Related party transactions are common in businesses of all sizes, especially in corporate groups, family-owned companies, and organizations with shared ownership. These transactions involve the transfer of goods, services, assets, or financial resources between parties that have a close relationship. While such transactions are legal and often necessary for business operations, they require careful accounting and transparent reporting to ensure financial statements remain accurate and trustworthy.
What Are Related Party Transactions?
Related party transactions are business dealings between entities or individuals that have an existing relationship capable of influencing the terms of the transaction. Unlike transactions between independent parties, these arrangements may not always occur at normal market prices, making transparency and proper disclosure essential.
Accounting standards require businesses to identify and disclose these transactions because they can affect the reliability of financial statements. Investors, lenders, auditors, and regulators rely on these disclosures to understand whether financial information fairly represents the company’s financial position.
Examples of related party transactions include:
- Selling products to a subsidiary
- Purchasing inventory from a parent company
- Providing loans to directors
- Paying management fees to affiliated entities
- Leasing office space from a shareholder
- Sharing administrative services among group companies
Accurate accounting and reporting ensure these transactions are properly recorded and disclosed in financial statements.
Who Is Considered a Related Party?
A related party may be an individual or an organization that has control, significant influence, or joint control over another entity.
Common related parties include:
- Parent companies
- Subsidiaries
- Associate companies
- Joint ventures
- Directors
- Key management personnel
- Major shareholders
- Close family members of directors or owners
- Companies under common control
- Trusts or entities controlled by key individuals
Businesses should maintain an updated register of related parties to simplify year-end reporting and audit procedures.
Common Types of Related Party Transactions
Related party transactions vary depending on the structure and operations of a business. Some occur regularly, while others happen only during major business decisions or restructuring.
Common examples include:
- Sale of goods – One group company sells products to another related company.
- Purchase of inventory – A subsidiary purchases inventory from its parent company.
- Related party loans – Funds are borrowed or lent between related entities with agreed repayment terms.
- Interest-free loans – Financial assistance is provided without charging interest.
- Asset transfers – Equipment, vehicles, intellectual property, or investments are transferred between related entities.
- Property rentals – Office buildings or warehouses are leased between related businesses.
- Service agreements – Administrative, IT, legal, or consulting services are shared within a corporate group.
- Management fees – Parent companies charge subsidiaries for strategic management or support services.
- Royalty payments – Payments are made for trademarks, patents, or intellectual property owned by a related company.
- Shared expenses – Companies allocate common operating costs across related entities.
- Financial guarantees – One company guarantees the loans or obligations of another related entity.
- Employee benefit arrangements – Pension or employee benefit costs are shared within a business group.
- Intercompany financing – Companies provide working capital or long-term funding to related businesses.
- Dividend transactions – Dividend payments are made between parent companies and subsidiaries.
Each transaction should be supported with appropriate documentation, approved according to company policies, and recorded accurately in the accounting system.
Why Proper Accounting for Related Party Transactions Is Important
Accurate accounting for related party transactions goes beyond meeting accounting standards. It improves financial transparency, strengthens governance, and supports informed decision-making.
Improves Financial Reporting Accuracy
Proper recording ensures financial statements present a true and fair view of business performance. Every transaction should reflect its economic substance and include sufficient supporting evidence.
Builds Investor and Lender Confidence
Investors and lenders expect complete disclosure of relationships that may influence financial results. Transparent reporting reduces uncertainty and improves credibility.
Supports Corporate Governance
Clear accounting procedures help directors demonstrate accountability and responsible financial management. Proper governance reduces conflicts of interest and promotes ethical business practices.
Prevents Fraud and Financial Misstatement
Undisclosed related party transactions can conceal fraud, manipulate profits, or hide financial obligations. Strong accounting controls reduce these risks.
Simplifies External Audits
Auditors review related party transactions carefully because they carry a higher risk of material misstatement. Well-maintained accounting records speed up the audit process and reduce follow-up queries.
Ensures Regulatory Compliance
Accounting standards require businesses to disclose material related party transactions. Non-compliance may lead to qualified audit opinions, regulatory investigations, or financial penalties.
Supports Better Business Decisions
Reliable financial information enables management to evaluate business performance, allocate resources effectively, and identify areas requiring improvement.
Accounting Treatment of Related Party Transactions
Businesses should account for related party transactions using the same disciplined approach applied to any other financial transaction while complying with applicable accounting standards. Proper accounting requires accurate recognition, measurement, classification, and documentation. Every related party transaction should be supported by written agreements, invoices, contracts, payment records, and management approvals. These records help demonstrate that the transaction is genuine and properly authorized.
Initial Recognition
Record the transaction when it occurs and when it meets the recognition criteria under the applicable accounting framework.
Examples include:
- Sale of goods when control transfers to the buyer.
- Service income when services are provided.
- Loan receivables when funds are advanced.
- Rental expenses when the lease period begins.
Measurement of Transactions
Businesses should measure transactions based on the agreed terms while considering whether pricing reflects market conditions.
Key considerations include:
- Transaction value
- Fair value, where required
- Contract terms
- Applicable accounting standards
- Supporting documentation
When pricing differs significantly from market value, additional disclosures may be necessary to explain the nature of the transaction.
Recording Transactions
Each transaction should be classified correctly in the accounting records.
For example:
- Revenue from related party sales
- Cost of goods purchased from related entities
- Loan receivables or loan payables
- Rental income or rental expense
- Management fee income or expense
Proper classification improves the accuracy of financial statements and simplifies reporting.
Importance of Supporting Documentation
Supporting documents provide evidence that transactions actually occurred and were properly approved.
Essential documentation includes:
- Signed agreements
- Purchase orders
- Sales invoices
- Loan contracts
- Payment receipts
- Bank transfer confirmations
- Board resolutions
- Management approvals
Maintaining complete documentation reduces audit risks and supports compliance with accounting standards.
Fair Value vs. Transaction Value
Not every related party transaction occurs at market price. Some transactions are intentionally structured at discounted rates or involve interest-free financing.
Businesses should clearly distinguish between:
| Fair Value | Transaction Value |
|---|---|
| Reflects the market price between independent parties. | Represents the amount agreed between related parties. |
| Often used for financial reporting purposes where required by standards. | Used to record the actual contractual amount. |
| Helps users assess whether pricing differs from market conditions. | Reflects the legal agreement between the parties. |
Clear disclosure helps users of financial statements understand the financial impact of non-market terms.
Understanding the Arm’s Length Principle
The arm’s length principle means related party transactions should, where appropriate, be conducted under terms similar to those agreed between independent businesses.
Applying this principle helps businesses:
- Improve transparency
- Reduce tax risks
- Support fair pricing
- Strengthen financial reporting
- Simplify regulatory reviews
- Enhance audit confidence
Even when transactions are not conducted at arm’s length, businesses should maintain complete documentation explaining the commercial reasons and disclose the arrangement where required.
IAS 24 Related Party Disclosure Requirements
IAS 24 Related Party Disclosures is the primary accounting standard that governs the disclosure of related party relationships and transactions. Its objective is to ensure that an entity’s financial statements contain the information necessary for users to understand whether the company’s financial position and performance may have been affected by related party relationships. The standard does not prohibit related party transactions. Instead, it requires businesses to disclose material information so investors, lenders, regulators, and other stakeholders can make informed decisions.
Proper compliance with IAS 24 improves financial transparency, reduces reporting risks, and supports high-quality financial reporting.
Objectives of IAS 24
IAS 24 aims to:
- Increase transparency in financial reporting.
- Highlight relationships that may influence business decisions.
- Ensure material related party transactions are disclosed.
- Improve comparability between financial statements.
- Help investors evaluate potential conflicts of interest.
- Strengthen confidence in financial reporting.
Information That Must Be Disclosed
Businesses should disclose sufficient information for users to understand the nature and financial impact of related party transactions.
Required disclosures generally include:
- Nature of the related party relationship
- Name of the related party, where appropriate
- Types of transactions completed
- Transaction values during the reporting period
- Outstanding receivables and payables
- Loan balances
- Terms and repayment conditions
- Interest rates, if applicable
- Guarantees provided or received
- Commitments with related parties
- Allowance for doubtful debts
- Bad debt expenses related to outstanding balances
- Compensation paid to key management personnel
These disclosures are normally included within the notes to the financial statements.
Key Management Personnel Compensation
IAS 24 also requires disclosure of compensation paid to key management personnel.
Typical categories include:
- Short-term employee benefits
- Post-employment benefits
- Other long-term benefits
- Termination benefits
- Share-based payments
Providing this information improves corporate transparency and strengthens governance.
IFRS Requirements for Related Party Reporting
Businesses preparing financial statements under International Financial Reporting Standards (IFRS) must ensure that related party transactions are accurately identified, recorded, and disclosed. IFRS emphasizes that users of financial statements should understand both the existence of related party relationships and the financial impact of transactions arising from those relationships.
Companies should establish internal procedures that identify related parties before year-end reporting begins. This approach reduces omissions and improves reporting accuracy.
Financial Statement Presentation
Related party disclosures are generally presented within the notes to the financial statements rather than in the primary financial statements.
Disclosures should clearly explain:
- The relationship between the parties
- The nature of the transaction
- Outstanding balances
- Settlement terms
- Pricing arrangements, if relevant
- Any guarantees or commitments
Information should remain clear, consistent, and easy to understand.
Materiality Considerations
Not every related party transaction requires extensive disclosure. Businesses should assess whether a transaction is material enough to influence the decisions of financial statement users.
Factors affecting materiality include:
- Transaction size
- Business significance
- Financial impact
- Frequency of transactions
- Nature of the relationship
Material transactions require more comprehensive disclosures.
IFRS vs Local Accounting Standards
| Area | IFRS | Local Accounting Standards |
|---|---|---|
| Related party identification | Comprehensive guidance | May vary by jurisdiction |
| Disclosure requirements | Detailed disclosures required | Often less detailed |
| Financial statement notes | Mandatory | Depends on local regulations |
| Materiality assessment | Principle-based | May include additional local rules |
| Audit expectations | High emphasis on documentation | Varies by country |
Businesses operating internationally should ensure compliance with both IFRS and local reporting requirements where applicable.
Related Party Transactions vs Arm’s Length Transactions
Understanding the difference between related party transactions and arm’s length transactions is essential for accurate accounting and regulatory compliance.
| Related Party Transactions | Arm’s Length Transactions |
|---|---|
| Occur between connected parties | Occur between independent parties |
| Relationship may influence pricing | Market competition determines pricing |
| Often require additional disclosures | Normally require no special disclosures |
| Higher audit risk | Lower audit risk |
| Greater regulatory attention | Standard business review |
| May require transfer pricing analysis | Generally no transfer pricing concerns |
Although related party transactions are common, businesses should maintain documentation demonstrating that pricing and commercial terms are reasonable whenever possible.
Internal Controls for Managing Related Party Transactions
Strong internal controls reduce reporting errors and help businesses comply with accounting standards. They also minimize fraud risks and improve the reliability of financial information.
An effective control framework should include the following practices:
- Maintain a related party register – Keep an updated list of directors, shareholders, subsidiaries, associates, and other related entities.
- Implement approval procedures – Require management or board approval before completing significant related party transactions.
- Use written agreements – Document all commercial terms, responsibilities, and payment conditions.
- Separate duties – Ensure no single employee controls authorization, recording, and payment processes.
- Maintain a complete audit trail – Preserve contracts, invoices, approvals, and supporting documents.
- Conduct periodic reviews – Review related party balances throughout the year instead of waiting until year-end.
- Monitor compliance – Verify that disclosures meet accounting standards and internal policies.
- Require conflict-of-interest declarations – Directors and key management should disclose potential conflicts promptly.
Strong controls improve financial reporting quality while reducing the likelihood of omissions and audit findings.
Common Accounting Mistakes Businesses Make
Many businesses experience audit issues because they overlook related party reporting requirements rather than intentionally ignoring them. Identifying common mistakes helps organizations strengthen compliance.
1. Missing Related Party Disclosures
Businesses sometimes disclose the transaction but fail to identify the relationship between the parties. This limits transparency and may result in non-compliance.
2. Incorrect Transaction Valuation
Recording transactions using inaccurate values or unsupported estimates can misstate financial statements and affect reported profits.
3. Poor Documentation
Missing contracts, invoices, approvals, or payment records make it difficult to support transactions during an audit.
4. Hidden or Undisclosed Transactions
Failure to report loans, guarantees, or service agreements with related parties creates significant audit and regulatory risks.
5. Lack of Board Approval
Major related party transactions should follow established governance procedures. Missing approvals may indicate weak internal controls.
6. Ignoring IAS 24 Requirements
Some businesses record transactions correctly but overlook disclosure requirements, resulting in incomplete financial statements.
7. Weak Internal Controls
Without formal policies, businesses may fail to identify related parties or consistently apply accounting procedures.
8. Incorrect Account Classification
Misclassifying loans, expenses, income, or receivables affects financial reporting accuracy and makes analysis more difficult.
9. Delayed Recording
Recording transactions long after they occur can create reporting inconsistencies and complicate period-end reconciliations.
10. Incomplete Audit Evidence
Auditors require sufficient evidence to verify related party transactions. Missing supporting documents often lead to additional audit procedures and reporting delays.
How These Mistakes Affect Businesses
These errors can lead to:
- Qualified audit opinions
- Regulatory investigations
- Financial statement restatements
- Reduced investor confidence
- Tax disputes
- Increased compliance costs
- Delays in completing external audits
Addressing these issues early helps businesses maintain accurate financial reporting and stronger corporate governance.
Related Party Transactions and External Audits
Related party transactions receive significant attention during external audits because they may present a higher risk of material misstatement or fraud. Auditors evaluate whether transactions have been properly identified, recorded, authorized, and disclosed in accordance with applicable accounting standards.
The audit process focuses not only on the transaction itself but also on the relationship between the parties and whether the transaction was conducted transparently.
Auditor Responsibilities
External auditors perform several procedures to assess related party transactions, including:
- Identifying related parties and significant relationships
- Reviewing board minutes and governance records
- Assessing internal controls over related party transactions
- Evaluating transaction pricing and commercial terms
- Testing accounting entries and supporting documentation
- Confirming outstanding balances where appropriate
- Reviewing financial statement disclosures
- Assessing fraud risks associated with related parties
These procedures help auditors determine whether the financial statements present a true and fair view.
Documents Auditors Commonly Request
During an audit, businesses should be prepared to provide documentation such as:
- Related party register
- Shareholder records
- Organizational structure charts
- Board resolutions
- Signed agreements and contracts
- Loan agreements
- Sales and purchase invoices
- Payment vouchers
- Bank statements
- General ledger reports
- Trial balance
- Management approval records
- Rental agreements
- Service contracts
- Legal correspondence, where applicable
Maintaining organized documentation throughout the year simplifies the audit process, reduces delays, and demonstrates strong financial governance.
Best Practices for Accurate Related Party Reporting
Following consistent accounting procedures helps businesses maintain compliance, improve financial transparency, and reduce audit risks. Implementing the following best practices strengthens financial reporting and supports effective corporate governance.
- Maintain an updated related party register – Regularly update records of directors, shareholders, subsidiaries, associates, joint ventures, and key management personnel.
- Use written agreements – Document every related party transaction with signed contracts that clearly define terms, pricing, and payment conditions.
- Review transactions throughout the year – Conduct quarterly reviews instead of waiting until year-end to identify and disclose related party transactions.
- Implement strong accounting controls – Use accounting software and approval workflows to reduce manual errors and improve recordkeeping.
- Perform internal audits – Periodically assess compliance with accounting policies and disclosure requirements.
- Train finance teams – Ensure accounting staff understand IAS 24, IFRS requirements, and company reporting procedures.
- Retain complete supporting documents – Store invoices, contracts, approvals, and bank records in an organized manner.
- Monitor disclosure requirements – Review financial statement notes before finalization to ensure all required information is included.
- Consult accounting professionals when needed – Complex transactions should be evaluated by experienced accountants or auditors.
- Review related party balances before year-end – Reconcile receivables, payables, loans, and other balances to ensure reporting accuracy.
Adopting these practices improves financial reporting quality while reducing the likelihood of regulatory issues and audit adjustments.
Practical Example of a Related Party Transaction
Consider a manufacturing company that owns a wholly owned subsidiary responsible for distribution. During the financial year, the parent company provides a loan of AED 500,000 to the subsidiary to support working capital requirements. The accounting team records the loan as a receivable in the parent company’s books and as a payable in the subsidiary’s records. A formal loan agreement specifies the repayment schedule and interest terms.
At year-end, both companies disclose:
- The relationship between the entities
- The outstanding loan balance
- Any interest charged
- Repayment terms
- Outstanding receivable and payable balances
The external auditor reviews the loan agreement, bank transfers, board approvals, and accounting records to verify the transaction. Because the documentation is complete and disclosures comply with IAS 24, the audit proceeds efficiently without significant adjustments.
This example illustrates how proper documentation, accurate accounting, and transparent reporting contribute to reliable financial statements.
Why Choose Ripple Business Setup for Accounting and Financial Reporting?
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FAQ
What is a related party transaction?
A related party transaction is a business transaction between parties that have an existing relationship, such as a parent company and subsidiary, directors and the company, or businesses under common ownership. These transactions may involve goods, services, loans, assets, or financial obligations.
Why are related party disclosures important?
Related party disclosures improve transparency by helping investors, lenders, auditors, and regulators understand how related relationships may affect a company’s financial position and performance.
Which accounting standard governs related party reporting?
IAS 24 Related Party Disclosures is the primary accounting standard governing the identification and disclosure of related party relationships and transactions for businesses reporting under IFRS.
Are related party transactions illegal?
No. Related party transactions are common and legally permitted when conducted appropriately. However, they must be accurately recorded, supported by proper documentation, and disclosed in accordance with applicable accounting standards.
How do auditors verify related party transactions?
Auditors review agreements, invoices, board minutes, bank statements, ownership records, accounting entries, and supporting documentation. They also assess whether disclosures in the financial statements are complete and accurate.
What documents should businesses maintain?
Businesses should retain:
- Related party registers
- Contracts and agreements
- Board resolutions
- Loan documents
- Sales and purchase invoices
- Payment records
- Bank statements
- Accounting ledgers
- Approval records
- Financial statement disclosures
Maintaining organized records simplifies audits and supports compliance.
What happens if related party transactions are not disclosed?
Failure to disclose material related party transactions may lead to qualified audit opinions, regulatory penalties, financial statement restatements, reputational damage, and reduced stakeholder confidence.
How often should related party transactions be reviewed?
Businesses should review related party transactions throughout the year, ideally on a quarterly basis, and perform a comprehensive review before preparing annual financial statements.
Final Thoughts
Related party transactions are a normal part of business operations, particularly for corporate groups and companies with shared ownership. However, they require careful accounting, comprehensive documentation, and transparent reporting to ensure financial statements remain accurate and reliable. By following IAS 24 disclosure requirements, maintaining strong internal controls, keeping complete supporting records, and conducting regular reviews, businesses can improve financial transparency, strengthen corporate governance, and reduce audit and compliance risks.
Disclaimer: This article is intended for general informational purposes only and should not be considered accounting, tax, legal, or financial advice. Businesses should consult qualified accounting or financial professionals regarding their specific reporting and compliance requirements.
