Sometimes relation between two or more enterprises effects the arm length price transactions between them. To know the effect of this relation on financial statement, one must know this relation. For this purpose ICAI issued AS-18 “Related Party Disclosure”. This is mandatory to all companies.
This Statement 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 consolidate financial statements presented by a holding company.
AS-18 deals with following related party transactions:
a. Enterprises that directly or indirectly by one or more intermediaries, control or are being controlled by reporting enterprise OR in under common control with reporting enterprise. (this includes holding companies, subsidiaries and fellow subsidiaries). i.e. X Ltd has 60% shares of Y Ltd. Y Ltd has 52% share of Z Ltd. Then X Ltd and Z Ltd are related. Because X Ltd controls Z Ltd through Y Ltd.
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. i.e. A Ltd has two associates, B Ltd and C Ltd. In this case B Ltd and C Ltd is not related. Because B Ltd is associated with A. But it doesn’t associated with C. So if B is reporting enterprise then only A is related. If C is reporting enterprise then only A is related. But if A is reporting enterprise then B and C is related.
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. The relatives of any such individual are also considered as related party. AS-18 defines Relative – in relation to an individual, means the spouse, son, daughter, brother, sister, father and mother who may be expected to influence, or be influenced by, that individual in his/her dealings with the reporting enterprise. i.e. Mr. M and Mrs. M has 45% shares in XYZ Ltd. So Mr. M and Mrs. M are related with enterprises. Father of Mr. M is also related with XYZ Ltd.
d. Key management personnel and relatives of such personnel. i.e. Managing Director or any director who has influence in policy making.
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. i.e. in example of C. Father of Mr. M has a partnership firm then it is related with XYZ Ltd. But if Mr. M has 2% share in ABC Ltd then ABC Ltd and XYZ Ltd is not related because Mr. M doesn’t has significant influence on ABC Ltd.
Following are not deemed to be related parties:
a. Two companies simply because they have a director in common, notwithstanding paragraph 3(d) or (e) above (unless the director is able to affect the policies of both companies in their mutual dealings);
b. 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; and
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):
i. providers of finance;
ii. trade unions;
iii. public utilities;
iv. Government departments and government agencies including government sponsored bodies.
An enterprise can control other by following methods:
1. Ownership of more than half voting rights.
2. Control over composition of board of director of other enterprise.
Having substantial interest in voting rights and the power to direct the policies of the enterprise. In this and word is used not OR. So both substantial interest in voting right and power to direct must be there.
How to say if someone has control over composition of the board of directors of a company.
If it has the power, without the consent or concurrence of any other person, to appoint or remove all or a majority of directors of that company. An enterprise is deemed to have the power to appoint a director if any of the following conditions is satisfied:
a. A person can not be appointed as director without the exercise in his favour by that enterprise of such a power as aforesaid; or
b. A person’s appointment as director follows necessarily from his appointment to a position held by him in that enterprise; or
c. The director is nominated by that enterprise; in case that enterprise is a company, the director is nominated by that company/subsidiary thereof.
If there is relationship due to control over enterprise then following must be disclosed whether or not there is transactions during the year:
i. Name of the related party.
ii. Nature of relationship.
If there is relationship due to significant influence then no disclosure if there is no transaction during the year.
But if there is transaction between parties during the year. Then following disclosures are mandatory:
a. The name of the transacting related party;
b. A description of the relationship between the parties;
c. A description of the nature of transactions;
d. Volume of the transactions either as an amount or as an appropriate proportion;
e. Any other elements of the related party transactions necessary for an understanding of the financial statements;
f. The amounts or appropriate proportions of outstanding items pertaining to related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and
g. Amounts written off or written back in the period in respect of debts due from or to related parties.
But if the disclosure requirement effect the duties of reporting enterprise such as confidentiality then AS-18 doesn’t apply on that till that extend. Like banks are strict in their customer’s transactions so if the disclosure of this effect that then bank will be exempt for that information.
In a consolidate financial statement, no need to disclose transactions between group. Because in consolidation it become one.