IAS-24 Related party relationship

[Porus]

Hi All,

IAS-24 para 11 (b) basically states that two joint venturers, simply because they share joint control of a joint venture, are NOT related parties.

I guess the same would apply if they were two joint operators, jointly controlling a joint operation.

Is this statement in the standard to be taken at face value ? Is it logical ?
If one joint venturer / operator supplies goods or services to another joint venturer / operator, it is fairly likely that the transaction may not be at arms length. But the standard says NO, these are NOT related parties ? Doesn't para 11(b) defeat the very purpose of the standard ?

[Ketan Marwah]

Hi Porus,

The definition of a related party includes joint ventures but not joint operations. The list of related parties in IAS 24 is exhaustive and joint operations are not included in that list and are therefore outside its scope. The exclusion of JO's is not discussed in the standard but it is consistent with the principle that joint operations are viewed as part of the entity itself. It is also consistent with IFRS 12, Disclosure of Interests in Other Entities, which does not require summarized financial information for joint operations.

Additionally, under IFRS 11, Joint Arrangements, each of the transactions, assets and liabilities of a joint operation is attributable to one or other of the participants and each participant recognizes the amounts in its own financial statements. Since these transactions are viewed as the participant’s own transactions, a participant in a joint operation does not need to disclose transactions with the joint operation entity as related party transactions.

[Ketan Marwah]

& in determining whether a related party transaction exists, the substance of the relationship and not merely the legal form must be considered. The reason for these exclusions is that, without them, many entities that are not usually regarded as related parties could fall within the definition of related party. For example, a small clothing manufacturer selling 90% of its output to a single customer could be under the effective economic control of that customer. IAS 24 gives examples of situations where parties are not necessarily related. For example, entities may have a common member of key management or may be economically dependent upon each other but these situations do not necessarily mean that the entities are related unless there is some other connection. Similarly, two venturers are not necessarily related parties simply because they share joint control over a joint venture.

[Porus]

Thanks Ketan, I agree. The essence however, of the related party standard (IAS-24) is to disclose relationships and balances where arms length transactions are likely to be overriden ? I think some of the relationships that are scoped out by the standard should be scoped in ? But ofcourse, that is the for the standard setters to consider. Two joint operators doing business with each other (not within the joint operation) are likely to help each other out with below market rates for goods or services supplied by one to the other, and so should be considered as RPs ?

[Marek Muc]

Two joint operators doing business with each other (not within the joint operation) are likely to help each other out with below market rates for goods or services supplied by one to the other

This could be said about any two companies, even completely unrelated.

[Porus]

"Highly likely" to help each other out, more than two completely unrelated entities - is probably a more appropriate description of what I had in mind. Came across a case recently where one joint operator provided technical staff to their other joint operator for their in-house HR/Accts functions and did not charge them anything in return. That was the trigger for the query.

[Ketan Marwah]

Hi Porus,

I am trying to follow where you are coming from and maybe that's how someone would comprehend related parties at the beginning but that is a generic logic to use as the same logic would hold true for other exclusions specified in the same para such as a customer, supplier, franchisor, distributor or general agent with whom an entity transacts a significant volume of business, simply by virtue of the resulting economic dependence can also influence price.

I would recommend that you follow the standard setters intent in how have they defined related parties by referring IAS 24.BC18-20 for further clarity. The two parties need to be locked in a certain specific relationship which may be sufficient to affect the transactions of the entity with other parties. For example, a subsidiary may terminate relations with a trading partner on acquisition by the parent of a fellow subsidiary engaged in the same activity as the former trading partner. Alternatively, one party may refrain from acting because of the significant influence of another—for example, a subsidiary may be instructed by its parent not to engage in research and development.

Once you follow the genesis of how related parties are defined then price/arm length etc. are inconsequential as a related party transaction is a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.

Having said all the above, I admit it is a very theoretical standard but I can sympathize with the the standard setters as they had a tough task on hand to draw a line in the sand

[Marek Muc]

Great explanation, Ketan!
Interesting example Porus, thanks for sharing. Having known this particular relationship, do you think it's possible that such free-of-charge services will become significant?

[Porus]

Yes Marec, the entity receiving the service is smaller than the other joint operator, hence the value of such services is significant in the current year for the recipient.

And yes, its true Ketan, they have a tough job drawing the boundary lines, but transfer of resources free-of-charge in such cases, should be disclosed IMO. However, thankfully, I am not a standard-setter

[Marek Muc]

I'd argue that nothing in business is for free, so probably the smaller entity pays for these services in some indirect way

[Porus]

Most likely yes!

[Ketan Marwah]

but transfer of resources free-of-charge in such cases, should be disclosed IMO.

Hi Porus,

Your focus is on transaction price whereas I requested in my previous post to shift it to understanding relationships instead that in standard setters eye’s could be treated as related. Transaction price do not drive the basis of writing this standard.

Lastly, standards have to be consistent in there themes across other standards too therefore bear in mind that your “wish” could have a bearing on IFRS 12 too. I am not saying that that should deter you from concluding something but I am saying that consistency has to be maintained across standards. Just being tied in a legal relationship do not suffice the very theme of how related is defined. In your case the price might be influenced but in a lot of case that might not happen and guidelines cannot be set on too much generic basis. Tchao and best of luck!!

[Porus]

We don't have a smiley for thumbs up

[Marek Muc]

You can write 'thank you' instead

[Porus]

Already did