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Related party relationships and transactions with such parties are an integral part of day-to-day business for many groups. Users of financial statements are likely to be interested in the existence of these relationships and in transactions, along with their potential impact, between such parties when they assess the operations, financial performance and financial position of an entity.
The accounting definition of a related party under AS-18, which is a part of the present Indian GAAP, is not as far reaching in its scope as the international practice.
As part of convergence to IFRS, the Ind AS attempts to address the above and introduces certain additional disclosure requirements to enhance the quality of financial information to the users of financial statements.
In this article we shall consider some of the key differences in the identification of related parties for financial reporting purposes between Indian GAAP and Ind AS.
Definition of related party
AS-18 defines a related party as follows — ‘Parties are considered to be related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/ or operating decisions’. It clarifies that AS-18 applies only to related party relationships described in the standard, which are as under:
(a) enterprises that directly, or indirectly through one or more intermediaries, control, or are controlled by, or are under common control with, the reporting enterprise (this includes holding companies, subsidiaries and fellow subsidiaries);
(b) associates and joint ventures of the reporting enterprise and the investing party or venturer in respect of which the reporting enterprise is 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 significant influence over the enterprise, and relatives of any such individual;
(d) key management personnel and relatives of such personnel; and
(e) enterprises over which any person described in (c) or (d) is able to exercise significant influence. This includes 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.
Ind AS 24 states that a related party is a person or entity that is related to the entity that is preparing its financial statements referred to as the ‘reporting entity’.
(a) A person or a close member of that person’s family is related to a reporting entity if that person:
(i) has control or joint control over the reporting entity;
(ii) has significant influence over the reporting entity; or
(iii) is a member of the key management personnel of the reporting entity or of a parent of the reporting entity.
(b) An entity would be a related party if any of the following conditions apply:
(i) The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others).
(ii) One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member).
(iii) Both entities are joint ventures of the same third party.
(iv) One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
(v) The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a). (vii) A person identified in (a) (i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).
Related party relationships included and excluded
For the purpose of this section, we shall analyse these relationships from the perspective of Reporting Entity (RE), and reference to Parent, Associates and Joint Ventures of the reporting enterprise shall be denoted as P, A and J, respectively. Further, to highlight indirect relations within a group structure, for instance, Parent company’s investment in its Joint venture is referred to as P-J, where the ‘P’ denotes RE’s Parent Company and the ‘J’ that follows ‘P’ denotes to another Joint venture of the Parent Company.
Parent’s investment in Joint Venture (i.e., P-J) and associates (i.e., P-A)
Under the present Indian GAAP, parent’s investment in another subsidiary (i.e., P-S) is a related party, as that subsidiary is reporting entity’s fellow subsidiary. However, from the drafting of the relationships stated above, the parent’s investment in its joint venture (i.e., P-J) is not considered as related party under current Indian GAAP. Similarly, the parent’s investment in its associate (i.e., P-A) is also not considered as a related party to RE.
Under Ind AS, two entities are related if one entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member). Since the group is defined to include the parent company and each of entities under its direct and indirect control, the parent’s investment in its joint venture (i.e., P-J) is a related party to RE. Similarly, the parent’s investment in its associates (i.e., P-A) is also considered to be related party to RE.
Subsidiaries of joint ventures (i.e., J-S) and associates (i.e., A-S)
The present Indian GAAP does not specifically clarify whether a reference to the associates and joint ventures in AS-18 should be interpreted as those stand-alone entities or their entire group. As such, it is a common practice of not considering the subsidiaries of associates and joint ventures as related parties.
Under Ind AS, it is specifically stated that an associate includes subsidiaries of the associate and a joint venture includes subsidiaries of the joint venture. As such, for instance, an associate’s subsidiary (i.e., A-S) and the investor (i.e., RE) that has significant influence over the associate (A) are related to each other. Similarly, J-S is also considered to be a related party under Ind AS.
Key managerial personnel (KMP)
Under present Indian GAAP, a non-executive director of a company is not considered as a KMP by virtue of merely his being a director unless he has the authority and responsibility for planning, directing and controlling the activities of the reporting enterprise.
Under Ind AS, KMP are those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity.
Classification of investees as subsidiaries, joint ventures and associates
It may be noted that the reference to the terms subsidiaries, joint ventures and associates as stated above are required from the perspective of the Ind AS principles in assessing control, joint control and significant influence, considering the rights to participate in the financial and operating policies of the investee. As such, unlike present Indian GAAP, the percentage ownership of the investee’s capital may not be the determinative factor in assessing the relationship with the investee.
As such, the related party relationships may undergo a change not only on account of changes to the identified related party relationships in the standard, but also on account of change in classification of the investees based on the degree to which the company can influence the operations of the investee.
State-controlled enterprise/Government-related entities
The present Indian GAAP defines a state-controlled enterprise as an enterprise which is under the control of the Central Government and/or any State Government(s). Under the definition of state-controlled enterprises, those enterprises that are under joint control or under significant influence of the Central and/or State Government(s) are not considered as state-controlled enterprises. As such, the disclosure exemptions provided under AS-18 do not extend to such enterprises under joint control/ significant influence of the government.
Under Ind AS, a government-related entity is an entity that is controlled, jointly controlled or significantly influenced by a government. As such, disclosure exemptions provided under Ind AS 24 extend to enterprises under joint control/significant influence of the same government. Further, it follows that the differences stated above (such as subsidiaries of associates i.e., A-S) may additionally be considered for this purpose.
Disclosure requirements
Duties of confidentiality
Like the present Indian GAAP, the Ind AS states that the related party disclosure requirements as laid down under Ind AS 24 do not apply in circumstances where providing such disclosures would conflict with the reporting entity’s duties of confidentiality as specifically required in terms of a statute or by any regulator or similar competent authority.
However, this is a departure from the IFRS as issued by IASB (commonly referred to as a carve-out). As such, IFRS does not prescribe any such exemption from disclosure requirements prescribed under IAS 24 on account of duties of confidentiality as specifically required in terms of a statute or by any regulator or similar competent authority.
Compensation to KMP
Under the present Indian GAAP, the employee compensation provided to KMP is required to be disclosed. However, there is no specific requirement to disclose the breakup of such compensation.
Under Ind AS, the employee compensation to KMP is required to be disclosed, along with its breakup into short-term employee benefits, post-employment benefits, other long-term benefits, termination benefits and share-based payments.
Disclosure of terms and conditions of transaction
The present Indian GAAP requires disclosure of, amongst other things, name of related party, description of related party relationship and the description of the transaction.
Ind AS additionally requires disclosure of terms and conditions of the related party transactions, including whether they are secured, and the nature of the consideration to be provided in settlement; and details of any guarantees given or received.
Disclosure exemptions for government-related entities
As per AS-18, no disclosure is required in the financial statements of state-controlled enterprises as regards related party relationships with other state-controlled enterprises and transactions with such enterprises.
As per Ind AS 24, the reporting entity is exempt from the disclosure requirements in relation to related party transactions and outstanding balances, including commitments, with:
a) a government that has control, joint control or significant influence over the reporting entity; and
b) another entity that is a related party because the same government has control, joint control or significant influence over both the reporting entity and the other entity.
If a reporting entity applies the exemption as stated above, it shall disclose the following about the transactions and related outstanding balances:
a) the name of the government and the nature of its relationship with the reporting entity (i.e., control, joint control or significant influence);
b) the following information in sufficient detail to enable users of the entity’s financial statements to understand the effect of related party transactions on its financial statements:
i) the nature and amount of each individually significant transaction; and
ii) for other transactions that are collectively, but not individually, significant, a qualitative or quantitative indication of their extent.
Summary
One of the key GAAP differences between present Indian GAAP and Ind AS is that of indirect relationships, whereby Ind AS considers the all group entities of an entity (instead of that separate legal entity) to be related if that entity is related to the reporting entity. Accordingly, for instance, if an entity is related to a reporting entity in the capacity of an associate or joint venture, all entities controlled by such associates and joint ventures are considered as related parties under Ind AS. Similar is the case with the associates and joint ventures of the reporting entity’s parent company.
Overall, the implementation of Ind AS will require identifying the additional related party relationships covered within the scope of the standard. Further, the related party relationships need to be identified after appropriately classifying all the entities concerned as subsidiaries, associates and joint ventures, in accordance with Ind AS (that could be different from its classification under present Indian GAAP) from the perspective of the investor i.e., the reporting entity or its investee within its group or its associates/joint ventures as the case may be. It may particularly be difficult at times to assess the appropriate classification of the investees of an associate into subsidiary/ associates/joint venture, on account of associate company not reporting under Ind AS and limited access to the financial information of the associate.
While the Ind AS is not mandatory as yet, it is expected that preparers will want to evaluate their involvement with related parties under the new standard soon, as the changes in the group structure from an accounting perspective under Ind AS will have additional implications.
