As 18 Related Party

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Amit Majmudar April , 2009

Accounting Standard 18 Related

Party Disclosures


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AS - 18 - Contents

Scope

Specified Related Party Transactions

Parties not to be treated as Related Parties

Definition of control, significant influence and Key managementpersonnel

Examples of Related Parties

Disclosure requirements

Provisions of Clause 49 Corporate Governance

Key Issues


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AS 18Scope:

- should be applied in reporting related party relationshipsand transactions between a reporting enterprise and itsrelated parties

- the requirements of this Statement apply to the financialstatements of each reporting enterprise as also toconsolidated financial statements presented by a holding

company


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AS 18 The statement deals only with specific related

party transactions as specified below:(a) enterprises that directly, or indirectly through one or moreintermediaries, control, or are controlled by, or are under commoncontrol with, the reporting enterprise (this includes holding companies,subsidiaries and fellow subsidiaries).

(b) associates and joint ventures of the reporting enterprise and theinvesting party or venturer in respect of which the reporting enterpriseis an associate or a joint venture.

(c) individuals owning, directly or indirectly, an interest in the voting

power of the reporting enterprise that gives them control or significantinfluence over the enterprise, and relatives of any such individual.


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AS 18

(d) Key management personnel (KMP) and relatives of such personnel

(e) enterprises over which any person described in (c) or (d) is able toexercise significant influence. This includes enterprises owned by

directors or major shareholders of the reporting enterprise andenterprises that have a member of key management in common withthe reporting enterprise


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AS 18The following are deemed not to be related parties:

- two companies simply because they have a director in common (unless thedirector is able to affect the policies of both companies in their mutual dealings)

- a single customer, supplier, franchiser, distributor, or general agent with whoman enterprise transacts a significant volume of business merely by virtue of theresulting economic dependence

- the parties listed below, in the course of their normal dealings with anenterprise by virtue only of those dealings (although they may circumscribe thefreedom of action of the enterprise or participate in its decision-makingprocess):

Providers of finance

Trade unions

Public utilities

Government departments and government agencies including governmentsponsored bodies


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AS 18

Control

Own more than voting power Control over composition of board

Substantial interest in voting power and power to direct financialand/or operating policies

Significant Influence (participation in the financial and/oroperating policy decisions of an enterprise, but not controlof those policies)

Representation on board

Participation in policy making

Material inter-company transactions

Sharing of managerial personnel

Dependence on technical information

Ownership of 20% or more


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AS 18

Key management personnel

Those persons who have the authority and responsibility for planning,

directing and controlling the activities of the reporting enterprise.


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Enterprises that directly, or indirectly through one or more

intermediaries, control, or are controlled by, or are under

common control with, the reporting enterprise (includes

holding companies, subsidiaries and fellow subsidiaries);

A Ltd60%

Reporting

Enterprise

40%

B Ltd 15%

A Ltd60%

Related Party

Reporting

Enterprise

40%

B Ltd 15%

AS 18


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AS 18

Related parties include associates and joint ventures

Reporting

Enterprise

Company S

Company H

Company F

60% 55%

Company SI

21%

Reporting

Enterprise

Company S

Company H

Company F

Related Party

Company SI

50%


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Associate joint ventures of the enterprise and investingparty or venturer in respect of whom the reporting entity

is an associate or joint venture

Company I

Reporting

enterprise

Company JVCompany A

Company CV

Company I 2

40%60%

60%40%

5% with an agreement

for management

JV

JV Associate

Company I

Reporting

enterprise

Company JVCompany A

Company CV

Company I 2

40%60%

60%40%

5% with an agreement

for management

Related Party

JV

JV Associate

AS 18


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Enterprises over which controlling individuals/relatives or

KMPs/relatives are able to exercise significant influence. Thisincludes 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

Individual

Reporting

enterprise

25%

Partnership

firm

1:1 PSR

and capital

MD of Reporting

Enterprise

Company S

Company D

MD of Company D

80%

Example 1 Example 2

Individual

Reporting

enterprise

25%

Partnership

firm

1:1 PSR

and capital

MD of Reporting

Enterprise

Company S

Company D

MD of Company D

80%

Related Party

AS 18


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AS 18

Disclosure requirements:

Where control exist: Name of the related party and nature of the related

party relationship should be disclosed irrespective of whether or not there

have been transactions between the related parties.

If there have been transactions between related parties, during the

existence of a related party relationship, the reporting enterprise should

disclose the following:

Name of transacting related party

Description of relationship

Nature of transaction

Volume of transactions

Other key elements

Outstanding balances & provision for doubtful debts

Amounts written off or written back


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AS 18 Para 26 of AS 18:

Items of a similar nature may be disclosed in aggregate bytype of related party except when separate disclosure isnecessary for an understanding of the effects of relatedparty transactions on the financial statements of the

reporting enterprise.


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AS 18Provisions relating to Related Party Transactions in

Clause 49 of the listing agreement

CorporateGovernance

A statement in summary form of transactions with related parties in theordinary course of business shall be placed periodically before the auditcommittee.

Details of material individual transactions with related parties, which arenot in the normal course of business, shall be placed before the auditcommittee.

Details of material individual transactions with related parties or others,which are not on an arms length basis should be placed before the audit

committee, together with Managements justification for the same.


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AS 18 Key issuesASI 13

Paragraph 26 and 27 of AS 18 provides for disclosure of items of similar naturein aggregate by type of related party except when the separate disclosure isrequired for understanding the effects of the transaction.

However, this is not done in such a way as to obscure the importance ofsignificant transactions. Nor a material related party transaction with anindividual party is clubbed in an aggregated disclosure.

Issue: How the test of materiality should be applied.

Depending on the circumstances, either the nature or the size of the item

could be the determining factor. As regards size, ordinarily a related partytransaction, the amount of which is in excess of 10% of the total related partytransactions of the same type (such as purchase of goods), is consideredmaterial.


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AS 18 Key issuesASI 19 Interpretation of the term

intermediaries

The term intermediaries should be confined to mean

enterprises which are subsidiaries as defined in AS 21,Consolidated Financial Statements.


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AS 18 Key issuesASI 21 Non executive directors on the board

whether related parties

A non executive director should not be considered as keymanagement person unless he has a authority andresponsibility for planning, directing and controlling the

activities of the enterprise.

The requirements of AS 18 should not be applied in respectof non executive director even if he participates in the

financial and / or operating policy decisions unless he falls inany categories in para 3 of AS 18 (the specified relatedparty transactions).


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AS 18 key issuesIssue:

What are the connotations to "planning, directing and controlling the activities of

the reporting enterprise"? Whether it is at strategic, functional or micro level?

Resolution:

Since key management personnel needs to have all the three authorities andresponsibilities of planning, directing and controlling the activities, such personwill be at strategic levels (with functional responsibility) for the reason thatemployee at functional level will have the authority (& also responsibility) only to

execute, direct and control the activities as already decided at strategic level.

He will not be involved in planning stage per se. The planning of activities whichhe does is not planning as such but a functional plan to execute a broaderstrategic plan.

Further the directing and controlling of activities will be at much lower levels(micro or functional) and therefore such persons should not be deemed as keypersonnel for AS 18 purposes.


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AS -18 Key issuesFurther, AS 18 examples also talk about Managing Director, Whole TimeDirector, manager or any person according to whose instructions Board of

Directors is accustomed to act.

The employee at functional level will not have any powers per se to influence theBoard of Directors or their activities ( but may in a limited way influence themfrom time to time by presenting a proper case or path).


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AS 18 Key issuesIssue:

In case of Joint Ventures entered into by the Company with other parties, there iscontrolling interest of more than 20% (in most of the cases the interest is 50%).There is joint management in all such joint ventures. Under the definition ofControl, para (c) states a substantial interest in voting power and the power todirect, by statute or agreement, the financial and/or operating policies of theenterprise.

Whether as per this definition, the reporting enterprise will also be deemed toexercise control over the joint venture within the meaning of para 3 (a) of the AS,irrespective of the fact that it will still be a related party within the meaning of para3 (b) of the AS. In case it is deemed to exercise control, then as per para 21 ofthe AS, names of the related parties are to be given irrespective of whether ornot there are any transactions.


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AS 18 Key issuesResolution:

For purposes of consolidation, AS 21 defines control as:

(a) own more than 1/2 of voting power

(b) controls the composition of the board

For purposes of AS 18, related party transactions, control includes the above two

factors plus 'a substantial interest in voting power and the power to direct, bystatute or agreement, the financial and/or operating policies of the enterprise'.Therefore a related party may exercise control over another enterprise, which isnot subject to consolidation.

The relationship with the joint venture will fall under the definition of 'control',names of such related parties should be given irrespective of whether there isany transaction or not.


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AS 18 Key issuesIssue: The Company is a joint venture of X and Y (50:50). Z is the 100% holding company

of X. Are the following transactions required to be disclosed as related partytransactions?

(a) The Company pays 8% sales commission to Z for the sales promoted by them oncompany's behalf.

(b) The Company is required as per the agreement to pay license fee and salescommission to X which is not paid and a certificate of waiver has been received forthe year.

Resolution:

(a) X is a 50% Venturer and accordingly Z has the joint control over joint venture throughX. Joint control does not give the power to direct financial/operating policies to anyone Venturer as decisions are taken jointly. Therefore paragraph 3(a) of AS 18cannot be said to be applicable.

(b) Waiver of income/expense is a related party transaction. A transaction under AS 18is defined as ' a transfer of resources or obligations between related parties,regardless of whether or not price is charged'. Therefore waiver would be atransaction.


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The Company has transformed the application money paid to Y Ltd (which is a relatedparty) for Deep Discount Bond (DDB) in to security deposits for a property taken on leasefrom Y Ltd. Application money was given in the previous year. In the current year, the DDBallotment is cancelled and the refund money is transformed into security deposit. Whetherthe disclosure should be specifically made stating that amount in the form of application forDDB converted in to Security deposit during the year?

Resolution:

All related party transactions are required to be disclosed. Related party transactions areany transfer of resources or obligations between related parties regardless of whether ornot a price is charged.

AS 18 requires the disclosure for nature of the transaction. Accordingly, the transactionwith Y should be disclosed by way of giving the description. In the given example, thedescription should state that application money for DDB being converted into security

deposit. It will not be correct to show only outstanding amount as security deposit at theyear end, since the transaction of transforming refund money into security deposit hastaken place during the year, which needs to be disclosed.


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The Company has been provided with the technical information and formulationby Z Ltd. Z Ltd is the owner of the product brand which is manufactured andmarketed by the Company. The Company pays royalty to Z Ltd as per the licenseagreement and also the raw materials are imported from Z ltd. Whether thedisclosure of Z Ltd is required in the event they are considered to have asignificant influence?

Resolution:

Paragraph 13 of AS 18 states that significant influence may be exercised inseveral ways. One of the examples given in this paragraph is by way ofdependence on technical information. However, definition of related parties as

per paragraph 3 of AS 18, does not include as related parties the enterpriseswhich have significant influence over the reporting enterprise. It includes onlyindividuals having significant influence over the enterprise. In the present case, ZLtd, not being an individual, will not be covered by the related party definition.


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A listed Company , has made donations to a trust formed for charitable andsocial development purposes. The settler of the trust is the Managing Director ofthe Company. The three trustees are heads of the finance and certain businessdivisions of the Company. MD as the settler of the trust , has only initiated theformation of the trust as an one time action( like initial subscriber to thememorandum in case of companies). He has no role to play in the functioning

and activities of the trust which are driven by the trust deed and monitored by theboard of trustees. The trustees are not key management personnel of thecompany as they are only the business unit heads. Hence the trust does not fallinto the category of the enterprises directly or indirectly controlled by thereporting entity

Whether the donations made need to be disclosed as a related party

transactions?


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As 18 Key issuesResolution:

As per the definition of related party in para 3 (a) of AS 18, which includesindirect control, the enterprise is able to exercise significant influence on thetrust. If it was not the intention of the enterprise to control the trust, why would itnot appoint independent trustees. In many cases of the trusteeship the employeeholds expires with the termination of his employment itself. Even by virtue of thecorpus of the trust being funded by the enterprise, it would have control over thetrust. The trust would also be a related party based on definition in para 3 (e) ofAS 18 if the MD is able to exercise significant influence on the trust. In the

present case, one needs to see the function of the MD in the trust and whatpowers are given to him and whether he can influence the operations of the trust.Given that the divisional heads report to the MD, the MD would be in a position toinfluence the working of the trust though he may have been titled only as asettler.

The fact that the trust is a charitable trust should in no way influence judgementon AS 18. One needs to look at the trust deed and the minutes of the meeting toget more clarity. The bottom line is that if as an enterprise it can exercisesignificant influence or control over another enterprise, then it is a related party.The trust is a related party under AS 18.


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Under para 3(b) of the AS - 18, related party includes associates and jointventures of the reporting enterprise and the investing party or venturer in respectof which the reporting enterprise is an associate or a joint venture. Whether, asper this definition, the other parties in the Joint Ventures of the reportingenterprise will also be construed as related party. For example, reportingenterprise A has formed a joint venture C with another enterprise B. Whetherenterprise B will also be falling within the definition of related party for the

purpose of reporting enterprise A.

Resolution:

A co-venturer is not a related party, though a venturer and the joint venture arerelated parties. Between co-venturers there does not exist any significantinfluence or control. However co-venturers may be otherwise related, forexample if they otherwise exercise significant influence or control over eachother.


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Whether disclosure under AS 18 on Related Party Transactions require auditor'sopinion on the measurement of such transactions?

Resolution:AS 18 does not deal with measurement issues. But that does not exemptauditors from looking at related party pricing. After all auditors give the opinionthat the accounts are true and fair, and it would be difficult for auditors to escapefrom this responsibility should something major go wrong. Auditors also reportspecifically on these issues in the CARO.


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The Company is a subsidiary of ABC International BV, a company incorporatedin the Netherlands, which holds 74 percent of the equity shares. The balance 26percent shares are held by ABC (Mauritius) Limited, a company incorporated inMauritius. All of these companies are part of the ABC Group of France, which isa leading independent Company. The ABC Group is very closely held andprivately owned. The Company is principally engaged in marketing of finished

dosage forms, based on active pharmaceutical ingredients imported from XYZLaboratories ABC (XYZ), France and ABC Egypt Industries (AEI), Egypt; boththese companies are also part of the ABC Group.

During the current year, the companys turnover has exceeded Rs 50 crores, andconsequently certain accounting standards including AS 18 on Related PartyDisclosures have become applicable to the Company.


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AS 18 Key issuesIssue (continued)

Paragraph 21 of AS 18 requires the name of the related party and nature of the relatedparty relationship where control exists to be disclosed irrespective of whether or not therehave been transactions between the related parties.

The Company does not have information about the ownership of its holding company or theownership structure of other entities in the ABC Group. It is also not aware of the nature ofrelationship with other ABC Group entities with whom it enters into transactions.

The Company in its Transfer Pricing Report and Form 3 CEB for the year ended March 31,XXXX, has disclosed that the Ownership pattern of the associated enterprises asdisclosed under Attachment 1 are not available with the assessee.

Considering that the Company is aware of only the identity of its immediate parent, thedisclosures relating to names of parties where control exists may not be complete.Further, considering that the Company is not aware of the exact nature of its relationship

with other group entities, it may not be appropriate to describe these relationships as thatoffellow subsidiaries


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As 18 Key issuesIssue (continued)

In view of the above facts, the following issues need to be resolved:

What disclosures are required to be made in the financial statements relating tothe above?

Would the auditors report require modification to bring out the possibility ofincomplete disclosures, arising from lack of information with the Company?

Resolution:

Any procedures that may have been performed by the company for identificationof related parties and transactions with them would be inadequate and notcomprehensive. To this extent auditors may have to give a limited disclaimer oncompliance with AS 18 as well as on the true and fair view. Such limiteddisclaimer will be based on materiality - but in the absence of any comprehensiveinformation, materiality of the undisclosed information cannot be assessed.

Further, in the absence of information the disclosure requirements as perSchedule VI also can not be met.

The auditor should give limited disclaimer in respect of Schedule VI and AS 18disclosers.


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What should we look for:

Completeness

Manner of disclosure

Shareholding, Investments, 301 Register, TP report,

JV agreements, Prior year work paper

Entitys procedures for identifying Related parties

AAS 23

Management representation

AS 18

As 18 Related Party

Documents

Transcript of As 18 Related Party