Accounting Standards
Related-party transactions
occur in numerous areas, such as sales and purchases, loans, investments,
financial guarantees, cost sharing arrangements, share-based payments, etc.
When a related-party transaction takes place at arm’s length, the accounting is
the same as for a non-related party. However, the challenge arises in
situations where the related-party transactions are not at arm’s length. Under
Indian GAAP (IGAAP), AS-18 requires disclosure of related-party transactions.
However, either there is no guidance on the accounting of related-party
transactions or the IGAAP practice does not reflect the substance. This is one
of the fundamental difference between International Financial Reporting
Standards (IFRS) and IGAAP. Let us consider some examples.
A parent company extends INR
1000 interest-free loan to a subsidiary, which is repaid after two years by the
subsidiary. The applicable interest rate for a similar loan is 10% p.a. The loan
will be recorded by the parent company at INR 826, which is the fair value (INR
1000 discounted by 10% for 2 years). The balance INR 174 represents an
investment by the parent in the subsidiary. In subsequent years, interest would
be imputed, and recognised as income by the parent company and as expense by the
subsidiary company.
|
|
|
INR
|
INR
|
|
|
In the books of the Parent Company
|
|
|
Year 0
|
Loan to Subsidiary Dr
|
826
|
|
|
|
Investment in Subsidiary Dr
|
174
|
|
|
|
Cash Cr
|
|
1000
|
Year 1
|
Loan to Subsidiary Dr
|
83
|
|
|
|
Interest Income Cr
|
|
83
|
Year 2
|
Loan to Subsidiary Dr
|
91
|
|
|
|
Interest Income Cr
|
|
91
|
|
|
Cash Dr
|
1000
|
|
|
|
Loan to Subsidiary Cr
|
|
1000
|
In the subsidiary, the
accounting would be exactly the reverse. Investment would be replaced by equity
contribution from the parent, and instead of interest income there would be
interest expense. At the consolidated level, the entries would cross out, and
there would be no impact.
Similar accounting may apply in the case of financial guarantees (a financially strong company in the group provides a financial guarantee to a bank for loans extended to another group member) or cost sharing arrangements or purchases and sales between related parties. In the case of group settled share-based payments, the company whose employees receive stock options will have to bear the charge in accordance with the requirements of IFRS 2. In IGAAP the accounting practice with regards to group settled share-based payments is quite disparate. In many cases, the practice is not to account for such arrangements under IGAAP.
Under IGAAP, the accounting for related-party transactions is developed by conjecture and practice than any robust standard/guidance. Whilst some of these issues will be addressed in IFRS, IGAAP will continue to apply for some companies. Therefore there is a need to make suitable amendments to IGAAP and to keep it dynamic.
