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26.2 Related party scope and relevant guidance
Publication date: 28 Feb 2022
us Financial statement presentation guide
ASC 850 covers transactions and relationships with related parties. It applies to all reporting entities, including the separate financial statements of a subsidiary, as discussed in ASC 850-10-15-2. Identifying related party relationships and transactions requires a reporting entity to first determine whether a party meets the definition of a “related party.”
ASC 850-10-20
Related parties include:
- Affiliates of the entity
- Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity
- Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management
- Principal owners of the entity and members of their immediate families
- Management of the entity and members of their immediate families
- Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests
- Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests
Certain terms used in the definition of related parties are specifically defined by ASC 850.
Definitions from ASC 850-10-20
Affiliate: A party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with an entity.
Control: The possession, direct or indirect, of the power to direct or cause the direction of the management and policies of an entity through ownership, by contract, or otherwise.
Immediate family: Family members who might control or influence a principal owner or a member of management, or who might be controlled or influenced by a principal owner or a member of management, because of the family relationship.
Management: Persons who are responsible for achieving the objectives of the entity and who have the authority to establish policies and make decisions by which those objectives are to be pursued. Management normally includes members of the board of directors, the chief executive officer, chief operating officer, vice presidents in charge of principal business functions (such as sales, administration, or finance), and other persons who perform similar policy making functions. Persons without formal titles also may be members of management.
Principal owners: Owners of record or known beneficial owners of more than 10% of the voting interests of the entity.
Question FSP 26-1
Do any of the rules and regulations addressing related parties that have been issued by the SEC impact the ASC 850 definition of a related party?
PwC response
No. For purposes of the financial statements, S-X 1-02 refers to the definition of related parties in US GAAP. Other SEC rules (e.g., S-K 404) contain interpretations or definitions of certain terms that, while similar to those used in ASC 850, only apply to the term as used in those specific rules and, therefore, do not impact how a related party is defined in ASC 850.
The SEC believes that reporting entities should consider whether to disclose information about parties that fall outside the definition of a related party, but with whom a relationship exists that enables the parties to negotiate terms of material transactions that may not be available for other, more clearly independent, parties on an arm's-length basis. This could include, for example, doing business with former management. The SEC believes that reporting entities should disclose such circumstances when a user of the financial statements may not be able to understand the reporting entity's results of operations without a clear explanation of these arrangements and relationships.
Question FSP 26-2
If an individual is a member of the board of directors for both Entity A and Entity B, should Entity A and Entity B be considered related parties?
PwC response
Generally, Entity A and Entity B would not be considered related parties to one another based solely on the fact that they have a common board member. The board member would meet the definition of a related party of both Entity A and Entity B as board members are typically considered “management” as defined by ASC 850. However, the definition of a related party does not result in Entity A and Entity B being related parties simply because of a common director. We believe that a member of the board of directors of two separate reporting entities—taking into account both the rights conveyed to directors via their board seat as well as their fiduciary responsibilities to shareholders—would generally not have the ability to control or significantly influence the management or operating policies of either entity to an extent that one or both of the entities might be prevented from fully pursuing their own separate interests. However, additional analysis should be performed to determine if the entities meet any of the other aspects of the definition of a related party. For example, further consideration would generally be needed if the board member, through other relationships, rights, or interests, can control or significantly influence the management or operating policies of one or both entities.
Question FSP 26-3
Does ASC 850 specify who should be considered an immediate family member of a member of management or a principal owner?
PwC response
No. ASC 850-10-20 provides a broad definition of the term “immediate family,” but the definition is not prescriptive. Therefore, judgment should be applied in evaluating whether an immediate family member might control or influence a principal owner or a member of management or whether an immediate family member might be controlled or influenced by a principal owner or a member of management.
The SEC has defined the term “immediate family” in S-X 2-02 and 9-03 and S-K 404. Each of these definitions are more prescriptive than the ASC 850 definition. We believe that these definitions may influence a reporting entity’s process for identifying related parties; however, given that the definition in ASC 850 is not explicit and allows for judgment to be exercised, we do not necessarily believe that all individuals included in the SEC definitions are required to be designated as related parties of the reporting entity to comply with ASC 850. However, SEC registrants are required to utilize the relevant definitions of immediate family within Regulations S-X and S-K for all specific SEC reporting requirements, where applicable.
Question FSP 26-4
Does ASC 850 specify which individuals should be considered members of management?
PwC response
No. ASC 850-10-20 defines the term management; however, this definition is not prescriptive and allows for judgment to be exercised in determining which members within a reporting entity constitute members of management.
The following factors, which are not meant to be all inclusive, are helpful to consider when evaluating which individuals constitute management for purposes of applying ASC 850:
- The structure of the reporting entity
Similar to segment reporting, understanding the structure of the reporting entity is important to ensure the appropriate identification of those individuals who may constitute management. For instance, a reporting entity with a flat structure generally will have more individuals who are considered management compared to a reporting entity with multiple management layers. There are no bright lines with regard to the minimum or maximum position an individual needs to hold within a reporting entity to be considered management. Rather, identifying members of management is based on identifying those individuals who are responsible for achieving the objectives of the reporting entity and who have the authority to establish policies and make decisions by which those objectives are to be pursued.
- Management over principal owners
The management of principal owners should be considered, as well as any other relationships identified at a level above the reporting entity, such as parties that control or significantly influence the reporting entity. For example, individuals at a private equity fund level may participate in the policy making and key decisions of portfolio companies and should be considered as potential members of management at the portfolio company.
- The board of directors
Although members of the board of directors are typically independent from management, members of the board of directors would be considered management based on the definition in ASC 850.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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