Related Party Transactions in Financial Statements

Explore practical examples of related party transactions in financial statements, including context and detailed explanations.
By Jamie

Related party transactions refer to transactions that occur between two parties who have a pre-existing relationship. These can be between a company and its executives, shareholders, or other entities with which the company has a relationship. It is crucial for these transactions to be disclosed in the notes to financial statements to maintain transparency, as they may not operate at arm’s length and could potentially distort the financial position of the company. Below are three practical examples of related party transactions that illustrate how they are presented in financial statements.

Example 1: Lease Agreement with a Shareholder

In this scenario, a company named XYZ Corp. has entered into a lease agreement for its office premises with one of its major shareholders, Mr. John Smith. The lease is for a term of five years at an annual rental rate of $100,000.

XYZ Corp. discloses the following in the notes to its financial statements:

  • Nature of the relationship: Mr. John Smith is a majority shareholder who owns 30% of XYZ Corp.
  • Transaction details: The lease agreement was signed on January 1, 2023, and is set to expire on December 31, 2027.
  • Financial impact: Total rental expense recognized during the year ended December 31, 2023, was $100,000.

Relevant Notes: The terms of the lease were determined based on market rates for similar properties, ensuring that the transaction is at fair value.

Example 2: Loan from a Director

ABC Ltd., a manufacturing company, secured a loan of $500,000 from its director, Ms. Sarah Lee, to support its expansion plans. The loan is interest-bearing at a rate of 5% per annum, with a repayment term of five years.

In the notes to its financial statements, ABC Ltd. provides the following information:

  • Nature of the relationship: Ms. Sarah Lee is a director of ABC Ltd., holding a 10% stake in the company.
  • Transaction details: The loan agreement was executed on June 1, 2023, and is due for repayment on June 1, 2028.
  • Financial impact: Interest expense recognized for the year ended December 31, 2023, amounted to $25,000.

Relevant Notes: The terms of the loan were negotiated based on prevailing market interest rates to ensure an arm’s length transaction.

Example 3: Sale of Goods to an Associated Company

DEF Inc. sells products to its associated company, GHI LLC, which is 40% owned by DEF Inc. During the fiscal year, DEF Inc. sold goods worth $250,000 to GHI LLC.

The notes to DEF Inc.’s financial statements include the following disclosures:

  • Nature of the relationship: GHI LLC is an associated company in which DEF Inc. holds a significant influence.
  • Transaction details: Sales transactions occurred throughout the fiscal year, with terms similar to those offered to unrelated customers.
  • Financial impact: Revenue recognized from sales to GHI LLC for the year ended December 31, 2023, was $250,000.

Relevant Notes: The pricing for these transactions was determined based on competitive market rates, ensuring compliance with relevant accounting standards regarding related party transactions.