Related-party transactions can adversely affect profit

Managing conflicts of interest could be the next hot topic for accounting disclosures, says Ray Jones

Ray Jones
Ray Jones

At a meeting of a group of accountants a few weeks ago, the focus was on technical issues. Someone raised the subject of what might be the next hot topic for accounting disclosures.

Last year's focus was on executive salary disclosures and, looking further back to the aftermath of the MPs expenses scandal in 2009, how charities report on expenses caused considerable debate. But what will be the next subject to grab attention?

The smart money is on related-party transactions. Thankfully, this is an area where accounting disclosure requirements are well ahead of the game, as is the Charity Commission. We are updating our current guidance on managing conflicts of interest and hope to publish new guidance in the spring.

Recommended practice

Auditors have long paid close attention to the disclosure of charity transactions with directors, senior executives and their close families and with companies or other entities controlled by them.

The accounting standard (FRS 8) on this was issued as long ago as 1995. Indeed, the 1995 Statement of Recommended Practice, issued in the same month as the standard, similarly required the disclosure of material transactions with connected parties.

Since then, the Sorp has further tightened these disclosures, requiring all transactions with related parties to be "presumed material" and extending accounting disclosures to include transactions with entities where related parties have a significant interest.

In the commercial world, this accounting disclosure exists to draw attention to the possibility that the financial results might have been affected by transactions with related parties - quite simply, there is an inherent risk that transactions with a related party might be on favourable terms to one or other of the parties, and this can have an impact on profit.

In the context of charities, the disclosure also provides important stewardship information that allows the user of the accounts to assess the scale of any private benefit. Moreover, disclosure should explain briefly the legal authority for the transaction and auditors should, if they follow charity audit guidance, check the rigour of any internal processes for the approval of the transaction.

Audit assurance

For auditors, it can be difficult to identify related-party transactions, but where potential conflicts of interest are managed transparently and well, obtaining audit assurance is far easier. For example, does your charity keep a register of interests setting out organisations connected with each trustee? Do you have clear procedures to declare any potential conflict of interests? Do you ensure that all transactions with a related party are authorised by the board of trustees? Do your trustees make annual declarations of all related-party transactions of which they are aware?

If not, then the job of your auditor is made difficult and your charity might not be managing potential conflicts of interest as well as it could.

Ray Jones is policy accountant at the Charity Commission

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