11.2 Measurement and recognition of related party transactions

Related party transactions are a crucial aspect of financial reporting. These transactions between entities with close relationships can significantly impact financial statements, requiring careful measurement and recognition to ensure transparency and accurate representation.

Proper accounting for related party transactions involves choosing between fair value and carrying amount measurements. Consistent application, special considerations for different transaction types, and compliance with accounting standards are essential for accurate financial reporting and disclosure of these transactions.

Measurement Bases for Related Party Transactions

Fair Value and Carrying Amount

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• Related party transactions typically measured at fair value representing price received for asset sale or paid for liability transfer in orderly transaction between market participants
• Carrying amount used in some cases representing recognized amount of asset or liability on balance sheet
• Choice between fair value and carrying amount depends on transaction nature, party relationship, and applicable accounting standards
• Arm's length transactions between related parties measured at fair value to reflect economic substance
• Non-arm's length transactions may require special consideration (measuring at carrying amount or recognizing difference between fair value and transaction price directly in equity)

Consistency and Special Considerations

• Measurement basis consistently applied to similar related party transactions ensuring comparability and faithful representation
• Special considerations for different transaction types:
  • Asset transfers may be accounted for at carrying amount in transferor's financial statements
  • Share-based payment transactions may require modified accounting treatment
  • Long-term contracts assessed for embedded leases or arrangements requiring separate accounting

Recognition of Related Party Transactions

Disclosure Requirements

• Related party transactions disclosed in financial statement notes including relationship nature, transaction types, and amounts involved
• Disclosure details:
  • Outstanding balances
  • Terms and conditions
  • Guarantees given or received
• Key management personnel transactions separately disclosed (compensation and other benefits)
• Group transactions between parent and subsidiaries:
  • Eliminated in consolidated financial statements
  • Disclosed in separate financial statements
• Materiality considerations apply to disclosures but relationship nature may make transaction material regardless of size

Accounting Standards Compliance

• Specific requirements for recognition and disclosure provided by accounting standards (IAS 24, ASC 850)
• Standards guide:
  • Identification of related parties
  • Transaction types requiring disclosure
  • Quantitative and qualitative information to be reported
• Compliance ensures consistency and comparability across entities

Substance of Related Party Transactions

Economic Substance Evaluation

• Evaluate economic substance of related party transactions to determine if different from legal form affecting accounting treatment
• Assess potential distortion of financial performance and position if not properly accounted for and disclosed
• Consider if transactions conducted on terms equivalent to arm's length transactions
• Analyze impact on key financial ratios and performance metrics (liquidity ratios, profitability margins)

Professional Skepticism and Manipulation Risk

• Assess potential for management to use related party transactions for financial result manipulation or specific accounting outcomes
• Auditors apply professional skepticism when evaluating transactions and disclosures ensuring true and fair view of financial statements
• Consider:
  • Unusual transaction terms
  • Circular flow of goods or services
  • Transactions lacking clear business purpose

Accounting for Common Related Party Transactions

Sales and Purchases

• Recognize sales and purchases between related parties at fair value
• Account for difference between transaction price and fair value appropriately
• Eliminate intragroup sales and purchases in consolidated financial statements avoiding revenue and expense overstatement
• Example: Parent company sells inventory to subsidiary at cost plus 20% markup

Loans and Financing

• Initially recognize loans between related parties at fair value
• Treat difference between fair value and transaction amount as capital contribution or distribution
• Accrue and recognize interest based on market rates even if stated rate differs
• Example: Parent company provides interest-free loan to subsidiary, recognize interest expense at market rate in subsidiary's books

Complex Transactions

• Assess long-term contracts for embedded leases or arrangements requiring separate accounting
• Example: Parent company leases equipment to subsidiary at below-market rate, may need to recognize implicit subsidy
• Consider substance of share-based payment transactions involving related parties
  • Example: Parent grants stock options to subsidiary employees, may require modification of standard accounting treatment