What it means
The concern behind the rules is simple: when the person on both sides of a deal has an interest in each outcome, the price may serve the individual rather than the company. A chief executive who leases a warehouse to their own business at double the market rent has moved money from shareholders to themselves without anyone stealing anything.
Disclosure is the mechanism that makes such arrangements visible. Related parties are defined broadly and deliberately so.
The category covers parent companies, subsidiaries and fellow subsidiaries, joint ventures, key management personnel and their close family members, and entities those people control or significantly influence. Many disputes over these rules turn not on the numbers but on whether a particular counterparty falls inside the definition at all.
Disclosure requirements sit in IAS 24 under international standards and in ASC 850 under US rules, and both demand the nature of the relationship, the amounts involved, outstanding balances and the terms. Notably, the standards do not forbid the transactions or require them to be at market rates; they simply require that readers of the accounts be told.
The practical control is a written policy: transactions above a threshold go to the audit committee, the conflicted person leaves the room, and an independent benchmark such as a market valuation or competing quote supports the price. Companies that skip this step often find the transaction is perfectly reasonable but impossible to defend after the fact.
The nuance worth remembering is that intra-group trading is the most common form by far. Sales between subsidiaries of the same group are related party transactions, and while they are eliminated on consolidation, they sit at the heart of transfer pricing rules and attract close attention from tax authorities.
In practice
Real-world examples.
Example
A manufacturer buys 60% of its packaging from a supplier owned by the finance director's brother. Procurement runs a competitive tender to confirm the pricing is in line with alternatives, and the audit committee approves the arrangement with the finance director recused from the vote.
Example
A founder lends her own company $2,000,000 at 4% interest to bridge a cash shortfall while a funding round completes. The loan is disclosed in the accounts with its rate, term and outstanding balance, because a director's loan is a related party transaction even when the terms favour the company.
Example
A group's UK subsidiary charges its Irish subsidiary $8,000,000 a year for management services. Both tax authorities scrutinise the charge under transfer pricing rules, and the group has to show the fee reflects the actual cost and value of the services provided.
Think of it
“Related party transaction is a deal between connected parties-insiders transacting.
Formula
Calculation
Excess over arm's length terms = amount actually paid - amount an independent party would charge
A company rents its 12,000 square foot head office from a building owned by its chief executive and pays $480,000 a year. That works out at $480,000 / 12,000 = $40 per square foot.
Two independent agents confirm the local market rate for comparable space is $30 per square foot, which would cost 12,000 x $30 = $360,000. The excess is $480,000 - $360,000 = $120,000 a year. Against pre-tax profit of $1,500,000, that excess is $120,000 / $1,500,000 = 8% of profit quietly transferred to the chief executive, which is exactly the kind of figure the disclosure note is designed to make visible.Case study
Seen in the real world.
This is a fictional and illustrative example. Tanglewood Components, an invented family-controlled parts manufacturer preparing for a trade sale, had for years bought its raw castings from a foundry owned by the founder's two sons, with no written contract and no benchmarking.
During due diligence the buyer's advisers found that the foundry charged roughly 15% above quotes from three independent suppliers, which had reduced reported operating profit by about $600,000 a year. The buyer did not allege wrongdoing, but it repriced the deal, arguing that the true cost base was uncertain and that the supply arrangement would end at completion.
In this illustrative account, Tanglewood eventually closed the sale at a valuation roughly $4,000,000 below the initial offer. Its finance director's later verdict was blunt: the transaction had been defensible all along, but nobody had gathered the evidence at the time it happened.
Watch out
Common mistakes.
- Believing that related party transactions are prohibited, when the rules require disclosure and governance rather than a ban.
- Defining related parties too narrowly and missing close family members or entities under a director's influence.
- Approving a related party deal without an independent benchmark, leaving the company unable to demonstrate the price was reasonable when questioned later.
Questions
People also ask.
Do these transactions have to be at market rates?
Accounting standards do not require it, though company law, listing rules and tax authorities frequently apply pressure in that direction.
Are transactions between a parent and its subsidiary disclosed in the group accounts?
They are eliminated on consolidation, but they must still be disclosed in the separate accounts of each individual company.
What should a manager do if they spot an undisclosed related party arrangement?
Raise it with the finance team or audit committee promptly, since the reputational damage comes from concealment far more often than from the deal itself.
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