Related Party and Ownership Issues

Art Franczek

IAS # 22, 24, 27,28, 31

One of the most important issues a user of IAS financial statements is concerned about when determining whether or not to invest in a particular enterprise whether or not all relevant financial activity is included. This Module covers IASs that deal with accounting for and disclosures about different levels of inter-company relationships.
IAS 24, Related Party Disclosure, requires that a company's transactions with Related Parties must be disclosed in the financial statements. This IAS defines a Related Party as a situation if one party has the ability to control the other party or exercise significant influence over the other party in making financial and operating decisions. Some examples of organizations that are not deemed to be related parties are: providers of finance, trade unions, public utilities and others. If a related party relationship exists some transactions that may be influenced are purchases or sales of goods, rendering or receiving of services, management contracts and leasing arrangements. Simply put, if a related party relationship exists in these cases there is likelihood that these transactions will not be based upon arms length standards.
IAS 28, Accounting for Investments in Associates, describes the various kinds of Accounting that should be applied to investments in that are under 20% and those investments that are between 20% and 50% of the equity shares of a company. If an enterprise has an investment that represents less than 20% of another company the Cost method is used. The Investment is recorded at its cost and Dividends are recognized as Revenue when they are received. If the investment is between 20 and 50% the investing company is deemed to have significant influence in the invested. In this circumstance the Equity method is required. The Investment is recorded at cost but the income of the investee recognized by the investor the percentage of income based in the investee based on in percentage of ownership. Dividends received by the investor from the investee are not recognized as income but rather as a reduction to the Investment account.

Illustration of Equity Accounting:

Assume that on January 1, 1999 Company A purchases 30% of the stock of Company B (the book value of company B is $100,000) for $30,000. During 1999 Company B earns $300,000 and declares a dividend of $80,000. The following entries would be made on the Financial Statements of Company A :

In this illustration consolidated financial statements are not required because A owns only 30% of B and under IAS is required to use the Equity method of accounting.
IAS 27, Consolidated Financial Statements and Accounting for Investments in Subsidiaries, describes the rules for the preparation of Consolidated Financial Statements. Consolidated Financial Statements are required when a parent/subsidiary relationship exists. A parent is an enterprise that controls (ownership of over 50% the voting stock) of it's subsidiary. Consolidated Financial Statements essentially add together the financial statements of the Parent and Subsidiary and account for the elimination of interrelated accounts such as Investment for the Parent and common Stock for the Subsidiary. Consolidated Financial Statements also account for Minority Interest in cases where the parent owns less that 100% of the subsidiary.
IAS 22, Business Combinations, describes accounting treatment for both an aquisition of one enterprise by another and also the rare situation of uniting of interests when aquier can not be identified. In an acquisition the acquirer obtains control over the net assets and operations of another enterprise. A uniting of interests is a business combination in which shareholders of the combining enterprises combine control over the whole, or effectively the whole, of their net assets and operations to achieve a continuing mutual sharing in the risks and the benefits attaching to the combined entity.
IAS 31, Financial Reporting of Interests in Joint Ventures, reminds the reader that Joint Ventures are not a separate type of legal entity but can take several forms. For example it can be the result of a Contractual Agreement or a Jointly Controlled Entity. This standard describes how in a Jointly Controlled Entity that the Benchmark Treatment is Proportionate Consolidation meaning that they indicate in their financial statement assets and liabilities based on the percentage of ownership of each partner.
All of the IASs in this article are interrelated in that they describe how at different levels different disclosures and accounting are required. At the level of Related Party only a disclosure is required, while different accounting methods are required based on the percentage of ownership of the investor in the investee, if under 20% the Cost Method is used between 20 and 50% the Equity Method is used and over 50% Consolidated Financial Statements are required. All of the issues are of great importance in assisting the investor to determine the financial well being of an enterprise.

Art Franczek is a President of American Institute of Business and Economics in Moscow. He can be contacted by phone/fax (095) 373 6241, e-mail artf@online.ru.