The term related party transactions is a term used to describe a transaction or arrangement between two parties connected by a prior commercial relationship, or a common interest. Businesses often look for business deals with those that they have a relationship with or share a common interests.
Although related-party transactions themselves are legal, they can result in conflicts of interests or create other legal circumstances. Companies that are public have to disclose the transactions.
The understanding of Related Party Transactions
It’s not uncommon for businesses to conduct business with individuals and companies with whom they have already established relationships. This kind of business venture is referred to as a related-party deal. The most frequent types of related parties include businesses that have affiliates as well as shareholder organizations, subsidiaries, and minority-owned businesses. Related-party transactions may comprise sales leasing and service contracts, as well as loan agreements.
As we’ve said the above, these kinds of transactions aren’t necessarily unlawful. However, they can muddy the business environment due to conflicts of interests since they favor close friends of the hiring company. For instance, a business may hire an important shareholder’s company to improve its office. In certain instances related-party transactions need to be approved by a management agreement or the corporate board of directors. They also restrict competition in the market.
The United States, securities regulatory agencies are responsible for ensuring that transactions between related parties are free of conflicts and don’t impact shareholders’ values or the company’s earnings negatively. For instance there is a requirement that the Securities and Exchange Commission (SEC) mandates that publicly traded companies report any transactions with related parties, such as associates, executives and family members, in the quarterly 10Q reports and annually filed 10K annual reports. 1 As so, many businesses have policies and procedures for compliance in place to outline the best way to document and execute related-party transactions.
Related-party transactions should be transparently reported to ensure that any actions are ethically and legally legal and don’t compromise the value of shareholders.
Special Takes into Account
It is the Financial Accounting Standards Board (FASB) The Financial Accounting Standards Board (FASB), which creates accounting guidelines for private and public corporations as well as non-profits across the United States, has accounting standards for related-party transactions. These standards include the monitoring of competitiveness in payments as well as payment terms, financial transactions as well as the authorization of expenditures. 2
While there are guidelines and rules for transactions between related parties however, they are difficult to verify. Managers and owners are responsible to disclose related parties as well as their interests However, if they choose to withhold information to gain personal advantage it is possible that the transactions be uncovered. The transactions of related parties could be recorded alongside similar transactions, which makes them difficult to discern. Undisclosed relationships and hidden transactions can result in improperly overinflated earnings and possibly the possibility of fraud.
A case study of Related Party Transactions
Enron is an U.S.-based firm that dealt in energy and commodities located in Houston. In the notorious incident of the company employed the use of related-party transactions through special-purpose companies to hide billions of dollars of loans from investment and business ventures that failed. The entities were manipulated by the related parties to deceive their board of directors the audit committee, their employees, as well as the public.
These fraudulent related-party transactions resulted in the company’s bankruptcy and the imprisonment of its top executives, the loss of pensions and savings for employees as well as shareholders, and the destruction and closing of Arthur Andersen, Enron’s auditor and auditor, who was indicted for federal crimes as well as SEC violation. 3
This financial catastrophe caused the development of the Sarbanes Oxley Act of 2002 that established new and expanded requirements in U.S. public companies, their boards of directors, and accounting public firms. It also includes specific rules to limit conflicts of interests arising out of related-party transactions.
What are Related Parties?
Related parties are parent companies subsidiary companies, associate companies joint ventures or any entity that is controlled or affected or managed by an individual who is a relative party.
What IFRS Regulation Covers Related Parties?
IFRS’ IAS 24 covers related parties. The purpose in IAS 24 is make sure that the financial statements of an entity contain the information necessary to alert the reader to the possibility that the financial position and profits or losses could be affected by the presence of related entities and the transactions and balances that remain and commitments with these parties. 4
Do the IRS Have to Be notified of Related transactions parties?
Yes. Yes. The Internal Revenue Service (IRS) scrutinizes related-party transactions for conflicts of interests. If they find conflicts there are conflicts, the IRS will not grant any tax benefits derived from the transaction. Particularly the case of related parties, the IRS frequently scrutinizes sales of property between related parties and tax-deductible payments among related parties.
