The Concept of Significant Influence

Based on IAS 24 : Related Party Disclosures, entities are considered to be related parties when one of them either :

1. has the ability to control the other entity
2. can exercise significant influence over the other entity in making financial and operating decisions
3. has joint control over the other
4. is a joint venture in which the other entity is a joint venturer
5. functions as key management personnel of the other entity
6. is a close family member of any individual having the ability to control or influence the entity or is a key management member thereof

Significant Influence

The existence of the ability to exercise significant influence is an important concept in relation to this standard. It is one of the two criteria stipulated in the definition of a related party, which when present would, for the purposes of this standard, make one party related to another. In other words, for the purposes of this standard, if one party is considered to have the ability to exercise significant influence over another, then the two parties are considered to be related.

The existence of the ability to exercise significant influence may be evidenced in one or more of the following ways :

1. By representation on the board of directors of the other entity;
2. By participation in the policy-making process of the other entity;
3. By having material intercompany transactions between two entities;
4. By interchange of managerial personnel between two entities; or
5. By dependence on another entity for technical information

Significant influence may be gained through agreement, by statute, or by means of share ownership. Under the provisions of IAS 24, similar to the presumption of significant influence under IAS 28, an entity is deemed to possess the ability to exercise significant influence if it directly or indirectly through subsidiaries  holds 20% or more of the voting power of another entity (unless it can be clearly demonstrated that despite holding such voting power the investor does not have the ability to exercise significant influence over the investee).

Conversely, if an entity, directly or indirectly through subsidiaries, owns less than 20% of the voting power of another entity, it is presumed that the investor does not possess the ability to exercise significant influence (unless it can be clearly demonstrated that the investor does have such an ability despite holding less than 20% of the voting power).

Further, while explaining the concept of significant influence, IAS 28 also clarifies that “a substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence” (emphasis added).

Source of this article : WILEY – 2010 Interpretation and Application of International Financial Reporting Standards, by Barry J.Epstein and Eva K.Jermakowicz

Purpose of Related Party Disclosures

IAS 24 : Related Party Disclosures defines a related party as a person or entity that is related to the entity that is preparing its financial statements (reporting entity).

(a) A person or a close member of that person’s family is related to a reporting entity if that person :

1. has control or joint control over the reporting entity;
2. has significant influence over the reporting entity; or
3. is a member of the key management personnel of the reporting entity or of a parent of the reporting entity

(b) An entity is related to a reporting entity if any of the following conditions applies:

1. 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)
2. 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)
3. Both entities are joint ventures of the same third party
4. One entity is a joint venture of a third entity and the other entity is an associate of the third entity
5. 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
6. The entity is controlled or jointly controlled by a person identified in (a)
7. A person identified in (a)(1) 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 are a normal feature of commerce and business. For example, entities frequently carry on parts of their activities through subsidiaries, joint ventures and associates. In those circumstances, the entity has the ability to affect the financial and operating policies of the investee through the presence of control, joint control or significant influence.

A related party relationship could have an effect on the profit or loss and financial position of an entity. Related parties may enter into transactions that unrelated parties would not. For example, an entity that sells goods to its parent at cost might not sell on those terms to another customer. Also, transactions between related parties may not be made at the same amounts as between unrelated parties.

The profit or loss and financial position of an entity may be affected by a related party relationship even if related party transactions do not occur. The mere existence of the relationship may be sufficient to affect the transactions of the entity with other parties. For example, a subsidiary may terminate relations with a trading partner on acquisition by the parent of a fellow subsidiary engaged in the same activity as the former trading partner. Alternatively, one party may refrain from acting because of the significant influence of another – for example, a subsidiary may be instructed by its parent not to engage in research and development.

For these reasons, knowledge of an entity’s transactions, outstanding balances, including commitments, and relationships with related parties may affect assessments of its operations by users of financial statements, including assessments of the risks and opportunities facing the entity (Hrd).

The revised version of IAS 24 Related Party Disclosures

The International Accounting Standards Board (IASB) issued today (4 November 2009) a revised version of IAS 24 Related Party Disclosures that simplifies the disclosure requirements for government-related entities and clarifies the definition of a related party. The revised standard is effective for annual periods beginning on or after 1 January 2011, with earlier application permitted.

IAS 24 requires entities to disclose in their financial statements information about transactions with related parties. In broad terms, two parties are related to each other if one party controls, or significantly influences, the other party.

The IASB has revised IAS 24 in response to concerns that the previous disclosure requirements and the definition of a ‘related party’ were too complex and difficult to apply in practice, especially in environments where government control is pervasive. The revised standard addresses these concern by :

(1) Providing a partial exemption for government-related entities. Until now, if a government controlled, or significantly influenced, an entity, the entity was required to disclose information about all transactions with other entities controlled, or significantly influenced by the same government. The revised standard still requires disclosures that are important to users of financial statements but eliminates requirements to disclose information that is costly to gather and of less value to users. It achieves this balance by requiring disclosure about these transactions only if they are individually or collectively significant.

(2)  Providing a revised definition of a related party. The IASB has simplified the definition and removed inconsistencies.

The softcopy of IAS 24 Related Party Disclosures is available to download for eIFRS subscribes from today.

Click here for IASB Press Release.