Page 454 - SBR Integrated Workbook STUDENT S18-J19

Chapter 25

Chapter 15

Example 1

Related party transactions

The subsidiaries of X are related parties to each other and to X itself as they
are under common control.

If the director’s figures are accurate B would have made a profit on these
transactions of $6 million ($20m – $14m) rather than the $1 million it has
actually made. The obvious implication of this is that the transactions have
moved profits from B to A. The transactions will also affect reported revenue
and cost of sales and working capital in the individual financial statements of A
and B.

Some might argue that as the profit remains within the group, there is no real
overall effect as, in the consolidated financial statements, intra-group
transactions are eliminated. This is not entirely true.

 B has a non-controlling interest of 45% and they have been deprived of
their share of the $5 million transferred profit.

 There is a similar effect on the profit share that the directors of B might
be entitled to under the group profit sharing scheme as B’s profits are
effectively $5 million lower than they should be.

 The shareholders of B would find it difficult to appraise its true
performance. The related party transaction gives the impression that B is
under-performing.

 The tax authorities may wish to investigate the transactions under
transfer pricing rules. The profit may have been moved to A’s financial
statements to avoid paying tax in B’s tax jurisdiction which may have
high levels of taxation.

 A’s results look better than they would have without the transaction. This
may have been done deliberately. X may intend to dispose of A in the
near future and thus its more favourable results may allow X to obtain a
higher sale price for A.

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