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26.5 Common related party transactions
Publication date: 28 Feb 2022
us Financial statement presentation guide
In order to comply with the related party disclosure requirements, a reporting entity must identify all of its transactions with related parties.
ASC 850 provides examples of common transactions with related parties.
Transactions between related parties commonly occur in the normal course of business. Examples of common transactions with related parties are:
- Sales, purchases, and transfers of real and personal property
- Services received or furnished, such as accounting, management, engineering, and legal services
- Use of property and equipment by lease or otherwise
- Borrowings, lendings, and guarantees
- Maintenance of compensating bank balances for the benefit of a related party
- Intra-entity billings based on allocations of common costs
- Filings of consolidated tax returns.
As noted in ASC 850-10-05-4, this is not an all-inclusive list. A reporting entity may identify additional related parties based on analysis of its individual circumstances. Once a related party transaction is identified, a reporting entity should determine the appropriate presentation and disclosure based on the requirements in ASC 850, SEC guidance (if applicable), and other relevant guidance, if any. Reporting entities should consider the substance of the related party transaction, which could be different than the legal form of the arrangement, when determining the appropriate presentation and disclosure.
The following sections discuss presentation and disclosure considerations for some common related party relationships.
26.5.1 Disclosure of related party equity method investments
Equity method investees are, by definition, related parties of the equity holder. A reporting entity could also hold investments in other related parties, including partnerships or joint ventures. In addition to the disclosures in FSP 26.4, refer to FSP 10 for information about disclosures for such investments. Application of the ASC 825-10-15 fair value option to an equity method investment does not generally reduce disclosure requirements.
Example FSP 26-1 illustrates the determination of whether transactions between a reporting entity's equity method investments should be disclosed in the reporting entity's financial statements.
EXAMPLE FSP 26-1
Transactions between equity method investees
Transactions between equity method investees
FSP Corp owns 20% of Investee A, a manufacturer, and 30% of Investee B, a retailer. Investee A and Investee B are unrelated entities. Investee A sells finished goods to Investee B in the ordinary course of business.
Should FSP Corp disclose the transactions between Investee A and Investee B as related party transactions in its consolidated financial statements?
Analysis
No. Investee A and Investee B are related parties to FSP Corp; however, Investee A and Investee B would not be considered related parties to one another as the relationship between these entities does not meet the definition of a related party in ASC 850-10-20. FSP Corp has an ownership interest in both entities and can significantly influence the management and operating policies of both entities; however, FSP Corp does not control either entity and, therefore, is unable to prevent one or both of the entities from fully pursuing its own separate interests. Accordingly, any transactions between Investee A and Investee B would not be reflected as related party transactions in FSP Corp’s consolidated financials.
26.5.2 Related party leasing arrangements
Use of a reporting entity's property and equipment by a related party, or use of a related party's property and equipment by the reporting entity, is often subject to the terms of a lease. In addition to the disclosures in FSP 26.4, a reporting entity with related party leases should include the required lease disclosures (see FSP 14).
26.5.3 Disclosure of related party debt
Related parties may also have borrowing and lending relationships. Common examples include lending relationships between parents and subsidiaries, among subsidiaries, between advisors and funds they advise, and between shareholders and the companies in which they invest, among others. A reporting entity should disclose the terms of related party lending relationships upon issuance and while the debt remains outstanding, consistent with the disclosures discussed in FSP 12.
As discussed in ASC 470-50-40-2, upon modification or extinguishment of related party debt, a reporting entity should consider whether the modification or extinguishment transaction is, in substance, a capital transaction. Refer to FG 3.3.5 for further discussion. If the reporting entity concludes that it is a capital transaction, it should provide the disclosures discussed in FSP 5.
If affiliates’ securities constitute a substantial portion of the collateral for any class of an SEC-registered (or to be registered) reporting entity’s securities, the reporting entity may need to include the affiliates’ separate financial statements in certain SEC filings, as required by S-X 3-16.
Question FSP 26-5
Are there disclosures that a reporting entity should consider with regard to related party debt arrangements that are incremental to the debt disclosures required by ASC 470?
PwC response
Yes. Because related party debt may not be issued in an arm’s-length transaction, a reporting entity should consider disclosure of certain information in addition to the lending terms required to be disclosed by ASC 470—for example, commitment fees or fees incurred to structure the debt. A reporting entity should also consider disclosing circumstances in which unused commitments for long-term financing arrangements may be withdrawn. For example, an investor may lend to an equity method investee but limit the capacity of the loan to the amount that it has available on its line of credit with a third-party lender.
Question FSP 26-6
Is a loan to a related party subject to an allowance for current expected credit losses (for an entity has adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments)?
PwC response
Maybe. The current expected credit losses model does not apply to loans and receivables between entities under common control. However, there is no scope exemption for loans and receivables from related parties that do not have a common controlling shareholder.
26.5.4 Related party guarantees
A reporting entity may make guarantees for the benefit of related parties. In those cases, the guarantor is required to comply with the related party disclosure requirements discussed in FSP 26.4, as well as the disclosures included in other applicable GAAP, including those applicable to guarantees (see FSP 23), equity method investments (see FSP 10), and variable interest entities (see FSP 18), as applicable.
Under US securities laws, a guarantee (whether registered or to be registered) of a security that is registered or to be registered is considered to be a security separate and apart from the security it guarantees. Reporting entities with these circumstances should consider the guidance in S-X 3-10 and FSP 12.
26.5.5 Equity held by related parties
Related party arrangements are common between a reporting entity and its shareholders. Securities held by related parties may be different classes of common or preferred equity, or have different rights such as liquidation preferences, voting rights, or dividend rights. These special terms may need to be disclosed as related party transactions.
The SEC requires certain disclosures when a reporting entity is restricted in its ability to transfer or dividend assets (cash or other assets) from its subsidiaries. SEC registrants should comply with the disclosure requirements in S-X 4-08(e).
26.5.6 Advances to and receivables from related parties
A reporting entity may enter into arrangements that result in advances to, or receivables from, shareholders that could have presentation or disclosure implications. Refer to FG 4.5 for further discussion.
Related party receivables from the sale of equity have specific presentation and disclosure requirements. Refer to FSP 5 for further discussion.
26.5.7 Related party business combinations
A business combination may include the settlement of a preexisting relationship such as between a vendor and customer, licensor and licensee, or plaintiff and defendant. If the counterparty in the preexisting relationship was a related party before the business combination, a reporting entity should consider appropriate disclosure in accordance with the principles underlying ASC 850. For disclosures related to business combinations, including those related to the settlement of a preexisting relationship, refer to FSP 17. If the business combination involves entities under common control, the measurement of the transaction may also be impacted. See further discussion in FSP 26.5.11.
26.5.8 Deconsolidation of a subsidiary
ASC 810 provides guidance for deconsolidation of a subsidiary that meets the definition of a business on a prospective basis as a result of an event. In the period that a subsidiary that meets the definition of a business is deconsolidated, it requires the reporting entity to disclose: (1) whether the transaction that resulted in the deconsolidation or derecognition was with a related party and (2) whether the former subsidiary or entity acquiring the assets will be a related party after deconsolidation. See FSP 18.7.2 for further discussion.
26.5.9 Compensation arrangements among related parties
Compensation arrangements among related parties can take many forms, including royalty arrangements or payments made or received for various services, such as accounting, management, engineering, marketing, and legal services. They can include payments of cash, other assets, or equity. These arrangements can result in compensation at levels that are not commensurate with market rates.
In addition to the disclosures described in FSP 26.4, SEC FRM 7220.1 also requires a reporting entity to provide quantified disclosure of significant related party compensation arrangements that resulted in below market compensation expense.
As noted in ASC 850-10-50-1, certain compensatory arrangements between related parties may occur in the ordinary course of business, such as compensation arrangements, expense allowances, and other similar items, and may not meet the requirement for disclosure. For example, a private company whose only employees are its owners may not need to provide detail about compensation arrangements beyond their existence even though compensation is being paid to related parties.
26.5.10 Related party franchisor relationships
A franchise arrangement may constitute a related party relationship. For example, a franchisor may own outlets that it also operates, or significantly influence the management or operating policies of the franchisee such that the franchisee might be prevented from fully pursuing its own separate interests. ASC 952-605-45 requires franchisors to distinguish revenue and costs related to franchisor-owned outlets from revenue and costs related to franchised outlets where practicable. ASC 952-605-50-3 also requires disclosures about significant changes in franchisor-owned outlets.
26.5.11 Common control transactions
Some related party transactions involve transactions between entities under common control, such as a transfer of a business or a combination of businesses. These transactions could result in a change in the reporting entity. For more on the presentation and disclosure requirements associated with a change in reporting entity, refer to FSP 30. See BCG 7 for details on assessing whether common control exists and for additional guidance on accounting for combinations between entities or businesses under common control.
Question FSP 26-7
Should expenses incurred by a parent on behalf of its subsidiary be disclosed as a related party transaction in the separate financial statements of the subsidiary?
PwC response
Yes. All transactions entered into between the parent and its subsidiary, including the allocation of any expenses incurred by the parent on behalf of its subsidiary (as required by SAB Topic 1.B), should be considered related party transactions because the two entities meet the definition of affiliates. The treatment of such transactions is consistent with the guidance in ASC 850-10-05-4, which specifically identifies intra-entity billings based on allocations of common costs as a common related party transaction.
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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