When a company decides to do business with another company that is highly related in terms of ownership structure (for example, the CEO owns the shipping company) the shareholders should know – because of potential conflicts of interest that may occur. In the worst case scenario, the company may be paying too much for said shipping because the shipping company has an unfair advantage over the other competitors.
What is not included in FASB ASC 850?
Certain items are excluded from the standard. These items such as compensation arrangements for employees, expense allowances, or other similar items that may occur in the course of business are not required to be disclosed. Similarly, items which do not have or could not have a material impact are not required to be disclosed.
What are the criteria for recognition?
One should generally disclose all relationships, even if there is not an accounting entry made for it. This would include services which were done for free. The reasons for doing this are that it plays an important role for an investor to consider as it is a competitive advantage if the company is receiving, or a potential lost revenue the company is providing these for free.
What are some potential related parties?
Related parties can include investors, affiliates, management, and immediate family members of the owners or management.
What needs to be noted in the related party disclosure?
As the risk is that the transactions being undertaken with the related parties are not at market, or arms length, the disclosure should include the following:
- Nature of the relationship between the two parties
- Describe the transactions which took place and the financial effects for each of the periods presented
- Quantify the dollar effect of any changes in the terms which may have taken place as a result of changes in the terms of the prior year’s arrangement
- Dollars designated as Due To and Due From with each of the related parties, and terms of settlement
The overall objective of this disclosure is to provide more information to the users of the financial statements, including investors, banks, regulators, etc. when evaluating the performance of the business. It is important to note that related party relationships can be a large advantage to companies over the competition, and a source of greater than market returns.
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