Impairment in the interim period

Chapter 25 – Related Party Disclosures Page 353 Close members of family of an individual are family members who may be expected to influence, or be influenced by, that individual in their dealings with the entity. Examples of close family members include the individuals domestic partner and any dependants of the individual or of his or her partner. [IAS 24.9] Other relationships that are specifically identified as being a related party include a post- employment benefit plan for the benefit of the entity’s employees. [IAS 24.9] 4 Substance over Form In identifying a related party relationship, attention should be directed to the substance of the relationship rather than focusing on its legal form. For example, two entities that have a common director are not necessarily related parties, nor are two venturers purely because they share joint control over a joint venture. Significant volumes of business with a customer or supplier do not necessarily create a related party relationship with them. Illustration 1 Mint is an entity that complies with the minimum requirements of IAS 24. The following relationships have been identified: 1 Toffee is a separate entity in which one of Mint’s junior managers owns 10 of the share capital. This is not a related party. A junior manager is unlikely to be a member of ‘key management personnel’ in Mint and with only a 10 holding in Toffee is unlikely to have significant influence over it. 2 The daughter of a director of Mint. The daughter is a related party. The director is a related party as a member of ‘key management personnel’ and his or her daughter falls within the definition of close family members. 3 A director of Mint owns 60 of the share capital of another entity called Chocolate. Chocolate is a related party as it is under the control of a member of ‘key management personnel’. 4 Miss Butterscotch owns 25 of the share capital of Mint. Miss Butterscotch is probably a related party since a 25 shareholding is likely to provide her with the ability to exert significant influence. This will depend, however, on who owns the remaining 75 holding. 5 A director of Mint is also a director of Sugar which is independent of Mint but is not a shareholder in either entity. If the director is one amongst many on the board of Sugar and there are no others who are directors of Mint and Sugar, then it is unlikely that there is common control or influence. The act of merely being a director on both boards does not mean that the second entity is automatically a related party of the first entity. There is probably no related party relationship. 6 Cream is an entity owned by the niece of the finance director of Mint. The niece is not a sufficiently close relative of Mint’s finance director for Cream to constitute a related party. Chapter 25 – Related Party Disclosures Page 354 5 Related Party Transactions A related party transaction is defined as a transfer of resources, services or obligations between related parties, regardless of whether a price is charged. [IAS 24.9] In simple terms this covers any transaction between two related parties even if the transactions take place at a full arm’s length price, i.e. a market price. Contrast this with the common practice whereby employees receive goods or services at reduced prices or for free; if the employees fall within the definition of key management personnel, such transactions will be between related parties and the entity will need to disclose them. IAS 24 is based on the principle that it is the identification of the related party relationship that triggers the disclosure requirements. 6 Disclosures IAS 24 requires an entity to disclose the relationship between an entity and its parent andor subsidiaries. This relationship is seen as so important to users of the financial statements that disclosure is required irrespective of whether there have been any transactions between the group entities. [IAS 24.12] In addition, an entity is specifically required to disclose the name of its parent and, if different, the ultimate controlling party. If the financial statements of the parent or ultimate controlling party are not publicly available, the entity is required to identify the next most senior parent in the group that does have financial statements available to the general public. [IAS 24.12] An entity should also disclose in all circumstances the compensation, being the consideration in exchange for their services, received by key management personnel of the entity in total and for each of the following five categories: [IAS 24.16]  short-term employee benefits, for example salary and holiday pay;  post-employment benefits, for example pensions;  other long-term benefits, for example long-service awards or sabbatical leave;  termination benefits; and  share based payment transactions, for example shares and share options. A number of disclosures are required where related party transactions have taken place during the period. These disclosures are designed to provide users of the financial statements with relevant information about the transactions, so that the effect of them on the financial performance of the entity can be understood. Such disclosures should include the nature of the relationship, the amount of the transactions, the amount of any balance outstanding at the year-end and the terms and conditions attaching to any outstanding balance, for example whether security or guarantees have been provided and what form the payment will take. If an amount has been recognised in profit or loss for non-recoverability of an outstanding balance with a related party, this should be disclosed. [IAS 24.17] Transactions between related parties may be on an arm’s length basis. This does not however negate the requirement to disclose the transactions. These disclosures should be presented separately for different categories of related parties, although items of a similar nature may be disclosed in aggregate. Where aggregation would result in key information necessary to understand the effect of the transactions on the financial statements being unavailable, separate disclosure should be made. [IAS 24.22] Chapter 25 – Related Party Disclosures Page 355 The different categories for which separate disclosures are required are identified as: [IAS 24.18]  the parent;  entities with joint control, or significant influence, over the entity;  subsidiaries;  associates;  joint ventures in which the entity is a venturer;  key management personnel of the entity or its parent; and  other related parties. Although information is required about the nature of related parties there is no requirement to identify them specifically by name. Illustration 2 Pinot is an entity that complies with the minimum requirements of IAS 24. The disclosures that would be required by IAS 24 in the financial statements of Pinot, in respect of each of the following transactions are shown below. 1 Pinot sells goods on credit to Chablis, which is an entity owned by the son of one of the directors of Pinot. At the year end there was a receivable of CU100,000 owing from Chablis to Pinot. The CU100,000 was recognised in profit or loss as it was considered as being non-recoverable. Debt collection costs incurred by Pinot were CU4,000. The ownership of Chablis makes it a related party of Pinot. Disclosure is required of the nature of the relationship, any transactions during the period and the fact that the CU100,000 balance was considered to be non-recoverable and therefore recognised in profit or loss. There is no requirement to disclose the debt collection costs of CU4,000, or the names of Chablis, the director of Pinot or his or her son. 2 Pinot purchased goods from Merlot for CU600,000, which was deemed to be an arm’s length price. Pinot owns 40 of the ordinary share capital of Merlot. Merlot is almost certainly a related party of Pinot, as a result of Pinot’s significant influence through the 40 shareholding. Despite being at an arm’s length price, the value of the transaction should be disclosed aggregated with similar transactions during the year if appropriate. Disclosure by Pinot that the related party transactions were made on terms equivalent to market price transactions should only be made if such terms can be substantiated. The nature of the relationship, but no names are required to be disclosed. 3 An amount of CU90,000 is due to one of Pinot’s distributors, Shiraz. A distributor is not a related party, so no disclosure is required. 4 A house owned by Pinot, with a carrying amount of CU200,000 and a market value of CU450,000, was sold to one of its directors for CU425,000. Pinot guaranteed the loan taken out by the director to purchase the property. Chapter 25 – Related Party Disclosures Page 356 The nature of the relationship, details of the amount and nature of the transaction should be disclosed, along with the fact that Pinot is guaranteeing the loan of a related party. If payment is outstanding at the year-end, then the amount should be disclosed, although the director does not need to be named. 7 Proposed Amendment to the Standard In September 2007 an Exposure Draft of a revised IAS 24 was published. The final standard is due for publication in the first half of 2008. The revised standard contains some limited amendments and is not a fundamental change in approach. The amendments cover three main areas:  providing an exemption from the main disclosure requirements of IAS 24 for entities that are related simply because of control or significant influence by the same state, i.e. national, regional or local government;  amending the definition of a related party to remove some inconsistencies that previously existed. The amended definition provides clear guidance in relation to associates; for example it confirms that an associate and a subsidiary of an entity are related parties of each other for the purpose of their individual financial statements; and  amending the definition of a related party transaction to clarify the intended meaning. This amendment confirms that transactions between two parties, A and B, which are related parties of the reporting entity, C, are not required to be disclosed. Instead disclosures are required of transactions between C and either, or both, of A and B. 8 Chapter Review This chapter has covered:  the scope and objectives of IAS 24 on related party disclosures;  the important terminology and concepts which relate to the identification of related party relationships and related party transactions; and  the key requirements concerning related party disclosures in financial statements. Chapter 25 – Related Party Disclosures Page 357 9 Self Test Questions Chapter 25 1. According to IAS24 Related party disclosures, which TWO of the following fall within the definition of an entitys related party? A Another entity in which the entity owns 5 of the voting rights B A post-employment benefit plan for the benefit of the employees of the entitys parent C An executive director of the entity D The partner of a key manager in a major supplier to the entity 2. Are the following statements in relation to compensation true or false, according to IAS24 Related party disclosures? 1 Compensation includes social security contributions paid by the entity. 2 Compensation includes post-employment benefits paid on behalf of a parent of the entity in respect of the entity. Statement 1Statement 2 A False False B False True C True False D True True 3. Are the following statements in relation to related parties true or false, according to IAS24 Related party disclosures? 1 A party is related to another entity that it is jointly controlled by. 2 A party is related to another entity that it controls. Statement 1 Statement 2 A False False B False True C True False D True True Chapter 25 – Related Party Disclosures Page 358 4. The Sulafat Company has a 70 subsidiary Harbinger and is a venturer in Thabit, a joint venture company. During the financial year to 31 December 20X7, Sulafat sold goods to both companies. Consolidated financial statements are prepared combining the financial statements of Sulafat and Harbinger. Under IAS24 Related party disclosures, in the separate financial statements of Sulafat for 20X7, disclosure is required of transactions with A neither Harbinger nor Thabit B Harbinger only C Thabit only D both Harbinger and Thabit 5. The Druckman Company completed the following transactions in the year to 31 December 20X7: 1 Sold a car for CU9,250 to the uncle of Druckmans finance director. 2 Sold goods to the value of CU12,400 to Quokka, a company owned by the daughter of Druckmans managing director. Quokka has no other connection with Druckman. Which transactions, if any, require disclosure in the financial statements of Druckman under IAS24 Related party disclosures? A Neither transaction B Transaction 1 only C Transaction 2 only D Both transactions 6. The Stead Company has a wholly-owned subsidiary, Guanaco. During the year to 30 June 20X7, Stead sold goods to Guanaco totalling CU250,000. Guanaco paid CU135,000 of this debt before the year end and then encountered financial difficulties. Guanaco is not expected to be able to pay the remainder of the balance and therefore it has been provided against as uncollectible. Administration costs incurred as a result of Steads credit controllers chasing the debt by have been calculated as CU600. Under the minimum disclosure requirements of IAS24 Related party disclosures, which TWO of the following are required to be disclosed in relation to this arrangement? A The costs of the credit control department incurred in pursuing the debt B Details of any guarantees received in relation to the outstanding balance C The provision in relation to the debt being uncollectible D Future plans regarding trading arrangements with this subsidiary Chapter 25 – Related Party Disclosures Page 359 7. Eleanor is a director of The Tartarus Company. She also owns 65 of The Grison Company and is a director of, but not a shareholder in, The Flounder Company. Eleanors husband is the sole shareholder in The Koala Company. Eleanors daughter holds 5 of the shares in The Bluegill Company. The only involvement she has in the company is to receive dividends. Which TWO companies would be classified under IAS24 Related party disclosures as related parties of Tartarus? A Koala B Grison C Bluegill D Flounder 8. The Atrato Company carried out the following four transactions during the year ended 31 March 20X8. Which TWO of the four are related party transactions according to IAS24 Related Party Transactions? A Transferred goods from inventory to a shareholder owning 40 of the companys ordinary shares B Sold a company car to the wife of the managing director C Sold an asset to The Little Company, a sales agent D Took out a CU1 million bank loan 9. According to IAS24 Related party disclosures, which ONE of the following is not a related party of The Parnaby Company? A A shareholder of The Parnaby Company owning 30 of the ordinary share capital B An entity providing banking facilities to The Parnaby Company C An associate of The Parnaby Company D Key management personnel of The Parnaby Company Chapter 26 – Construction Page 361 Chapter 26 CONSTRUCTION 1 Business Context Construction contracts are common in certain industries, such as the building and aerospace industries where entities enter into contracts for the construction of a substantial asset that takes a considerable amount of time to complete. Such contracts may extend over several years. Few entities can afford to wait until the end of the contract before being paid by the customer. In practice, stage payments for work completed are agreed within the overall contract, and partial payment is received from the customer. Similarly, if profit was only recognised at the end of each contract, then reported profits in the financial statements would not represent the value of work achieved in an accounting period. It is therefore necessary to divide the overall contract over the total time it takes and to recognise an appropriate part of the contract costs, revenues and profit each period. 2 Chapter Objectives This chapter deals with the accounting and disclosure requirements in IAS 11 Construction contracts. On completion of this chapter you should be able to:  demonstrate a knowledge of the objectives and scope of IAS 11;  demonstrate a knowledge of the important terminology and definitions which relate to the valuation of construction contracts;  demonstrate an understanding of the key principles relating to the valuation of construction contracts and the allocation of contract costs and revenues to accounting periods; and  apply this knowledge and understanding in particular circumstances through basic calculations. 3 Objectives, Scope and Definitions of IAS 11 The objective of IAS 11 is to prescribe the accounting treatment of the revenues receivable and costs incurred in a construction contract. IAS 11 defines a construction contract as one specifically negotiated for the construction of an asset, for example a building, pipeline or ship, or a combination of assets that are closely related in terms of their design, technology and function or their ultimate purpose or use. Services that are directly related to the construction of an asset, for example project management, meet the definition of a construction contract, as does a contract for the demolition of an asset. [IAS 11.3] The dates on which a construction contract starts and ends usually fall in different accounting periods, so the principal concern is how to allocate revenue and costs to the different accounting periods to reflect the reality of the construction activity as it takes place.