Definition
Under ASC 850, related parties include affiliates, principal owners, management and their immediate families, and entities that can significantly influence or be influenced by the reporting entity. Financial statements disclose the nature of the relationship, a description of the transactions, the dollar amounts for each period, and amounts due to or from related parties with terms and settlement method. Compensation arrangements, expense allowances in the ordinary course of business, and transactions eliminated in consolidation are not required to be disclosed. Representations that transactions were on arm's length terms should not be made unless they can be substantiated.
Why it matters in an audit or review
AU-C 550 requires auditors to inquire about related parties and look for undisclosed ones. Management's list, loan agreements, leases with owners, and unusual transactions are evaluated. Undisclosed related party transactions are a recurring risk in closely held businesses.
Example
(Illustrative) A company pays $120,000 per year rent to an entity owned by its CEO and owes $20,000 at year-end. Disclosure: nature of the relationship, the lease terms, $120,000 of rent expense, and the $20,000 payable.
Common mistakes
- Omitting guarantees of owners' debt.
- Describing transactions as arm's length without support.
Sources
- FASB ASC 850-10-20 (definition of related parties) and 850-10-50 (disclosures, including the arm’s-length representation)
- AICPA, AU-C Section 550, Related Parties
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error