exposure draft

PUBLIC SECTOR ACCOUNTING BOARD PROPOSED ACCOUNTING STANDARDS

Related Party Transactions

September 2012

COMMENTS MUST BE RECEIVED BY NOVEMBER 21, 2012

This Exposure Draft is issued by the Public Sector Accounting Board. The members of the Board are drawn from government, legislative auditors, public accounting, business and academe. All members serve as individuals and not as representatives of their governments, employers or organizations. Individuals, governments and organizations are invited to send written comments to the Board on the Exposure Draft proposals. Comments are requested from those who agree with the Exposure Draft as well as from those who do not. All comments received will be available on the website at www.psab-ccsp.ca shortly after the comment deadline, unless confidentiality is requested. The request for confidentiality must be stated explicitly within the response.
To be considered, comments must be received by November 21, 2012, addressed to: Tim Beauchamp, Director Public Sector Accounting 277 Wellington Street West Toronto, Ontario M5V 3H2 A PDF response form has been posted with this document to assist you in submitting your comments. Alternatively, you may send comments by e-mail (in Word format), to: ed.psector@cica.ca Public Sector Accounting Standards, Guidelines and Recommended Practices need not be applied to immaterial items. Materiality is a matter of professional judgment in the particular circumstances. Materiality may be judged in relation to the reasonable prospect of its significance in the making of assessments and judgments by the users of financial statements. A material item would be expected to affect assessments of and judgments on government financial operations and management.

Highlights
The Public Sector Accounting Board (PSAB) proposes, subject to comments received following exposure, to issue a new Section, RELATED PARTY TRANSACTIONS. This Section would apply to all governments and government organizations that base their accounting policies on the CICA Public Sector Accounting Handbook. The following documents accompany this Exposure Draft: An issues analysis that summarizes PSABs considerations by providing background information and discussing alternatives evaluated. A plain language document that explains the proposals in non-technical language. Main features of the Exposure Draft The main features of the Exposure Draft are as follows: Related parties include entities that control or are controlled by a reporting entity, entities that are under common control and entities that have shared control over or that are subject to shared control of a reporting entity. Individuals that are members of key management personnel and close members of their family are related parties. Disclosure of key management personnel compensation arrangements, expense allowances and other similar payments routinely paid in exchange for services rendered is not required. Determining which related party transactions to disclose is a matter of judgment based on assessment of: the terms and conditions underlying the transactions; the financial significance of the transactions; the relevance of the information; and the need for the information to enable users understanding of the financial statements and for making comparisons. A related party transaction, with the exception of contributed goods and services, should normally be recognized by both a provider organization and a recipient organization on a gross basis. A reporting entity may either: disclose information about contributed goods and services; or recognize a revenue and expense if those goods and services would otherwise have been purchased. Related party transactions, if recognized, should be recorded at the exchange amount. A public sector entitys policy, budget practices or accountability structures may dictate that the exchange amount is the carrying amount, consideration paid or received or fair value. It may not be necessary or practical for the provider organization or recipient organization to disclose information about transactions undertaken by an entity as part of its operations. Implications of the proposals The new Section requires disclosure only when related party transactions are material to the financial statements. When assessing whether related party transactions are reportable, the quantitative characteristics of materiality are considered. Certain related party transactions are of such significance that it is essential that they be adequately described in the financial statements in order to provide an understanding of the reporting entitys financial results and position.

RELATED PARTY TRANSACTIONS

The effect of this Section on the government reporting entity is expected to be minimal. This Section does not deal with transactions with entities within a reporting entity. Related party transactions with members of key management personnel and their close family members would generally not be financially significant at the government reporting entity level. As well, most jurisdictions have established financial disclosure and conflict of interest legislation. Entities that are subject to such legislation are likely to have processes in place to protect the integrity of financial transactions and provide accountability to the public. These processes can be leveraged to comply with this Section. If required, reference to other public reports where the information is available could be made in financial statements. Those government organizations that were previously using pre-changeover accounting standards in Part V of the CICA Handbook Accounting may have to adjust their current disclosures because this Exposure Draft does not include significant influence. Comments requested PSAB welcomes comments from individuals, governments and organizations on all aspects of the Exposure Draft. When comments have been prepared as a result of a consultative process within an organization, it is helpful to identify generically the source of the comment in the response. This will promote understanding of how the proposals are affecting various aspects of an organization. Comments are most helpful if they relate to a specific principle, paragraph or group of paragraphs and, when expressing disagreement, they clearly explain the problem and indicate a suggestion, supported by specific reasoning, for alternative wording. Supporting reasons for your comments are most valuable when they demonstrate how the Exposure Draft proposals, or your alternatives: produce more relevant information for accountability and decision-making by external users; improve the representation of the substance of the underlying transaction or event; contribute to improved measures and understanding of financial position and annual results; facilitate enhanced comparability; and provide sufficient information for external users to understand the financial statements. Please respond to the following questions: 1. Do you agree that in determining whether a related party transaction is reportable, it is only the quantitative characteristics of materiality that are considered? 2. Do you agree with the essential characteristics of related parities? 3. Do you agree that related party transactions, with the exception of contributed goods and services, should be recognized by both a provider organization and a recipient organization on a gross basis at the exchange amount? 4. Do you agree that a reporting entity may either disclose information about or recognize contributed goods and services?

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5. Do you agree with the proposed disclosure requirements? For your convenience, a PDF response form has been posted with this document. You can save the form both during and after completion for future reference. You are not restricted by the size of the interactive comment fields in the response form and there is also a general comments section. Alternatively, you may send written comments by email in Word format to: ed.psector@cica.ca

RELATED PARTY TRANSACTIONS

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Related Party Transactions

TABLE OF CONTENTS
PARAGRAPH

Purpose and scope............................................................................. .01-.04 Definitions............................................................................................ .05 Reportable transactions..................................................................... .06-.08 Identifying a related party................................................................... .09-.16 Key management personnel......................................................................... .12-.14 Close family members of key management personnel................................. .15-.16 Recognition.......................................................................................... .17-.29 Cost allocation and recovery........................................................................ .19-.23 Contributed goods and services................................................................... .24-.29 Measurement....................................................................................... .30-.35 Disclosure............................................................................................ .36-.45 Unrecognized transactions........................................................................... .40-.42 Transactions undertaken as part of operations............................................. .43-.45 Transitional provisions....................................................................... .46 PURPOSE AND SCOPE .01 This Section establishes standards for the recognition, measurement and disclosure of related party transactions. .02 This Section establishes standards for disclosure of the terms and conditions under which transactions between related parties are conducted and the relationship underlying them. Sufficient information about transactions would enable users to assess their effect on the reported financial position and financial performance. .03 This Section identifies: (a) which parties are related; (b) the extent to which related party transactions are recognized in the financial statements of both the provider and recipient organizations; (c) the appropriate basis of measurement for recognized transactions; and (d) disclosure requirements for transactions including those that have not been given accounting recognition. .04 This Section does not deal with: (a) special purpose reports issued by an entity; (b) amalgamations and restructurings; (c) transactions between governments that are separate financial reporting entities (see GOVERNMENT REPORTING ENTITY, Section PS 1300); (d) transactions with entities within a reporting entity including those that are accounted for under the modified equity method; (e) cost-sharing arrangements; (f) disclosure of key management personnel compensation arrangements, expense allowances and other similar payments routinely paid in exchange for services rendered; and (g) ownership interests in a public sector entity held by individuals.

RELATED PARTY TRANSACTIONS

DEFINITIONS .05 The following terms are used in this Section with the meaning specified: (a) Carrying amount is the amount of an item transferred, or cost of services provided, as recorded in the accounts of the provider organization, after adjustments, if any, for amortization or write-downs. (b) Exchange amount is the amount of the consideration as established and agreed to by the related parties. (c) Fair value is the amount of the consideration that would be agreed upon in an arms length transaction between knowledgeable and willing parties who are under no compulsion to act. (d) Key management personnel are those individuals having authority and responsibility for planning, directing and controlling the activities of the reporting entity. (e) A related party exists when one party has the ability to exercise control or shared control over the other. Two or more parties are related when they are subject to common control or shared control. Related parties also include key management personnel and close family members. (f) A related party transaction is a transfer of economic resources or obligations between related parties, or the provision of services by one party to a related party. These transfers are related party transactions whether or not there is an exchange of considerations or transactions have been given accounting recognition. The parties to the transaction are related prior to the transaction. When the relationship arises as a result of the transaction, the transaction is not one between related parties. (g) Shared control occurs when two or more entities are bound by a contractual arrangement that establishes shared control over another entity and specifies the agreed sharing of the ongoing power to determine the entitys financial and operating policies. REPORTABLE TRANSACTIONS .06 Governments commonly conduct activities necessary for different aspects of their responsibilities and for achieving their objectives through separate entities. These entities may prepare financial statements intended to provide users with relevant and reliable information for decision-making purposes and to demonstrate the accountability of the reporting entity for the resources entrusted to it. .07 Governments can also establish different operating relationships between entities that allow them to operate together to achieve the overall objectives of the government. Governments establish individual policies regarding inter-organization arrangements that reflect a governments policy objectives, accountability structures and budgetary practices. .08 Determining which transactions between a reporting entity and its related parties to disclose is a matter of professional judgment. For example, it may be necessary to disclose information about contributed goods and services and other unrecognized transactions for users to understand the environment within which the reporting entity operates. Factors to consider in assessing users needs include, but are not limited to, the following: (a) whether the transactions are undertaken on different terms and conditions that would be expected to have been adopted if the parties were dealing at arms length in the same circumstances;

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(b) the financial significance of the transactions in terms of the effect they have or could have on the reporting entitys financial position and financial performance; (c) the relevance of the information to the decisions of users and their evaluation of the financial effect or potential financial effect of the transactions on the financial position and financial performance of the reporting entity; (d) the contribution the information would have to users understanding of the operating environment and the financial statements of the reporting entity; and (e) the need for the information to enable users compare the reporting entitys financial position and financial performance with that of other entities. IDENTIFYING A RELATED PARTY .09 A related party is an entity or an individual that is related to the reporting entity. Related parties have one of the following characteristics: (a) entities that control or are controlled by the reporting entity; (b) the reporting entity and other entities that are subject to common control; (c) entities that have shared control over or are subject to shared control of the reporting entity; (d) an individual that is a member of key management personnel of the reporting entity and a close family member of that individual; (e) an entity controlled by, or under shared control of, a member of key management personnel of a reporting entity or a close family member of that individual; and (f) an entity when a member of key management personnel of a reporting entity or a close family member of that individual is a member of the management or governing body of the entity such that they have the ability to participate in the financial and operating policy decisions of the entity. .10 The determination of whether an entity controls another entity would be made by reference to the definition of control set out in GOVERNMENT REPORTING ENTITY, Section PS 1300. Reference would also be made to the characteristics of shared control set out in GOVERNMENT PARTNERSHIPS, Section PS 3060. .11 Parties to a contractual arrangement that establish shared control of an entity would not be related parties. The determination of whether parties to a shared control arrangement are related would be made giving consideration to the definition and characteristics of a related party. For example, if all parties to a shared control arrangement are under common control, they would be related parties. Similarly, when two or more entities are under the shared control of the same reporting entity, each is a related party. Key management personnel .12 The determination of whether an individual is included in key management personnel requires judgment. Key management personnel could include: (a) directors or members of the governing body of the reporting entity, where that body has authority and responsibility for planning, directing and controlling the activities of the reporting entity; (b) the senior management of the reporting entity, including the chief executive or permanent head and senior management group of the reporting entity; and

RELATED PARTY TRANSACTIONS

(c) any other individuals having the authority and responsibility for planning, directing and controlling the activities of the reporting entity. At the government level, the governing body may consist of elected or appointed representatives such as ministers, councillors, aldermen.

.13 In addition, an entity may be related to the reporting entity if a member of the reporting entitys key management personnel: (a) has control or shared control over the entity; (b) holds an ownership interest that allows the individual to participate in the financial and operating decisions of the entity; and (c) is a member of the management or governing body of the entity that allows the individual to participate in the financial and operating decisions of the entity. .14 Determining whether an entity is related to a member of key management personnel depends on the degree of influence the individual has over that entity. In some cases, the degree of influence may be so remote that they need not be considered related. For example, two entities may be unrelated even though a member of key management personnel serves on the board of each entity. In such a case, the degree of influence exercised by the director over the financial and operating policies of each entity determines whether the entities are related. Close family members of key management personnel .15 A related party includes individuals that are close family members of an individual who is a member of key management personnel of a reporting entity. The determination of whether an individual would be identified as a close family member requires judgement. In most cases, close family members include an individuals spouse and those dependent on either the individual or the individuals spouse. .16 Similarly, an entity is a related party if a close family member of an individual that is a member of key management of the reporting entity: (a) has control or shared control over the entity; (b) holds an ownership interest that allows the individual to participate in the financial and operating decisions of the entity; and (c) is a member of the management or governing body of the entity that allows the individual to participate in the financial and operating decisions of the entity. RECOGNITION .17 A related party transaction, with the exception of contributed goods and services referred to in paragraphs .24 - .29, should be recognized by both a provider organization and a recipient organization. .18 A reporting entity would recognize assets and liabilities in its financial statements when an item satisfies the definitions and meets the recognition criteria in FINANCIAL STATEMENT CONCEPTS, Section PS 1000. Therefore, if a related party transaction involves the transfer of an asset or liability, both the provider organization and recipient organization would recognize the transaction.

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Cost allocation and recovery .19 When there is a policy of allocating costs for the provision of goods and services: (a) the provider organization should report all revenues and expenses on a gross basis; and (b) the recipient organization should report all expenses on a gross basis. .20 A government may have established an organizational structure whereby a central agency provides goods and services to other entities under common control. The provider organization may be subject to a policy requiring that the related costs are allocated to the recipient organization(s). For example, a central agency may be responsible for provision of information services to other entities. It recognizes all revenues and expenses, on a gross basis, associated with the provision of information services. .21 Showing the gross revenues and costs of providing goods or services helps users to understand the full extent of the provider organizations operations. In certain circumstances, however, it may be appropriate to report on a net basis. Whether the reporting is to be done on a gross or net basis can be a matter of judgment. In making the determination, consideration is given to whether the reporting entity: (a) acts as a principal, as opposed to an agent or broker, in the transactions; (b) has assumed benefits and risks of ownership; and (c) is primarily responsible for providing the goods or services required by the recipient organization. .22 A strong indicator that an entity acts as an agent or broker is if a supplier or other third party entity is responsible for providing the goods or services desired by a recipient organization. In such a case, net reporting may be appropriate. .23 Under the policy of allocating costs, a recipient organization would recognize the expense in its financial statements. Expenses would be identified and reported at gross amounts in arriving at surplus or deficit for the period. Contributed goods and services .24 It is not unusual that certain activities are undertaken by a central entity to support the activities of other departments and agencies. For example, a central entity may be responsible for the debt management, pension administration, procurement and other shared services that apply across all government entities. .25 The provider organization may have a policy of funding expenses related to these common services through appropriations or other revenue sources and not allocating the costs to recipient organizations within the public sector reporting entity. Contributed goods or services between entities are a related party transaction.

RELATED PARTY TRANSACTIONS

.26 A reporting entity may recognize contributions of goods and services when those goods and services would otherwise have been purchased. The reporting entity may, or be required by government policy, to: (a) disclose information about the transaction; or (b) recognize a revenue and expense. .27 Whether related party transactions involving contributed goods and services would be recognized or disclosed in the financial statements of the recipient organization requires judgment. Factors to include, but are not be limited to: (a) the objectives of general purpose financial statements; (b) the information needs of users; (c) the nature of operations and legislative control; (d) the legislation or policy that requires an entity to prepare general purpose financial statements; and (e) in the absence of a legislative requirement, an established business model that reflects a governments policy objectives, accountability structures and budgetary practices. .28 If the objective is to demonstrate accountability for the use of resources for which a reporting entity is responsible and for assessing whether resources were administered in accordance with the limits established by legislative authorities, it may not be necessary to recognize contributed goods and services. Alternatively, if the objective is measuring the cost of resources consumed by each type of activity, it may be necessary to recognize contributed goods and services. .29 If recognized, the recipient organization reports the contributed goods and services in the statement of operations as an expense. It also recognizes an equivalent amount as a credit in the statement of operations. MEASUREMENT .30 Related party transactions should be recorded at the exchange amount. The exchange amount could be: (a) the carrying amount; (b) the consideration paid or received; or (c) fair value. .31 Generally, when a transaction that occurs between reporting entities under common control involves the transfer of an asset or liability or the provision of a service, a substantive change in the consolidated interest in the item does not occur. This may not justify a change in the measurement of the item. In this case, the carrying amount may be appropriate. .32 The amount of consideration paid or received may be appropriate for a related party transaction that involves a provision of goods or services by one entity to another. This reflects the existing accountability framework for a public sector entity and the way in which operations are managed. This amount would be representative of the economic substance of the transaction and sufficiently reliable to be used for financial reporting purposes. .33 Fair value may be appropriate when the recipient organizations future cash flows or service potential is expected to change significantly as a result of the transaction. For example, a local government may transfer a parking facility

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to a parking authority. The parking authority will charge commercial rates for parking. In this case, a change in the value of the facility could be justified since the transfer may significantly change the risk, timing and amount of future cash flows associated with the asset received. .34 When there is a difference between the exchange amount and the carrying amount, a gain or loss should be reported in the statement of operations for the period. .35 Measuring contributed goods and services may be difficult. In the absence of a public sector entitys policy, budget practices or accountability structures that would dictate how contributed goods and services would be measured, they would be measured at: (a) carrying amount; or (b) fair value. DISCLOSURE .36 A reporting entity should disclose: (a) adequate information about the nature of the relationship with related parties involved in related party transactions; (b) the types of related party transactions that have been recognized; (c) the amounts of the transactions recognized classified by financial statement category; (d) the basis of measurement used; (e) the amount of outstanding balances and the terms and conditions attached to them; (f) contractual obligations with related parties, separate from other contractual obligations; (g) contingencies involving related parties, separate from other contingencies; and (h) the types of related party transactions that have occurred for which no amount has been recognized. Items of a similar nature should be disclosed in aggregate. .37 A reporting entity would disclose sufficient information about related party transactions and the underlying relationships necessary for users to understand the effect of those transactions on its financial position and performance. Knowledge of a reporting entitys transactions with related parties and their terms and conditions is necessary for accountability purposes and to allow users to assess the cost of services and the management of resources. .38 Judgment is required to determine the level of detail to be disclosed. Factors that would be considered in making the determination include, but are not be limited to: (a) the closeness of the related party relationship; (b) the significance of the transactions in terms of size; and (c) whether the transactions were carried out on non-market terms. .39 Items of a similar nature may be disclosed in aggregate except when separate disclosure is necessary for an understanding of the effects of related party transactions on the financial statements of the reporting entity.

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Unrecognized transactions .40 A reporting entity should disclose in notes or in supplementary schedules to the financial statements, the nature of related party transactions that have not been given accounting recognition. .41 An exchange of goods or services between related parties that has not been given accounting recognition is a related party transaction. Such transactions could have a material effect on the financial position and performance reported in financial statements. A reporting entity would disclose information about related party transactions that have occurred for which no amount has been recognized in sufficient detail to enable users of its financial statements to understand the operating environment. .42 The information would include either a qualitative or quantitative indication of the extent of unrecognized related party transactions. When only qualitative information is disclosed about unrecognized related party transactions, it may be difficult for users to determine the terms and conditions under which they might have been transacted had the parties been unrelated. However, an explanation about the transactions helps users of financial statements detect and explain possible differences or evaluate their significance to the performance of the reporting entity. Transactions undertaken as part of operations .43 Related party transactions may be undertaken by an entity as part of its operations on terms and conditions no more or less favourable than those that it is reasonable to expect it would have adopted if dealing with that individual or entity at arms length. It may not be necessary or practical for the provider organization or recipient organization to disclose information about these transactions. .44 Disclosure of information about transactions involving the sale or purchase of utilities between related parties may not be necessary when the terms and conditions are the same as those for unrelated parties. On the other hand, if a significant portion of a reporting entitys revenues are derived from related parties, it may be necessary to disclose information about these transactions for users to understand the effect of those transactions on its financial position and performance. .45 When disclosure of information would assist users of financial statements understand the operating environment, a reporting entity may disclose: (a) information about the nature of the relationship with related parties involved; (b) the nature and extent in quantitative or qualitative terms of the transactions; and (c) the basis used for their recognition and measurement. TRANSITIONAL PROVISIONS .46 This Section would apply to fiscal years beginning on or after April 1, 2015. Earlier adoption is permitted.

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