“Updates: Related party disclosures and reporting” by Leovina Mae P. Villa-Chua (April 30, 2012)

SUITS THE C-SUITE By Leovina Mae P. Villa-Chua
Business World (04/30/2012)

Because of the recent crises that rocked the world economy, regulators have been strengthening rules and policies to protect the investing public against unscrupulous business practices. Modern-day stories of business failures would point to undisclosed related party transactions as one of the reasons for the “sudden deaths” of companies, leaving the investing public holding the bag.

Investors or shareholders who are not part of the management team often find it difficult to guess the rationale for the company’s actions, and the nature of the transactions it entered into. More often than not, they can rely only on the news, disclosures in the stock exchange, and most especially, in the audited financial statements.

Amendments to PAS 24

Since 2003, companies have been required to comply with Philippine Accounting Standard (PAS) 24, Related Party Disclosures. This standard seeks to ensure that related party transactions and balances are properly disclosed, as they may affect an entity’s financial position and results of operation.

Under the standard, a related party transaction is defined as “a transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.”
To avoid differing interpretations, the International Accounting Standards Board issued amendments and clarifications to the Related Party Disclosures standard. The amendments were approved and adopted in the Philippines and became effective for annual periods beginning on or after January 1, 2011, and will be applied retrospectively. Among others, these amendments clarify the broad definition of a related party. Thus:

• When an investor has control over an entity (subsidiary) and has significant influence over another entity (associate), the investor, the subsidiary and the associate are related parties to each other;

• When a person (or a close member of that person’s family) has significant influence over two associates, these associates are not related parties due to insufficient influence;

• Where the key management personnel of an entity hold an investment which result in control or joint control of an investee, the entity and the investee are related parties to each other;

• When a person has joint control over an entity and a close member of that person’s family has joint control or significant influence over another entity, both entities are related to each other.

With this clarification, some companies may need to review their relationships with other companies and report additional related parties in the financial statements. Care must likewise be taken to ensure that the relationship is appropriately established to enable an entity to be disclosed as a related party of another.

One must remember to treat the definition of a related party in a consistent manner – that is, if the first party is related to a second party, then, it follows that the second party is related to the first. As such, in their respective financial statements, both should disclose the nature of the relationship, transactions and balances between them.

Amendments to SRC Rule 68

In addition to the requirements of PAS 24, the Securities and Exchange Commission (SEC) also issued amendments to Securities Regulation Code (SRC) Rule 68 that are effective for audited financial statements covering periods ending December 31, 2011 and onwards, and for interim financial statements starting the first quarter of 2012, and thereafter.

SRC Rule 68 prescribes the required content and form of financial statements that must be filed with the SEC, including those which may impact the related party reporting of an entity. These requirements are in addition to those that may be required by relevant accounting standards. Non-compliance with the financial reporting disclosure rules may be subject to SEC sanctions.

One requirement is to disclose the balances and volumes during the period, and the specific terms of the payables and receivables to each related party, even if these amounts are eliminated during consolidation.

Hence, even if the consolidated statement of financial position does not reflect balances from these related parties, affected companies are now required to provide this information in the schedules submitted to the SEC, together with the consolidated financial statements, to allow the readers of the financial statements to have an idea of the magnitude of eliminated related party transactions. This was further clarified by the SEC in Financial Reporting Bulletin No. 003, indicating that the information previously mentioned need not be comparative and shall cover only those transactions eliminated at the reporting entity’s level.

On transactions with DOSRI (directors, officers, stockholders and related interests), the amended SRC Rule 68 requires investment houses to submit schedules showing the name of the related party, description and volume of transactions, terms and conditions, among others. Furthermore, listed companies and investment houses are required to submit a map showing the relationships between and among the company and its ultimate parent company, middle parent, subsidiaries or co-subsidiaries and associates.

The increased level of required disclosures will be challenging for many companies. One has to consider the amount of disclosures that should be presented, as some businesses may opt to hold back information to maintain their “trade secrets.” This will test the companies’ ability to balance what the laws and regulators require vis-à-vis what the companies think would be sufficient information to allow the users of its financial statements to arrive at informed decisions. Moreover, companies need to ensure that relevant data are gathered early enough to be able to meet financial reporting deadlines.

True to the SEC’s mission of “strengthening the corporate and capital market structure of the Philippines, and to maintain a regulatory system based on international best standards and practices that promotes the interests of investors in a free, fair and competitive business environment,” amendments to SRC Rule 68 allows for transparent and consistent reporting of related party transactions.

This allows shareholders to keep a watchful eye on related party transactions of their investee companies. The challenge to the SEC, however, is how it can continuously protect the shareholders’ interests without imposing undue costs on the companies.

Interest in related party transactions is a global trend, given the widespread clamor for more transparency in financial reporting. In fact, as regulations and disclosure requirements tighten everywhere, management should waste no time in equipping its businesses with the necessary tools to meet the informational needs of its shareholders – who, ultimately, are their bosses.

Leovina Mae P. Villa-Chu is a Partner of SGV & Co.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.