 21 of AS 18 requires the name of the related party and nature of the related party relationship where control exists to be disclosed irrespective of whether or not there have been transactions between the related parties. The Company does not have information about the ownership of its holding company or the ownership structure of other entities in the ABC Group. It is also not aware of the nature of relationship with other ABC Group entities with whom it enters into transactions. The Company in its Transfer Pricing Report and Form 3 CEB for the year ended March 31, XXXX, has disclosed that the Ownership pattern of the associated enterprises as disclosed under Attachment 1 are not available with the assessee. Considering that the Company is aware of only the identity of its immediate parent, the disclosures relating to names of parties where control exists may not be complete. Further, considering that the Company is not aware of the exact nature of its relationship with other group entities, it may not be appropriate to describe these relationships as that of fellow subsidiaries

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As 18 Key issues
Issue (continued)

In view of the above facts, the following issues need to be resolved:


What disclosures are required to be made in the financial statements relating to the above? Would the auditors report require modification to bring out the possibility of incomplete disclosures, arising from lack of information with the Company? Resolution: Any procedures that may have been performed by the company for identification of related parties and transactions with them would be inadequate and not comprehensive. To this extent auditors may have to give a limited disclaimer on compliance with AS 18 as well as on the true and fair view. Such limited disclaimer will be based on materiality - but in the absence of any comprehensive information, materiality of the undisclosed information cannot be assessed. Further, in the absence of information the disclosure requirements as per Schedule VI also can not be met. The auditor should give limited disclaimer in respect of Schedule VI and AS 18 disclosers.

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AS 18
What should we look for:
Completeness
Manner of disclosure Shareholding, Investments, 301 Register, TP report, JV agreements, Prior year work paper Entitys procedures for identifying Related parties

AAS 23
Management representation

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