A related party transaction is a transfer of resources, services or obligations between a company and a party with which it has a pre-existing close relationship. These transactions are significant because the parties may not be dealing with each other at arm’s length, meaning the terms may differ from those that would apply between independent parties.
Under FRS 102 Section 33, UK companies must disclose related party transactions in the notes to the financial statements so that users can assess their impact on the company’s financial position and performance.
Who is a Related Party?
FRS 102 defines a related party broadly. The key categories include:
| Related party | Relationship to the company |
|---|---|
| Directors | Current directors of the company (and their close family members) |
| Key management personnel | Those with authority and responsibility for planning, directing and controlling the company’s activities |
| Shareholders with significant influence | Typically those holding 20% or more of voting rights |
| Parent company | A company that controls the reporting entity |
| Subsidiary companies | Entities controlled by the reporting company |
| Fellow subsidiaries | Other subsidiaries of the same parent |
| Associates | Entities over which the company has significant influence |
| Joint ventures | Jointly controlled entities |
| Close family members of any of the above | Spouse, civil partner, children, dependants, and their close family |
| Entities controlled by any of the above | Companies owned or controlled by directors, key management or their families |
Close Family Members
The definition extends to close family members because transactions may be routed through family members to avoid direct disclosure. A contract awarded to a company owned by a director’s spouse is a related party transaction.
Why Disclosure Matters
Related party transactions raise concerns because:
- The parties may agree terms that are more or less favourable than arm’s length
- Transactions may occur that would not have taken place between independent parties
- They can be used to manipulate reported profits or asset values
- Users of accounts need to assess whether the company’s resources are being used in the interests of all shareholders
For example, a company paying above-market rent for a property owned by its director transfers value from the company (and its other shareholders) to the director personally.
Common Types of Related Party Transaction
| Transaction | Example |
|---|---|
| Loans to or from directors | A director borrows £50,000 from the company |
| Sales or purchases between group companies | A subsidiary buys materials from its parent at cost |
| Management charges | A parent company charges a subsidiary for management services |
| Property transactions | A company leases its premises from a director’s pension fund |
| Provision of guarantees | A parent guarantees a subsidiary’s bank borrowing |
| Remuneration of key management | Total compensation paid to directors and senior management |
| Dividends | Dividends paid to director-shareholders |
| Sale or purchase of assets | A company buys a vehicle from a director at an agreed price |
Disclosure Requirements Under FRS 102
What Must Be Disclosed
For each material related party transaction (or group of similar transactions), the company must disclose:
- The nature of the related party relationship
- A description of the transactions
- The amounts involved
- Any outstanding balances at the reporting date, including terms and conditions, whether secured, and the nature of the consideration to be provided in settlement
- Provisions for doubtful debts related to the outstanding balance
- Bad debts written off during the period
Key Management Personnel Compensation
The total compensation paid to key management personnel must be disclosed. This typically includes:
| Component | Description |
|---|---|
| Short-term employee benefits | Salary, bonuses, benefits in kind |
| Post-employment benefits | Pension contributions |
| Termination benefits | Redundancy or severance payments |
| Share-based payment | Share options or other equity-based compensation |
Exemptions
FRS 102 provides limited exemptions from related party disclosure:
- Transactions between group companies that are wholly owned within the group (provided the consolidated accounts are publicly available)
- Transactions entered into in the normal course of business (this exemption is narrow and does not eliminate the need for disclosure of material transactions)
Small companies applying Section 1A of FRS 102 have reduced but not eliminated disclosure requirements. They must still disclose transactions with directors and key management that are not on normal commercial terms.
Directors’ Transactions Under Company Law
The Companies Act 2006 imposes additional requirements on transactions with directors beyond FRS 102:
Loans to Directors
Under sections 197-214 of the Companies Act 2006:
| Transaction type | Requirement |
|---|---|
| Loans exceeding £10,000 | Require shareholder approval |
| Quasi-loans to directors (public companies) | Require shareholder approval if over £10,000 |
| Credit transactions exceeding £15,000 | Require shareholder approval |
| Related arrangements | Transactions connected to the above also require approval |
Substantial Property Transactions
Under Section 190, a company must not enter into an arrangement whereby a director (or a person connected with a director) acquires or disposes of a substantial non-cash asset from or to the company unless approved by shareholders. An asset is substantial if it exceeds the lower of £100,000 or 10% of the company’s net asset value (subject to a minimum of £5,000).
Practical Implications
Director Duties
Directors have a statutory duty under Section 175 of the Companies Act 2006 to avoid conflicts of interest. Any transaction where a director has a personal interest must be declared to the board. Failure to disclose can result in the transaction being voidable and the director being personally liable.
Audit Scrutiny
Auditors are required to obtain a complete list of related parties and to test whether all related party transactions have been properly identified and disclosed. This is an area where material misstatement risk is elevated because:
- Management may not voluntarily disclose unfavourable transactions
- Identifying all related parties (especially through family connections) requires thorough inquiry
- The valuation of transactions that are not at arm’s length requires judgement
Transfer Pricing
Transactions between UK companies and overseas related parties may also be subject to transfer pricing rules, which require transactions to be priced as if between independent parties. HMRC can adjust the taxable profits if transactions are not at arm’s length.
Group Companies
Transactions between companies within a group are among the most common related party transactions. Typical examples include:
- Intercompany loans and interest charges
- Management fees charged by the parent
- Recharges for shared services (IT, HR, finance)
- Transfer of assets between group entities
- Dividend payments up to the parent company
All intercompany transactions must be eliminated on consolidation when preparing group accounts, but they still require disclosure in the individual company accounts unless the exemption for wholly owned subsidiaries applies.
Related party transaction disclosure is one of the most scrutinised areas of UK financial reporting. Proper identification, documentation and disclosure protect shareholders, satisfy regulators and ensure the financial statements present a complete picture of the company’s dealings.