Related Party Transactions

Disclosures & Regulatory Issues

By
Lee Leok Soon
Head, Client Services
Minority Shareholder Watchdog Group
Smart Focus Business Solutions Seminar
17 November 2008
Hotel Maya Kuala Lumpur
Let me begin as follows:
IFRS 124 Disclosures & Listing Requirements
Definition and the Needs for regulations
Determining Disclosures and Procedural
Requirements
Aggregation and principles
Purposes for Disclosures and Percentage
Ratios/Thresholds
Main/Principal Advisers & Independent Advisers
Managing Related Parties
Corporate Liabilities of Directors
Case Studies & Examples
Definition
Definition of related parties under
IFRS 124 is widely drawn.
Related parties are considered in
two groups:
Those that are deemed to be related
Those where a related party
relationship is presumed.
Deemed related party relationships
cannot be rebutted. All material
transactions with directors, group
members, associates and joint ventures
must normally be disclosed.
Presumed relationship can be
rebutted. Such transactions need not
therefore be disclosed. The relevant party
must prove no significant influence over
the entitys financial and operating
policies.
A related party can mean a director, major
shareholder or person connected with
such director or major shareholder.
The question then arises who is a related
party?
Parties are considered to be related
if at any time during the reporting
period, one party has the ability to
control the other party or exercise
significant influence over the other
party in making financial and
operating decisions.
Generally, deemed related parties
include:
Holding companies, subsidiaries and fellow
subsidiaries
Associates and joint ventures
Individuals including their relatives having
voting power giving them control or
significant influence
Key management personnel including
their relatives
Enterprises where controlling individual or
key management personnel has significant
influence
Definition
A party is related to an entity if:
a) directly or indirectly through one or more
intermediaries, the party (i) controls, is controlled by, or
is under common control with, the entity (this includes
parents, subsidiaries and fellow subsidiaries); (ii) has an
interest in the entity that gives it significant influence
over the entity; or (iii) has joint control over the entity;
b) the party is an associate (as defined in IFRS 128 -
Investments in Associates) of the entity;
c) the party is a joint venture in which the entity is a
venturer (see IFRS 131 Interests in Joint Ventures);
d) the party is a member of the key management
personnel of the entity or its parent.
The party is a close member of the family
of any individual referred to in (a) or (d);
The party is an entity that is controlled,
jointly controlled, or significantly
influenced by or for which significant
voting power in such entity resides with,
directly or indirectly, any individual
referred to in (d) or (e); or
The party is a post-employment benefit
plan for the benefit of employees of the
entity, or of any entity that is a related
party of the entity.
Major shareholder - any person
controlling 5 per cent or more of the
voting rights in a listed issuer or in any of
its subsidiaries. Past person who no
longer has such voting rights but who did
have them at any time within 6 months
preceding the date of the transaction.
Such person and connected person must
abstain from all voting on the relevant
resolutions, and disclose the nature and
the extent of his/her interest.
Director - any person who is (was within
the previous 6 months), a director or a
shadow director of a company or its
subsidiaries. A shadow director is
someone in accordance with whose
instructions the directors of the company
are accustomed to act and also as an
alternate or substitute director.
Such person and connected person must
abstain from all board deliberations and
voting on the relevant resolutions, and
disclose the nature and the extent of
his/her interest.
Associates - directors and substantial
shareholders who are individuals,
including their family (i.e. spouse or
child). In case, the substantial
shareholders are companies and associate
includes a variety of associated companies
within any subsidiary, holding company or
fellow subsidiary of the holding company.
IFRS 128 defines an associate as an
entity over which the entity has a
significant influence and that is
neither a subsidiary nor an interest in
a joint venture.
Joint Venture - a contractual
arrangement between two or more
parties to undertake a specific
business project subject to joint
control in which parties meet costs
of the project and receive a share of
any resulting output.
Connected Person - a member of that
director or major shareholders family, a
trustee of a trust (under which director or
major shareholder or member of directors
or major shareholders family is sole
beneficiary), a partner of that director or a
partner of person connected to that
director or major shareholder, a person or
body corporate accustomed or obliged to
act in accordance with the director or
major shareholder or vice versa, a body
corporate in which a director or major
shareholder controls not less than 15 per
cent of the votes, and a related body
corporate.
Family member includes spouse,
parent, child including adopted child
and step child, brother or sister and
spouse of child and brother or sister.
Such person and connected person
must abstain from all deliberations
or voting on the relevant
resolutions, and disclose the nature
and the extent of his/her interest.
Interests can be categorized as direct or indirect.
Both direct and indirect interests must be
disclosed. A director has a direct interest when
he/she is (i) a party to a transaction; (ii) a parent,
child, adopted child or stepchild or spouse of a
party to the transaction; and a director, officer or
trustee of a party to the transaction.
An indirect interest arises in a number of
situations. For example, an indirect interest arises
if a director has a material financial interest in
another party to a transaction or in a party that
will obtain a material financial benefit from the
transaction.
Partner - any person with whom director,
major shareholder or person connected
with director or major shareholder is in or
proposes to enter into partnership with.
A partnership is the relation which subsists
between persons carrying on business in
common with a view of profit. The relation
between members of any company or
association which is registered as a
company under the Companies Act 1965 or
as a co-operative society under any written
law relating to co-operative societies or
Section 3 of the Partnership Act 1961.
IFRS 124 increases the disclosure
requirement. It requires a listed
issuer to disclose all material
transactions with related parties, i.e.
parties having a relationship (control
or influence) that affects the
independence of either the reporting
entity or the other party and could
have a significant effect on the
financial position and operating
results of the reporting entity.
The need for regulation: related
party transactions?
The general health of an entity is likely to
be affected by those who make the
decisions i.e. the directors of the
company.
The challenges to the regulators are
therefore to ensure that the interests of
all shareholders (majority and minority)
are protected and that the directors
maintain their duty in good faith and act
in the best interest of the company.
Related party transactions have been a
feature of a number of financial
scandals in recent years, many of
which have had in common the
dominance of the company by a
powerful chief executive who was also
involved with the related parties.
Sir David Tweedie
Chairman
International Accounting Standards Board
United Kingdom
Case Example 1: Undisclosed
Related Party Transactions
Allegations of financial mismanagement have come
to light in the hearings on the failed Principal Group
in Canada.
For example, the President of Principal Group,
Donald Cormie, has claimed that he was unaware
he had been signing authority for sales and
purchases of real estate belonging to Principal
Groups two failed subsidiaries namely First
Investors Corporation (FIC) and Associated
Investors of Canada (AIC) respectively.
When the subsidiaries had their licences revoked in
June 1987, about 67,000 investors lost about
$150.0 million. When the parent, Principal Group
filed for bankruptcy in August, other investors lost
about $60.0 million.
Donald Cormie had built up a financial services
conglomerate from the 1950s, eventually worth
$1.2 billion.
It is alleged that Donald Cormie used the company
to bankroll an extravagant lifestyle for himself and
his family using secret funds and a complex
labyrinth of inter-connected companies.
In his latest testimony, Donald Cormie has
attempted to distance himself from the operation
of the two key subsidiaries by saying that he did
not realize he had signing rights on contracts
issued by FIC and AIC respectively.
It also transpired during the hearings that Donald
Cormies daughter, Allison had been paid
$120,000.00 in 1986 for weather research.
Donald Cormie had a theory that economic cycles
were linked to changes in climatic conditions.
Allison described by her father as an archaeologist
and expert in isotope analysis and carbon dating
techniques received $120,000.00 in 1986 for
research on weather records going back hundreds
of years.
When the research is completed, Donald Cormie
said, he expects his daughters data on climate
cycles will enable him to formulate more exact
financial and economic predictions for the next 25
years.
Some of the money from Donald Cormies empire
also found its way to Estate Loan and Finance, a
company owned by his wife, Eivor Cormie. By the
time, Principal Group collapsed in August 1987,
payments of $300,000.00 a month were being
made to Estate Loan and Finance.
Eivor Cormie, the court heard, was paid
$270,000.00 in 1986 for developing a sales force
for FIC including goodwill promotion, dances and
parties staged for the companys sales staff.
Source: Singapore Accountant, June 1988
Joint ventures are often a means of
sharing risks where the risks are
particularly high. The amounts involved
can be considerable and the effects of
failure spectacular.
Geoffrey Holmes
Former Editor
Accountancy, ICAEW
IFRS 131 defines a joint venture as a
contractual arrangement whereby two or
more parties undertake an economic activity
which is subject to joint control.
Any transactions that may involve the
company in a number of important
procedural formalities, most notably
the obtaining of shareholders
approval, are the transactions with
related parties. It is not the size of the
transactions but the relationship
between the parties that is important
to make the classification.
A transaction with related parties is defined as a
transaction other than of a revenue nature in
the ordinary course of business between a
company (or any of its subsidiaries) and a
related party; or any arrangement in which a
company (or any of its subsidiaries) and a
related party each invest in, or provide
finance to, another undertaking or asset (a
joint investment arrangement); or the
entering into, amendment or termination of
any contractual arrangement with a
controlling shareholder.
A related party means a substantial shareholder,
director or any of their associates or venturers.
Case Example 2: Unincorporated
Joint Ventures
A company participates in a number of unincorporated joint
ventures which it proportionally consolidates in its group
accounts. It has entered into transactions with the joint
ventures.
Does IFRS 124 Related Party Disclosures require these
transactions and the amounts due to or from the joint ventures
at the balance sheet date, to be disclosed?
Or can the exemption for transactions or balances between
group entities that have been eliminated on consolidation be
applied?
IFRS 124 does require disclosure of the transactions and
balances with the joint ventures and that the exemption for
group entities does not apply. The joint ventures are not
subsidiaries and the transactions and balances between the
group and the joint ventures are not fully eliminated in the
group accounts by proportional consolidation. The disclosure
note could indicate the extent to which the transactions and
balances have been eliminated by proportional consolidation but
the gross details should be disclosed.
Source: Accountancy, July 1997
The usual recurrent related party
transactions
The recurrent related party
transactions are those with the
frequency and regularity (made at
least once in 3 years in the course of
business). They are of revenue or
trading nature necessary for the day
to day operations of the business,
contributing directly or indirectly to
generation of revenue for the listed
issuer.
A listed issuer having recurrent transactions of a
revenue or trading nature for daily operations may
seek shareholders mandate when (i) the transactions
are in the ordinary course of business and terms are
not more favourable than those generally available to
the public. In the ordinary course of business
only if reasonably expected to be carried out by
relevant entity given the type of business; (ii) annual
renewal for the shareholders mandate must be in
order; (iii) disclosure in the annual report if the
aggregate value of transactions conducted pursuant to
mandate where consideration, value of the assets,
capital outlay or costs of aggregate transactions is
equal to or exceeds RM1.0 million or the percentage
ratio of such recurrent transactions is equal to or
exceeds 1 per cent whichever is the lower.
Related party transactions that are exempt
from issuing circular to shareholders or
obtaining shareholders mandate or
appointing main/principal adviser and
independent adviser are covered in Bursa
Securities Listing Requirements -Chapter
10: Transactions, Paragraph 10.08; and (v)
interested parties must not vote. They
include interested directors, major
shareholder or interested persons
connected with director or major
shareholder.
They must not vote where related party
transactions involve their interests or the
interested persons connected with them or
major shareholder. Directors with any
interest direct or indirect must abstain from
board deliberations and voting on the
relevant resolutions in respect of the
related party transactions.
Bursa Securities issued Practice Note No.
12/2001 to clarify on recurrent related
party transactions of a revenue nature.
Guidance Note No. 8/2006 is for MESDAQ
companies
Procedural requirements
When the relevant transactions are those with
related party, the following procedural
requirements have to be observed, (i) make an
announcement if required by Bursa Securities
Listing Requirements; (ii) prepare to send an
explanatory circular to shareholders, currently
obtaining shareholders approval at the AGM; (iii)
for the approval of its shareholders, where
applicable, ensure that the related party abstains
and takes all reasonable steps to ensure that its
associates abstain from voting on the relevant
transactions; and (iv) the relevant contracts if
applicable must be supplied to Bursa Securities, i.e.
the Stock Exchange, if requested.
A related party transaction is a transfer of
resources, services or obligations between
related parties, regardless of whether a price
is charged.
Disclosures on related party transactions are (i) the
amount of the transactions; (ii) the amount of
outstanding balances, including terms and
conditions and guarantees; (iii) provisions for
doubtful debts related to the amount of outstanding
balances; (iv) expense recognized during the period
in respect of bad and doubtful debts due from
related parties.
The listed issuer must provide proof if it states that
related party transactions were made on terms that
are common in arms length transactions.
Aggregation means that separate transactions
may be aggregated and treated as one if agreed
upon within 12 months.
However, all material information, subject to
certain exemptions, shall be disclosed either
individually or in aggregate.
Transactions which may be aggregated include (i)
transactions entered into with the same party or
parties connected with one another; (ii) acquisition
or disposal of securities or interests in one
particular company or asset; and (iii) acquisition or
disposal of various parcels of land contiguous to
each other.
The principles on aggregation are (i) transaction
announced earlier pursuant to Chapter 10 shall not be
aggregated with latest transaction when determining
whether an announcement is required; (ii) transaction
approved by shareholders or which was subject of
aggregation with transaction approved by
shareholders pursuant to Chapter 10 shall not be
aggregated with latest transaction when determining
whether any obligations are applicable; and (iii) if
aggregation results in requirement for shareholders
approval under Chapter 10, approval required only for
latest transaction. Earlier transactions only require
disclosure in circular.
The rule of aggregation under Chapter 10,
Paragraph 10.11 must be complied. In addition to
making an immediate announcement for a related
party transaction, Chapter 10, Paragraph 10,08(2)
must be complied. However, a listed issuer is
allowed to seek shareholders mandate in respect of
recurrent related party transactions; (iv) circular to
shareholders for shareholders approval. All the
requirements set out under Chapter 10, Paragraph
10.09 must be complied.
Annual report must disclose the aggregate value of
recurrent transactions conducted pursuant to the
mandate by types, names of related parties involved
in each type and their relationship with the listed
issuer.
Related party transactions have been a
feature of a number of financial
scandals in recent years, many of
which have had in common the
dominance of the company by a
powerful chief executive who was also
involved with the related parties.
Sir David Tweedie
Chairman
International Accounting Standards Board
United Kingdom
The increasing emphasis on corporate governance
makes it important for listed issuers to demonstrate
transparency and accountability with proper
compliance. One area of concern is related party
transactions which are important for good
corporate governance practice to improve investor
confidence.
The existence of control, joint control or influence
can affect the terms on which the two parties
transact. An understanding of the relationship and
the terms on which two related parties have
transacted is therefore important for understanding
of a listed issuers financial statements.
Listed issuers are required to disclose all
transactions with related parties such as
with directors, executives, associates and
their family members under Bursa
Securities Listing Requirements. While the
great majority of related party transactions
are perfectly normal, the special
relationship between the involved related
parties could create potential conflicts of
interest which might result in transactions
which benefit the people involved,
detrimental to the shareholders.
In the infamous Enron scandal, related
party transactions with special purpose
entities were used to help the company
misreport their accounting numbers.
The Maxwell affairs in the 1980s that
caused the Accounting Standards Board
(ASB) to re-consider the issue of related
parties. The Maxwell affairs, it transpires,
resulted in difficulties at MGN Group and
Maxwell Communications, partly as a
result of a number of related party
transactions. Hence, the ASB revived the
issue which subsequently developed it as
FRS 8.
The rationale for considering related parties is the
reliability of accounting information that is involved with
assurance in ensuring that accounting tells it like it
is, something sometimes referred to as faithful
representation. Thus, transactions are assumed to
take place at arms length, i.e. on normal commercial
terms.
If that basic presumption (normally referred to as an
accounting concept) is untrue, then the normal free
market conditions do not exist and the results, cash
flows and financial position may be manipulated in some
way, possible to give investors the financial statements
a view of things which normal market forces would not
have given rise to.
As FRS 8 points out, even though the parties involved
may attempt to achieve arms length bargaining, the
nature of the relationship may prevent this from
happening.
In the nature of things, the
requirement to disclose related
party transactions can never be a
complete safeguard against
deliberate dishonesty.
Sir David Tweedie
Chairman
International Accounting Standards Board
United Kingdom
The Haw Par Affair Related Party
Transactions
In November 1979, the High Court of Singapore sentenced Richard
Tarling, a British and the former Chairman of Haw Par Brothers
International Limited (or Haw Par Brothers) to six (6) months
imprisonment for failing to give a true and fair view of Haw Par
Brothers profits for 1972. The decision was affirmed by the Criminal
Court of Appeal in January 1981.
The facts of the case
Slater Walker Securities Limited, U.K. in which Richard Tarling was
once an executive, held major but not a majority interest in Haw Par
Brothers, a company incorporated in Singapore. Haw Par Brothers
represented Slater Walkers interest in the Far East and was
effectively a director-controlled company through Richard Tarling.
Haw Par Brothers was mainly a holding company comprised of both
subsidiary with a 50% or more ownership and associated corporations
with a less than 50% ownership. One of its wholly-owned subsidiaries in
Hong Kong, Grey Securities Limited (GSL) was used as a vehicle for Haw
Par Brothers Group to trade on stock markets in Hong Kong and
Singapore respectively. GSL made phenomenal profits from its share
dealings and Haw Par Brothers management wanted to avoid
consolidating GSLs profits with those of Haw Par Brothers Group.
The Haw Par Affair Related Party
Transactions (Contd)
To do this, a private unit trust, Melbourne Unit Trust (MUT) was set up
on 27 June 1972 with all units of this trust effectively owned through
nominees by Haw Par Brothers. On 28 June 1972, Haw Par Brothers
then sold GSL to MUT at Haw Par Brothers original cost of HK$108
million. The market value of GSLs underlying net assets was HK$60.3
million. Haw Par Brothers thus avoided consolidating GSLs realised
profits of HK$25.5 million since they now belonged to MUT. Since
MUT was a unit trust as opposed to an incorporated company, its
profits too were not consolidated in Haw Par Brothers Groups profit
and loss accounts for 1972.
As a result, Haw Par Brothers Groups consolidated profits for the year
ended 31 December 1972 were grossly understated, contrary to being
consolidated in order to present a true and fair view of the Haw Par
Groups results and performance.
Source: The Haw Par Affair & The Reporting of Related Party Transactions
in Asia Pacific Journal of Management, May 1984
by Sebastian Chong
Senior Lecturer, School of Accountancy
National University of Singapore
Footnote comments: It is generally recognized that directors and managers are usually concerned with
how transfer prices should be determined. IFRS 124 deals with this concern about how transactions between
related parties should be reported in published financial statements. The mode of reporting and disclosures is
also regulated by Bursa Securities Listing Requirements, Chapter 10 and the relevant PN 12/2001, PN
14/2002 and Guidance Note No. 8/2006 for companies listed on the stock exchange.
The effects on the financial statements
can be seen in two-fold:
First, the amount of business might vary -
a controlling party may determine exactly
how much business is done.
Second, the terms of the transactions, i.e.
credit terms, the prices, may be different.
Goods or services may be transferred in
exchange for assets, the price of which is
difficult or impossible to determine. The
question is, how should all these
transactions be communicated to investors
so as to facilitate their understanding of
the situation?
Financial reporting is essentially just about
two things - how to measure and what to
disclose.
The first possibility is that the accounts
are restated to give the picture which
would have been shown had the
transactions taken place on normal
commercial terms, i.e. on terms which
would have been transacted with an
external unrelated party.
First, the transactions do not represent
what actually happened and indeed, to
pretend that the transactions took place
with an external party is simply untrue.
Second, it may lead to inflating profits
and assets, thus conflicting with the
concept of prudence.
Third, it may be difficult to estimate what
normal commercial terms might have
been.
The second possibility is to
disclose what has happened in the
notes to the accounts.
Disclosures are often thought to be
useful in showing a true and fair
view because it enables investors to
appreciate fully what has happened
and to make their own adjustments.
A concern about increasing
disclosure requirements would put
the onus on what to do about an
accounting issue of the investors
rather than on the preparer. It
should be borne in mind that the
increased disclosures and the
amount of detail in them are
perhaps, becoming somewhat
excessive.
Not only are related parties potentially
numerous, the required disclosures are
also lengthy (i) names of the transacting
related parties; (ii) description of the
relationship and the transactions; (iii) the
amounts involved; (iii) balances with the
related parties at the balance sheet date,
including provisions made and amounts
written off such balances; and (iv) any
other elements necessary for an
understanding of the financial statements.
Just how useful disclosures about
related parties are to the average
investor remains to be seen, (i) they
are often extremely complicated; (ii)
their significance is difficult to
assess; and (iii) nevertheless, they
largely remove the excuse if only I
had known, otherwise I would
not have bought the companys
shares.
The Percentage Ratios
The percentage ratios means the figures expressed as a
percentage, resulting from each of the following
calculations:
Value of assets/net tangible assets of listed issuer
Profit after taxation/profit after taxation of listed issuer
Aggregate value of consideration/net tangible assets of
listed issuer
Issued and paid up shares/share capital of listed issuer
Aggregate value of consideration/market capitalization of
listed issuer
Total assets of subject matter/total assets of listed issuer
Listed issuers portion of project cost/total asset of listed
issuer
Listed issuers portion of joint venture companys
shares/net tangible assets of listed issuer; and
Aggregate cost of investment of the subject matter/net
tangible assets of listed issuer (in the case of a disposal
and where the acquisition of the subject matter took place
within the last 5 years).
The Percentage Thresholds
If a listed issuer (or any of its
subsidiaries) has entered or proposes
to enter into a transaction (whether by
way if cash or otherwise) with a related
party (whether directly or indirectly),
then the said listed issuer should take
the following measures:
a) For transactions more than 5 per
cent of the percentage ratios
An immediate announcement, circular
and EGM are required to seek
shareholders approval. The appointment
of an independent adviser is required.
b) For transactions more than 25 per
cent of percentage ratios
An immediate announcement, circular
and EGM are required to seek
shareholders approval. The appointment
of main and independent advisers is
required.
Main/Principal Advisers &
Independent Advisers
The roles of main and independent
advisers are as follows:
Main Adviser/Principal Adviser
Whether transactions are fair and reasonable
Compliance with relevant laws and regulations
and guidelines
Disclosure in announcement and circular
Responsibility has been discharged with due
care.
Main adviser/principal adviser is
appointed with terms agreed upon to
ensure that the related party transactions
are carried out on fair and reasonable
terms, not detrimental to minority
shareholders. They must be complied with
relevant laws, regulations, and guidelines
along with full disclosure of all information
in announcement and circular.
Independent Adviser
Whether or not transaction is fair and
reasonable
Whether minority shareholders should
vote in favour of the related party
transactions
Whether it is detrimental to minority
shareholders
Must comply with the relevant laws,
regulations and guidelines, where
applicable.
Exceptions
A number of exceptions to the usual requirements
are available where the related party disclosures do
not apply. Among these exceptions are: (i) the issue
of securities for cash pursuant to an opportunity
which is made available to all shareholders on the
same terms. This would cover, for example, the case
of a related party benefitting from a rights issue; (ii)
the issue of new securities in accordance with the
exercise of conversion or subscription rights attached
to listed securities or previously approved by the
shareholders. For example, the act of conversion of
listed convertible loan stock would not trigger the
related party provisions. For example, payment of
dividend, bonus issue, share splits, issue of securities
for cash on a pro-rata basis;
(iii) Transactions between a listed issuer or
any of its subsidiaries and an investee
company where the related party has no
interest in the investee; (iv) common
directorship but with no shareholdings; (v)
acquisition or disposal whereby the related
party holds less than 5 per cent in the third
party company; (vi) provision of financial
assistance or services by licensed financial
institutions upon normal commercial terms
and in ordinary
(viii) where the terms and circumstances of a
joint investment arrangement are, in the
opinion of an independent adviser, no less
favourable to the company than for related
party; (ix) in relation to a listed issuer with
an issued and paid up capital of RM60.0
million and above, the consideration, value
of the assets, capital outlay or costs of the
recurrent transaction under Bursa Securities
Listing Requirements is equal to or exceeds
RM1.0 million or the percentage ratio of
such recurrent transaction is equal to or
exceeds 1 per cent whichever is the higher;
(x) in relation to a listed issuer with an
issued and paid up capital of less than
RM60.0 million, the consideration, value of
the assets, capital outlay or costs of the
transaction is equal to or exceeds RM1.0
million or the percentage ratio of such
transaction is equal to or exceeds 1 per
cent, whichever is the lower; and (xi) the
rule of aggregation under Bursa Securities
Listing Requirements - Chapter 10:
Transactions, Paragraph 10.11 - Aggregation
of Transactions.
Managing related parties and
relationships
It is one of the most difficult aspects in financial reporting.
It is a common practice of companies in organizing
their businesses through the medium of other
companies in the group, associated undertakings and
other related entities that have caused transactions
between related parties to become a routine and
necessary part of the operations of many business
enterprises. Related parties may nevertheless enter into
transactions that unrelated parties would either not
undertake or would undertake only on different terms.
Reporting control relationships and related party
transactions draws the attention of users of financial
statements to the possibility that those statements may
have been affected by the relationships.
Charles Gubbins, BSc, CA
Managing Director
Practical Training Division
ATC (Eastern) Ltd, U.K.
Related party transactions are one of the
most important elements because (i)
IFRS 124 and Bursa Securities Listing
Requirements require disclosures of all
material related party transactions and
certain control relationships; (ii) in the
absence of adequate disclosures, financial
statements may be distorted or
misleading; (iii) the instances of
fraudulent financial reporting and
misappropriation of assets that have been
facilitated by the use of undisclosed
related party.
In addition, related parties and related party
transactions are also difficult to audit for several
reasons (i) transactions with related parties are
not always easily identifiable; (ii) even though
auditors are thorough in their audit procedures,
they rely on directors and management to identify
related parties and related party transactions; (iii)
such transactions may not be easily tracked by
internal control system and risk management;
Related party transactions are complex, requiring
proper accounting and auditing through sound
knowledge and careful analysis.
Managing related party relationships
requires directors and management to
properly define the following terms
used.
Control
Significant influence
Joint control
Key management personnel
Close members of family and of
individuals
Willing seller-willing buyer principle
Arms length price
Fundamental to financial reporting is the
assumption that financial statements reflect
the results of arms length bargaining between
independent parties. The presence of
transactions between related parties inevitably
raises questions as to the meaningfulness of
the resulting information.
Mike Metcalf, BSc, FCA
Head of Technical Department
Arthur Young McClelland Moores & Co (Chartered Accountants), U.K.
Related party transactions - Why a standard is needed?
Accountancy, May 1979
Corporate Liabilities of Directors
To act honestly and use reasonable
diligence
Improper use of any information
Breach of any of the provisions to make
profits for oneself
Conflicts of interest in dealing with the
company
Use of company information
Role and responsibilities of audit
committee
Failure to identify related parties
and related party transactions
Inadequate examination of related
party transactions
Improper disclosures of related
party transactions
Internal auditors, external auditors and audit
committee must see that related party
confirmation letters are prepared and dispatched
to related parties concerned for confirmation to be
obtained.
They must also see that related party
questionnaire be prepared and responded to by
related parties concerned.
The primary objectives of related party
confirmation letters and questionnaire are to (i)
determine the existence of related parties; (ii) to
identify all material transactions with related
parties; (iii) to examine identified related party
transactions; and (iv) to determine the adequacy
of disclosures.
Recent business events reflect the
increasing use of complex business
structures that include off-balance
sheet entities. Because some of these
entities may be related parties, the
proper accounting and auditing of such
transactions require sound
understanding and extremely careful
analysis.
Chuck Landes
Director of Audit & Attest Standards,
AICPA, U.S.A
Case Study
Beyond salary and stock options, some executives and
board members find other ways to earn money from
their companies. For example, consider two board
members at Foamex International Inc had consulting
contracts worth up to US$150,000 last year, and the
wife of Chief Executive Officer of Channell Commercial
Corporation got US$72,000 for offering advice on the
companys insurance needs.
Such arrangements are not unusual, and they are not
illegal. All companies have to do is disclose them in the
annual reports. But such business deals between a
listed issuer and a side business are connected to its
related parties.
Source: Steve Toloken
Related party transactions attracting attention
Case Studies and Case Examples
Discussions and Participation
Related Party Transactions in
Annual Reports
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