Under FASB ASC 850, a company’s financial statement footnotes must disclose material transactions with related parties by covering four things: the nature of the relationship, a description of the transaction, the dollar amounts for each period an income statement is presented, and any outstanding balances between the parties along with their settlement terms. The standard exists because deals between affiliated parties may not reflect true market conditions, and users of the financial statements need enough information to judge that for themselves.
Who Counts as a Related Party
The scope is wider than parent-subsidiary ownership, and defining the circle too narrowly is where many preparers slip up. ASC 850 pulls in the following categories:
- Affiliates — any entity that controls the reporting company, is controlled by it, or shares common control. Control means the power to direct management and policies through ownership, contracts, or other arrangements.
- Equity method investees, because the investor is presumed to have significant influence over the investee’s operations.
- Employee benefit trusts, such as pension plans and profit-sharing trusts managed by or on behalf of the entity’s management.
- Principal owners holding more than 10% of the entity’s voting interests, plus their immediate family members who could influence or be influenced by the owner.
- Management — directors, executive officers, and anyone else with authority to plan, direct, or control the entity’s activities — and their immediate family members.
- Any other party that can significantly influence the management or operating policies of either side of a transaction, even without formal ownership.
Figuring out who belongs in “management” takes judgment. A general manager at a regional subsidiary might not qualify, while the CFO of a holding company almost certainly does. The test is whether the individual has genuine authority over the entity’s direction, not the seniority of the title.
“Immediate family” is similarly a judgment call. The concept captures family members close enough to influence or be influenced by the principal owner or manager because of the relationship. Spouses, children, siblings, and in-laws are the obvious cases, and the analysis should extend to anyone sharing a household with the related individual.
Which Transactions Trigger Disclosure
ASC 850 reaches almost anything that transfers value or creates a financial arrangement between related parties. Typical categories include:
- Property transfers — sales, purchases, or exchanges of real estate, equipment, inventory, or other assets.
- Financial arrangements — loans, lines of credit, debt guarantees, and compensating balance agreements maintained for the benefit of a related party.
- Service agreements — management fees, accounting or legal services, consulting arrangements, and technology support.
- Leases — any arrangement granting the use of property or equipment, whether operating or finance.
- Cost allocations — shared overhead, administrative expenses, or other intra-entity billings among commonly controlled entities.
Zero-dollar arrangements count. If a parent provides free legal counsel to a subsidiary, or an owner lets the company use a building rent-free, those arrangements require footnote disclosure. The point is transparency about the relationship, not just the cash flow.
Materiality here is not purely quantitative. Related party transactions carry inherent sensitivity, so smaller-dollar transactions can be material because of their nature. A $50,000 consulting fee paid to the CEO’s spouse might be immaterial by the numbers but material because of who is on the receiving end. Weigh the qualitative factors alongside the dollar amounts.
The Four Required Disclosure Elements
Once a material related party transaction is identified, the footnotes need to cover all four of the following.
Nature of the Relationship
Identify the related party category clearly. “Parent company,” “principal owner,” or “entity controlled by a member of management” are the kinds of labels that belong here. Vague references to “an affiliated party” without saying how the party is affiliated fall short.
Description of the Transaction
Explain what happened, including the terms and how the transaction was or will be settled. The reader needs enough context to understand the economic effect on the reporting entity.
Dollar Amounts
Quantify the transaction for each period for which an income statement is presented. If the method used to establish the terms changed from the prior period, describe that change and its effect.
Outstanding Balances and Settlement Terms
Report amounts due from or to related parties as of each balance sheet date, separated from ordinary trade receivables and payables. Include settlement terms when they aren’t otherwise obvious. This is the piece that most often ends up undercooked. “Due on demand” and “payable in 12 monthly installments at 5% interest” communicate very different risk profiles, so if the terms aren’t apparent from the face of the financial statements, spell them out.1Financial Accounting Standards Board. Statement of Financial Accounting Standards No. 57 Related Party Disclosures
Claiming Arm’s-Length Terms
Related party transactions are generally presumed not to be arm’s-length deals, because the competitive dynamics that discipline pricing between strangers may not exist between affiliated parties. ASC 850 does allow management to represent that a specific transaction was on terms equivalent to those with unrelated parties, but only if the representation can be substantiated.1Financial Accounting Standards Board. Statement of Financial Accounting Standards No. 57 Related Party Disclosures
Substantiation means comparable market data for identical or near-identical transactions with unrelated parties. Vague references to “market rates” without supporting evidence don’t cut it, and the standard explicitly warns against implying arm’s-length terms unless the proof is robust. If the company leased office space from an entity owned by the CEO, claiming the lease was at market rates requires actual comparable lease data for similar properties in the same area. Without that documentation, the assertion should be omitted rather than left in the footnote unsupported.
When Disclosure Isn’t Required
ASC 850 has several narrow carve-outs.
Transactions Eliminated in Consolidation
Intercompany transactions that wash out during consolidation do not require disclosure in the consolidated financial statements. A loan from a parent to its wholly owned subsidiary, for example, disappears in the group-level report. If that subsidiary issues standalone financial statements, though, the loan must be disclosed there, because users of the subsidiary’s individual financials need to know about the parent’s involvement.
Ordinary Course Compensation
Standard compensation arrangements and expense allowances for management do not require ASC 850 disclosure when they occur in the ordinary course of business. Regular salary, bonus, and benefits packages are covered by other rules, including proxy statement requirements for public companies.
This exemption breaks down as soon as the arrangement steps outside normal employment terms. A personal loan from the company to an executive, a below-market lease on company property for a director’s use, or a consulting arrangement with a board member’s family business all fall outside the ordinary course and require full related party disclosure.
Common Control Even Without Transactions
One provision often gets overlooked: ASC 850 requires disclosure of certain common control relationships even when no transactions have occurred between the entities. If common ownership or management control could cause the reporting entity’s operating results to differ significantly from what they would be if the entity operated independently, the nature of that control must be disclosed. The risk the standard targets is the potential for influence, not just its exercise.
Extra Requirements for Public Companies
ASC 850 sets the U.S. GAAP baseline. Public companies have two additional layers to worry about that overlap with, but are not the same as, ASC 850.
SEC Regulation S-K Item 404
Item 404 requires disclosure in proxy statements and Form 10-K of any transaction exceeding $120,000 in which a related person has a direct or indirect material interest. For smaller reporting companies, the threshold is the lesser of $120,000 or 1% of the company’s average total assets for the last two completed fiscal years.2eCFR. 17 CFR 229.404 – (Item 404) Transactions With Related Persons, Promoters and Certain Control Persons
The SEC’s definition of “related person” is not identical to ASC 850’s. Under Item 404, related persons include directors, executive officers, nominees for director, holders of more than 5% of the company’s voting securities, and the immediate family members of all of these individuals.2eCFR. 17 CFR 229.404 – (Item 404) Transactions With Related Persons, Promoters and Certain Control Persons Note the 5% ownership trigger for SEC purposes compared with the 10% threshold for “principal owner” under ASC 850. A 7% shareholder’s transactions would require SEC proxy disclosure but might not fall within ASC 850’s principal owner definition. Public company preparers need to run both analyses. Item 404 also requires a description of the company’s policies and procedures for reviewing related person transactions.
SOX Section 402 Loan Prohibition
Sarbanes-Oxley Section 402, codified at 15 U.S.C. § 78m(k), goes beyond disclosure. It makes it unlawful for any issuer to extend or maintain credit in the form of a personal loan to any of its directors or executive officers. The prohibition covers direct loans, indirect arrangements through subsidiaries, and renewals of existing credit.3Office of the Law Revision Counsel. 15 USC 78m – Periodical and Other Reports
Loans that were outstanding on July 30, 2002 are grandfathered, but only if they haven’t been materially modified or renewed since. Narrow exceptions exist for home improvement loans, consumer credit, and broker-dealer margin loans made in the ordinary course of the issuer’s consumer credit business, available to the general public on the same terms, and offered at market rates. Banks and other insured depository institutions can also continue making loans to their own officers and directors under the separate insider lending restrictions in federal banking law.3Office of the Law Revision Counsel. 15 USC 78m – Periodical and Other Reports
For a public company preparer, the practical order of operations is to identify the population of related parties under both ASC 850 and Item 404, run each material transaction through both frameworks, and check any officer or director loan against Section 402 before it goes further. The ASC 850 footnote is where the accounting disclosure lives, but the proxy disclosure and the SOX prohibition can pull in transactions or parties that the footnote alone would miss.