You are the auditor of Browning, Inc, a manufacturer of plastic products. In reviewing the balance sheet of the company, you notice several receivables from the officers of the company. You report your findings to the president of the company and inform
him that these receivables will be considered related party transactions for purposes of financial accounting and reporting. The president seems somewhat annoyed by your comments and asks you to explain what you mean by "related party" transactions and how the financial statements will be affected by these transactions. Prepare a brief response to the president's question.
Related party transactions occur when an enterprise engages in transactions in which one of the parties to the transaction has the ability to influence significantly the policies of the other, or in which one party to the transaction has the ability to influence the policies of the two transacting parties. The following are examples of related party transactions:
a . Transactions between a parent company and its subsidiaries.
b. Transactions between subsidiaries of a common parent.
c. Transactions between an enterprise and trusts for the benefit of employees (such trusts being controlled or managed by the enterprise).
d. Transactions between an enterprise and its principal owners, management, or members of immediate families and affiliates.
Transactions between related parties may be controlled entirely by one of the parties so that the transactions may be affected significantly by considerations other than those in arm's-length transactions with unrelated parties. Related party transactions frequently involve such things as borrowing or lending money at abnormally high or low interest rates, real estate sales at amounts that differ significantly from appraised values, exchanges of nonmonetary assets, and transactions with "shell" companies (enterprises having no economic substance).
Transactions with related parties are not conducted at arm's-length and thus their form may differ from their economic substance. In cases where the form of the transaction differs from the substance, auditors will require that the financial statements properly reflect the substance of the transaction. Auditors also will require that the financial statements include the following disclosures regarding related party transactions:
a . The nature of the relationship(s) involved.
b. A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed for each period for which an income statement is presented.
c. The dollar amounts of transactions for each of the periods for which income statements are presented.
d. Amounts due from or to related parties as of the date of each balance sheet presented.
The president may be reluctant to disclose the nature or amounts of related party transactions and may resist changes in accounting for related party transactions if the transactions have not been accounted for in accordance with applicable generally accepted accounting principles or do not reflect the substance of the transactions.
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