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Accounts receivable - related party transactions

You are the auditor of Plastico, Inc., a manufacturer of plastic products. In
reviewing the balance sheet of the company, you notice several receivables from
the officers of the company. You report your findings to the president of the
company and inform him that these receivables will be considered related party
transactions for purposes of financial accounting and reporting. The president
seems somewhat annoyed by your comments and asks you to explain what you
mean by "related party" transactions and how the financial statements will be
affected by these transactions. Prepare a brief response to the president's
question.

Solution
Related party transactions occur when an enterprise engages in transactions in
which one of the parties to the transaction has the ability to influence
significantly the policies of the other, or in which one party to the transaction has
the ability to influence the policies of the two transacting parties. The following
are examples of related party transactions:

a. Transactions between a parent company and its subsidiaries.

b. Transactions between subsidiaries of a common parent.
c. Transactions between an enterprise and trusts for the benefit of
employees (such trusts being controlled or managed by the enterprise).
d. Transactions between an enterprise and its principal owners,
management, or members of immediate families and affiliates.

Transactions between related parties may be controlled entirely by one of the

parties so that the transactions may be affected significantly by considerations
other than those in arm's-length transactions with unrelated parties. Related
party transactions frequently involve such things as borrowing or lending money
at abnormally high or low interest rates, real estate sales at amounts that differ
significantly from appraised values, exchanges of nonmonetary assets, and
transactions with "shell" companies (enterprises having no economic substance).

Transactions with related parties are not conducted at arm's-length and thus
their form may differ from their economic substance. In cases where the form of
the transaction differs from the substance, auditors will require that the financial
statements properly reflect the substance of the transaction. Auditors also will
require that the financial statements include the following disclosures regarding
related party transactions:

a. The nature of the relationship(s) involved.

b. A description of the transactions, including transactions to which no
amounts or nominal amounts were ascribed for each period for which an
income statement is presented.
c. The dollar amounts of transactions for each of the periods for which
income statements are presented.
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d. Amounts due from or to related parties as of the date of each balance

sheet presented.

The president may be reluctant to disclose the nature or amounts of related

party transactions and may resist changes in accounting for related party
transactions if the transactions have not been accounted for in accordance with
applicable generally accepted accounting principles or do not reflect the
substance of the transactions.