Understanding ASPE. Section 3840, Related Party Transactions

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1 Understanding ASPE Section 3840, Related Party Transactions

2 Four questions for private business owners: Related Party Transactions A better working world begins with asking better questions. Better questions lead to better answers. To help preparers of financial statements with Canadian accounting standards for private enterprises (ASPE) Section 3840, Related Party Transactions, we ve summarized the key aspects of the Section and offer relevant practical considerations for private mid-market companies through four commonly asked questions. Question 1What constitutes a related party? Typical examples of related parties of an entity encountered in practice include its shareholders, its ultimate shareholders, its directors, its management, its parent company, its subsidiaries (when non-consolidated financial statements are presented), entities in which it has a significant influence investment, a joint arrangement in which it has an interest, entities under common control and entities controlled by immediate family members of its shareholders or its ultimate shareholders. Paragraph describes the most commonly encountered related parties of a reporting entity, including: (a) An enterprise that directly or indirectly, through one or more intermediaries, controls, or is controlled by, or is under common control with, the reporting enterprise (b) An individual who directly, or indirectly through one or more intermediaries, controls the reporting enterprise (c) The other party, when an investment is accounted for by the equity method and the reporting enterprise is either the investor or the investee (d) Management: any person(s) having authority and responsibility for planning, directing and controlling the activities of the reporting enterprise (e) An individual having an ownership interest in the reporting enterprise that results in significant influence or joint control (f) Members of the immediate family of individuals described in (b), (d) and (e). (Immediate family comprises an individual s spouse and those dependent on either the individual or the individual s spouse.) (g) The other party, when a management contract or other management authority exists and the reporting enterprise is either the managing or managed party (h) Any party that is subject to significant influence, whether by reason of an ownership interest, management contract or other management authority, by another party that also has significant influence over the reporting enterprise (i) Any party that is subject to joint control by the reporting enterprise 2 Understanding ASPE Section 3840, Related Party Transactions

3 Question 2How is a business transferred between two enterprises under common control accounted for? A transaction resulting in a business transferred between two enterprises under common control is measured at the exchange amount or carrying amount depending on the circumstances. Paragraph states that when a monetary related party transaction or a non-monetary related transaction that has commercial substance is not in the normal course of operations, it shall be measured at the exchange amount when the change in ownership interests in the item transferred or the benefit of a service provided is substantive and the exchange amount is supported by independent evidence. if these criteria are not met, the transaction is measured at the carrying amount. The accounting for a business transferred between two enterprises under common control is described in paragraph and depends on whether the above criteria are met: When the criteria in paragraph are met, the business combination is accounted for in accordance with Section 1582, Business Combinations. Refer to the Understanding ASPE document on Section 1582 for guidance on the application of Section When the criteria discussed above in paragraph are not met, the appropriate accounting is as follows: The acquiring enterprise records the acquired assets and liabilities at their carrying amount in the balance sheet of the transferred business If appropriate, a non-controlling interest is recognized in accordance with Section 1602, Non-Controlling Interests. Any change in the non-controlling interest is recognized as an equity transaction in accordance with Section 1602 No previously unrecognized intangible assets or goodwill are recognized The financial statements of the combined enterprise reflect the earnings, assets and liabilities of the acquired enterprise for the entire period in which the transfer occurred and for all prior periods (but only since the date of acquisition of the business from an unrelated party) rather than only from the date of the transfer. Understanding ASPE Section 3840, Related Party Transactions 3

4 Question 3How is a related party transaction measured? Below is an illustrative decision tree from Section 3840 that can be used to determine the measurement basis of a related party transaction. Related party transaction occurs (Paragraph (h)) Is the transaction in the normal course of operations? (c) (Paragraphs ) No Is the change in the ownership interests in the item transferred substantive? (Paragraphs ) Is the amount of the exchange supported by independent evidence? (Paragraphs ) Is the transaction a non-monetary exchange or transfer of a nonmonetary asset? (Paragraph ) No (e) No (e) Is the transaction an exchange of product or property held for sale in the normal course of operations to facilitate sales? (c) (Paragraph ) No No No Does the transaction have commercial substance? (d) (Paragraphs ) Measure at the carrying amount (a) (f) Measure at the exchange amount (b) (a) Carrying amount The amount of an item transferred, or cost of services provided, as recorded in the accounts of the transferor, after adjustment, if any, for amortization or impairment in value. (Paragraph (a)) (b) Exchange amount The amount of consideration paid or received as established and agreed to by related parties. (Paragraph (b)) (c) Normal course of operations A related party transaction is in the normal course of operations when it is of a type that is usually, frequently or regularly undertaken by an enterprise for the purpose of generating revenue (d) Commercial substance A non-monetary related party transaction has commercial substance when the entity s future cash flows are expected to change significantly as a result of the transaction (e) Carrying amount is used for both monetary and non-monetary transactions in these circumstances (f) In rare circumstances, when the carrying amount of the item received is not available, a reasonable estimate of the carrying amount, based on the transferor s original cost, may be used to measure the exchange 4 Understanding ASPE Section 3840, Related Party Transactions

5 Question 4What are the disclosure requirements for related party transactions and balances? As noted in paragraph , an enterprise shall disclose the following information about its transactions with related parties: (a) A description of the relationship between the transacting parties (b) A description of the transaction(s), including those for which no amount has been recognized (c) The recognized amount of the transactions classified by financial statement category (d) The measurement basis used (e) Amounts due to or from related parties and the terms and conditions relating thereto (f) Contractual obligations with related parties, separate from other contractual obligations (g) Contingencies involving related parties, separate from other contingencies Paragraphs provide additional clarification on the disclosure requirements above. To learn more about these items or for application guidance, please contact our Private Client Services practice at privatecompanyinfo@ca.ey.com. Understanding ASPE Section 3840, Related Party Transactions 5

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8 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com/ca Ernst & Young LLP. All Rights Reserved. A member firm of Ernst & Young Global Limited ED None This publication contains information in summary form, current as of the date of publication, and is intended for general guidance only. It should not be regarded as comprehensive or a substitute for professional advice. Before taking any particular course of action, contact Ernst & Young or another professional advisor to discuss these matters in the context of your particular circumstances. We accept no responsibility for any loss or damage occasioned by your reliance on information contained in this publication. ey.com/ca