From the IFRS Institute – June 4, 2021
Related party disclosures are a critical component of a company’s financial statements. They provide transparency on how its financial position and financial performance may be affected by transactions with related parties, which may or not be conducted on an arm’s length basis. Despite similar objectives, IAS 241 has incremental requirements to US GAAP2, such as the disclosure of key management compensation and transactions with government related entities. Here we summarize our selection of the Top 10 GAAP identification and disclosure differences.
What’s a related party?
IAS 24 requires companies to identify related party relationships and transactions. Determining who is a related party sometimes requires significant judgment. Related party relationships may result from direct or indirect control (including common control), joint control or significant influence. The definition of a related party is not limited only to entities within the same group. It may include individuals such as controlling investors and key management personnel, as well as their close family members, or even a post-employment benefit plan.
A company’s related party relationships and transactions can also take a variety of forms. These transactions may occur in the normal course of business, such as the purchase and sale of goods, cash pooling or central treasury functions, management services, and loans and guarantees. They may or may not be conducted on an arm's length basis.
What are the IAS 24 requirements?
IAS 24 has no special recognition or measurement requirements for related party transactions. However, it requires companies to disclose transactions and outstanding balances, including any commitments, with related parties. Only intragroup transactions eliminated in consolidation are exempt from disclosure in the consolidated financial statements.
The disclosures are both quantitative and qualitative, such as terms and conditions. The requirements apply regardless of whether the price is charged. A company should state that transactions are made on an arm’s length basis only if that statement can be substantiated.
Additionally, key management personnel compensation must be disclosed in total, and analyzed by component – i.e. short term, post-employment, other long-term and termination benefits, and share-based payments. The information is provided on a no-name basis (unless otherwise required by local regulation); however this disclosure often turns out to be highly sensitive, particularly for US private companies, because US GAAP does not require anything similar.
How is IAS 24 different from US GAAP and SEC Regulations?
While both US GAAP and IFRS Standards share similar objectives, certain differences exist in the identification and disclosure requirements. Certain measurement differences may also exist that may impair comparability – e.g. unlike under IFRS Standards, in a sale-leaseback between related parties, neither party makes an adjustment for off-market lease terms under US GAAP. Further, SEC regulations require certain additional disclosures in this area. Here we summarize our selection of Top 10 differences in identifying and disclosing related party transactions under IFRS Standards and US GAAP.
Identifying related parties
1. Entities not treated as related parties under IFRS can be in scope under US GAAP
Under IAS 24, companies are not related parties simply because both are under significant influence (i.e. associates) of the same third party or have a director or other member of key management in common. Under US GAAP, however, such relationships could result in the companies being related parties in certain circumstances.
Companies S and T are both held 20% by Company P – i.e. are associates of P. Here we assess the relationship between S and T.
The assessment under IFRS Standards is generally straightforward. The indirect relationship between S and T does not meet the definition of a related party relationship because there is no control or joint control between P and S or T. However, the substance of the relationship should be considered.
Under US GAAP, however, S and T could be related parties if (1) they transact with each other, and (2) either S or T (collectively, the transacting parties) controls or can significantly influence the management or operating policies of each other to the extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. That said, we believe that, like IFRS Standards, the significant influence that P has over S and T generally would not, in and of itself, be sufficient to make S and T related parties.
2. ‘Key management personnel’ vs ‘management’
IAS 24 does not list which individuals are considered key management personnel. Key management personnel are those persons who have authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly. This includes all directors (both executive and non-executive). This definition serves not only to identify related party relationships but also to establish the basis for the disclosure of key management compensation.
US GAAP uses the term ‘management’ instead of the term ‘key management personnel’ for identifying related parties. It specifies that management normally includes members of the board of directors, the chief executive officer, chief operating officer, vice presidents of principal business functions, and other persons who perform similar policymaking functions. Although the wording of US GAAP is more prescriptive than IFRS Standards, all of the individuals and entities identified under US GAAP are likely to be related parties under IFRS Standards.
Related party disclosure triggers and requirements
|Category||IFRS Standards||US GAAP|
|3. Management compensation||Mandatory. Disclose key management personnel compensation in total and analyzed by its components.||
Not mandatory. There is no such requirement under US GAAP.
However, SEC regulations require disclosure (outside the financial statements3) of the compensation of certain members of management and the board of directors.
|4. Control relationships||Mandatory. Disclose parent and subsidiary relationships regardless of whether there have been any transactions between the parties. Also disclose the name of the company’s parent and ultimate parent or next most senior parent (i.e. first parent in the group above the immediate parent that produces consolidated financial statements available for public use), if different.||Not mandatory. There is no such requirement under US GAAP.|
|5. Categorized disclosures for each group of related party||Mandatory. Comprehensive disclosures of related party transactions are required for each category of related party relationship. For example, sales to subsidiaries are not aggregated with sales to joint ventures.||Not mandatory. There are no category-based disclosure requirements under US GAAP.|
|6. Allowances for doubtful debts||Mandatory. Where there are transactions with related parties, disclose any allowance for doubtful debts and any amounts written off during the period.||Not mandatory. There is no such requirement under US GAAP.|
|7. Commitments to related parties||Mandatory. Disclose commitments to do something if a particular event occurs or does not occur in the future, including recognized and unrecognized executory contracts.||Not mandatory. There is no such requirement under US GAAP.|
|8. Transactions with government or government-related entity||Partial disclosure exemption. Companies may elect to apply a partial exemption to disclosures about transactions and outstanding balances, including commitments, with a government that has control, joint control or significant influence over the company or another entity under control, joint control or significant influence of the same government. Under this partial exemption, the company may disclose the name of the government and the nature of its relationship with the company, the nature and amount of individually significant transactions, and qualitative or quantitative information about other transactions.||No exemption. There is no similar partial disclosure exemption under US GAAP.4|
|9. Separate disclosure of related party amounts on the face of the financial statements||Not mandatory. While disclosure may be provided on the face of the financial statements, such disclosure is typically provided in the notes to the financial statements.||SEC disclosure requirements. While US GAAP does not require separate disclosure of related party transactions on the face of the financial statements, SEC Regulation S-X Rule 4-08k requires amounts of related party transactions to be stated separately on the face of the balance sheet, income statement and cash flow statement.|
|10. Tax disclosures for an entity that issues separate financial statements and is a member of a group that files a consolidated tax return||Not mandatory. There is no such requirement under IFRS Standards.||Mandatory. Disclose the aggregate current and deferred tax expense, tax-related balances due to or from affiliates, the method by which the expense is allocated, and the nature and effect of any changes in that method.|
While both IAS 24 and US GAAP have similar objectives to provide adequate disclosure of related party relationships, the differences in identifying and disclosing related party transactions may be significant.
These differences may also affect how companies view and report their transactions. Dual reporters should be mindful of the different requirements in their financial statements, especially the IAS 24 requirement to disclose key management personnel compensation.
- IAS 24, Related Party Disclosures
- ASC 850, Related Party Disclosures
- Items required outside the financial statements can include, but are not limited to, compensation to named executive officers and directors under Item 402 of SEC Regulation S-K, discussion and analysis of material factors underlying compensation policies and decisions under Compensation Discussion and Analysis (CD&A).
- Many US government-related entities prepare financial statements in accordance with US governmental accounting standards, rather than in accordance with US GAAP, where other disclosure requirements apply.