As calendar year-end audit season moves into full swing, you can expect to receive a request from your audit firm for your related party listing. Related parties can sometimes be a topic of confusion and gray area. While judgment may still be required when applying the standards to your entity, hopefully the overview below will provide clarity to the topic.
FASB Accounting Standard Codification (ASC) 850, Related Party Disclosures, is the standard regarding related party transactions and the required disclosures. This standard applies to both public and private entities. The standard aims to provide transparency to financial statement readers regarding related party relationships and activity. Financial institutions are subject to the Federal Reserve Bank’s Regulation O requirements regarding extensions of credit (loans) to executive officers, directors and principal shareholders. An important distinction to note is the Regulation O definition is not the same as the FASB ASC 850 definition and should not be used in the determination of those designated as related parties for financial statement disclosure purposes.
Identification of Related Parties and Regulatory Guidance
ASC 850 cites example relationships involved in related party transactions as including:
- A parent entity and its subsidiaries
- Subsidiaries of a common parent
- An entity and trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of the entity’s management
- An entity and its principal owners, management, or members of their immediate families
Identification is not always easy; it can be complicated by the interpretations of the language used in the standard. Most often, the confusion stems from the definition of “immediate family.” The ASC Glossary defines immediate family as “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.” However, before you begin to interpret who may be related parties for your entity, you will need to consider which guidance applies to your entity.
While ASC 850 applies to all entities, both public and private, SEC registrants are required to follow the additional SEC guidelines for their filings. SEC Regulation S-K details the disclosure requirements for SEC filings and shareholder annual reports. Item 404 of this regulation pertains to transactions with related persons, promoters and certain control persons.
If you are an SEC registrant, defining immediate family members is more easily interpreted than the ASC 850 definition. Item 404 of Regulation S-K defines it as “any immediate family member of a director or executive officer of the registrant, or of any nominee for director when the information called for by paragraph (a) of this item is being presented in a proxy or information statement relating to the election of that nominee for director, which means any child, step-child, parent, step-parent, spouse, sibling, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, sister-in-law of such director, executive officer or nominee for director, and any person (other than a tenant or employee) sharing the household of such director, executive officer or nominee for director.”
Disclosure of material transactions with related parties is required in financial statements. Transactions eliminated during the process of preparing consolidated or combined financial statements are not required to be disclosed. ASC 850-10 details the specific disclosure requirements:
- “Disclosures shall include:
- The nature of the relationship(s) involved
- A description of the transactions, including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements
- The dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period
- Amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement
- The information required by paragraph 740-10-50-17 (Entities with Separately Issued Financial Statements that are Members of a Consolidated Tax Return)”
If your disclosure represents that the transactions were conducted at arm’s length and on terms equivalent for arm’s length transactions, these representations must be able to be substantiated.
While not an all-inclusive list, example related party transactions can include:
- Deposit relationships
- Loan relationships
- Lease arrangements
- Cost sharing agreements for services performed
- Contracted services
- Debt (disclosing entity is indebted to related party)
- Other Real Estate Owned transactions (specific to financial institutions)
Why is your auditor asking all of these questions regarding related parties and your entity’s process? There are two auditing standards that require your auditor to evaluate the identification and disclosure of related party relationships and transactions as part of the audit procedures. For audits conducted under Public Company Accounting Oversight Board Standards, which includes all SEC registrant audits, Auditing Standard 2410, Related Parties, applies (previously AS 18). All other audits are subject to the American Institute of Certified Public Accountants Auditing Standard Section 550 (AU-C 550, Related Parties). Both standards require the auditor to perform procedures to test the accuracy and completeness of related party transactions. Often the auditor will obtain an understanding of your entity’s related party identification, transaction authorization and approval and tracking processes, perform inquiries, review Board of Director and Committee minutes for indications of omitted transactions or relationships and test the accuracy of the related party listing to underlying support.
Board of Directors and Management Responsibilities
Entities should implement a related party policy or written procedures describing the entity’s related party transaction approval/authorization process, related party relationship and transaction identification process, tracking and periodic monitoring process, and details regarding what relationships are deemed to constitute related parties for financial reporting purposes. Most entities have put into practice the use of a related interest form or questionnaire to document related party relationships and transactions. The form is completed on an annual basis, at a minimum, by the related parties. The forms are available for revision and updates as necessary throughout the year. Then, at year-end, a designated individual performs a review of the forms for completeness and the forms are utilized in the financial reporting disclosure process.
At YHB we understand the complexities that come with running a community bank. That’s why we help make the complex simple, so you can grow confidently. If you have any questions, please do not hesitate to reach out to us at YHBcpa.com.
Meet the Author
As a manager on YHB’s Community Banking team, Rachel specializes in a variety of services including external audits, internal audits, and consulting services for community banks. She is actively involved in the creation and leadership of firm-wide and community bank-specific training.