Importance of disclosing related party transaction in financial statements

Related party relationship are common feature of commercial life. The objective of IAS 24 related party disclosures is to ensure that financial statements contain necessary disclosures to make users aware of the possibility that financial statements may have been affected by existence of related parties.

The following are importance of disclosing related party relationship and transaction in the financial statements:

  • Disclosure of related party is particularly important when the business is being sold. This is due to the fact that before being sold the business may be receiving customs, supplies or general help and advice from family or group companies which may be withdrawn once the company is sold.
  • Related party transaction are not illegal, nor are they necessarily a bad thing. However, shareholders and potential investors need to be informed of material related party transactions in order to make informed investment and stewardship decisions.
  • Investors invest in the business on assumption that, it aims to maximize its own profit and shareholder’s wealth. This means that all transactions of the business are being negotiated at arm’s length between willing and informed parties. This existence of related parties may encourage directors to make decisions for the benefits of another entity at an expense of their own shareholders. This can be done actively by selling goods and services cheaply to related parties, or buying goods and services at above market prices. It can also happen when directors chose not to compete with related party, or offer guarantee or collateral for other’s party loans.

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