A related party is a person or entity connected to the reporting entity through relationships recognized by the applicable financial reporting framework. Under U.S. generally accepted accounting principles (GAAP), identification considers ownership, decision-making power, management responsibilities, and family influence.
Related-party transactions can arise through several relationship categories:
- Control: A party can direct another entity's management and policies through ownership, contracts, or other arrangements. Entities under common control are also related.
- Significant influence: A party can affect another's management or operating policies enough to compromise independent pursuit of separate interests. Actual decision rights matter alongside ownership percentages.
- Principal owners: Recorded owners or known beneficial owners holding more than 10% of the entity's voting interests are related parties under U.S. GAAP.
- Management and family: Management includes people responsible for achieving objectives who possess corresponding decision-making authority.
- Investments and trusts: Related parties include investees whose equity holdings require equity-method accounting, absent a fair value option election, and employee-benefit trusts managed by or under management's trusteeship.
Common mistakes
- Ownership assigned to the entity. Elena's 60% Cedar interest cannot be recorded as Marlon's investment merely because she directs Marlon's operations.
- Concentration establishes related status. The customer producing 48% of sales remains unrelated on the established facts, although the concentration can affect audit planning.
- Resignation erases earlier dealings. An officer's December 31 resignation does not remove related-party transactions completed while that officer served during the year.
Bottom line
- Related-party identification follows the reporting framework's ownership, control, influence, management, and family concepts.
- An executive's personal ownership does not establish an investment held by the reporting entity.
- Identification combines inquiries, understanding management's processes, relevant records, and alertness throughout the audit; written representations do not replace required work.
- Executive dealings and significant unusual transactions can reveal omitted relationships, while unusual transactions can also involve unrelated parties.
Exam shortcut
Mark who owns each interest before classifying the counterparty. Trace personal holdings and corporate holdings separately, then connect actual decision rights to the transaction. Sort the evidence into confirmed facts and unresolved clues. Choose investigation when ownership or influence is missing, and communicate established significant findings while remaining questions are examined.
The full lesson (about 3,959 words, 26 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- II.G3
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