Related Party Transactions
Why a company selling goods to its own promoter's other business, at a price nobody outside the family would ever agree to, is completely legal — as long as it's disclosed loudly enough for everyone to see.
In plain English
Imagine a listed company sells a large chunk of its output every year to another company majority-owned by the same family that controls the listed company. Nothing about this is automatically illegal or even necessarily bad for minority shareholders — group companies genuinely do business with each other all the time, often for good operational reasons. But it creates an obvious risk: what if the price charged isn't a fair, 'arm's length' market price, but instead quietly favours the OTHER company at the listed company's expense, shifting value out of public shareholders' pockets? Related Party accounting doesn't ban these transactions — it forces them into the open, so anyone reading the accounts can judge for themselves whether they look fair.
Words you'll need first
Broadly, any person or entity that can influence, or be influenced by, the reporting company in a way that isn't purely at arm's length — this includes the company's own key management personnel and close family members, its parent and subsidiary companies, other companies under common promoter control, and entities where the company's own directors or major shareholders hold significant influence. The defining test isn't a specific ownership percentage alone, but whether a genuine, non-arm's-length RELATIONSHIP exists that could affect how a transaction gets priced or structured.
A transaction priced and structured as if the two parties were genuinely independent strangers, each looking out for their own interest — essentially, the price a normal, unrelated third party would have charged or accepted for the same goods, service, or loan under the same conditions. The whole point of Related Party disclosure is to let readers judge whether a transaction between connected parties was actually conducted at arm's length, or whether the relationship was used to strike a more favourable-than-market deal for one side.
A worked example, with numbers
| Item | Value |
|---|---|
| Sale price to unrelated (arm's length) customer | ₹100/unit |
| Sale price to promoter-owned related party | ₹80/unit |
| Implied value shifted per unit sold (below-market pricing) | ₹20/unit |
| On, say, 5 lakh units sold to the related party | ₹1 crore effectively transferred out |
- Even though both sales are perfectly legal and might individually look like ordinary business, the ₹20-per-unit gap represents value that has effectively moved from the listed company, and so from ALL its shareholders, into a business the promoter family owns entirely for itself.
- Ind AS 24 doesn't stop this transaction from happening — but it DOES require disclosure of the relationship and the transaction value, and (increasingly, under SEBI's listing regulations) specific approval by independent directors and, above certain thresholds, by shareholders themselves.
- This is exactly why the Related Party Transactions note in an annual report, often overlooked as a dry, technical disclosure, is one of the more important places to check for potential value leakage away from minority shareholders.
- A pattern of a listed company's margins on related-party sales being consistently lower than on unrelated sales, visible by comparing disclosed related-party transaction values against overall revenue, is a red flag worth investigating further, not proof of wrongdoing on its own.
What it does to the financial statements
Impact on the P&L
- Related party transactions flow through the P&L exactly like any other transaction — there's no separate 'related party' line item; the DISCLOSURE happens separately, in the notes to accounts.
- If related party pricing is genuinely non-arm's-length, a company's REPORTED margins can be systematically distorted, either flattered or depressed relative to what it would show doing equivalent business with unrelated parties.
- Loans or guarantees extended to related parties can create hidden credit risk that doesn't show up as a normal, arm's-length lending relationship would, since the terms may not reflect genuine independent lending decisions.
- Auditors and audit committees are specifically required to scrutinise material related party transactions more closely than ordinary transactions, precisely because of this inherent risk of favourable, non-market terms.
Impact on the Balance Sheet
- Amounts receivable from, or payable to, related parties are required to be separately disclosed in the notes, so a reader can identify how much of a company's working capital is tied up with connected entities.
- Loans and advances to related parties, disclosed separately, deserve particular scrutiny — money advanced to a group entity on favourable terms is effectively a related-party subsidy that doesn't show up as anything unusual on the balance sheet's face.
- A growing balance of related-party receivables that isn't being collected on normal commercial timelines can be an early warning sign of value being extracted from a listed company.
- Under SEBI's listing regulations, related party transactions above prescribed thresholds require prior audit committee approval and, for material transactions, shareholder approval — a structural governance safeguard layered on top of accounting disclosure.
Which standard covers this
In India this is governed by Ind AS 24 – Related Party Disclosures, notified under the Companies (Indian Accounting Standards) Rules, working alongside Section 188 of the Companies Act, 2013 and SEBI's Listing Obligations and Disclosure Requirements (LODR) Regulations, which impose additional approval and materiality thresholds specifically for listed companies.
How it's recognised globally
Globally, the equivalent is IAS 24, and Ind AS 24 mirrors its core definition of a related party and its disclosure requirements closely. Under US GAAP, equivalent guidance sits in ASC 850, sharing the same basic philosophy of disclosure over prohibition. What differs more by jurisdiction than by accounting standard is the surrounding GOVERNANCE and approval framework — India's SEBI LODR regime, with its mandatory independent-director and shareholder approval thresholds for material related party transactions, is comparatively stringent, reflecting the concentrated, promoter/family-controlled ownership structure common among Indian listed companies, versus the more dispersed shareholder base typical of large US-listed companies, where related-party risk more often centres on management and executive compensation arrangements than on transactions with a controlling family's other businesses.
Real example — Indian listed company
India's most consequential historical lesson in why related party and governance disclosures matter is the Satyam Computer Services fraud, which came to light in January 2009 when the company's own chairman, B. Ramalinga Raju, publicly confessed to years of fabricated accounts, including inflated cash balances and fictitious revenue running into thousands of crores of rupees. While the core fraud involved fabricated bank balances and revenue rather than related party pricing specifically, the broader Satyam episode — including an earlier, ultimately abandoned attempt by the company's board to have Satyam acquire two Raju-family-owned companies (Maytas Infra and Maytas Properties) in a deal investors saw as designed to plug a hole in the family's finances using the listed company's cash — became the defining Indian case study for why independent director oversight and related party transaction scrutiny needed to be strengthened. Much of the tightening in India's related party transaction and corporate governance regulations over the years since, including enhanced SEBI LODR requirements around independent director and shareholder approval for related party deals, traces its regulatory lineage directly back to lessons learned from the Satyam episode.
Where you'll see this
Related concepts
Revenue Recognition
Why a builder selling you a flat under construction might now have to wait until you get the keys before it can call the money 'revenue' — even though you've been paying instalments for two years.
Employee Stock Options (ESOPs)
Why a company can hand an employee something worth crores of rupees, pay no cash for it today, and still have to book a real expense against its profit — years before the employee can even sell a single share.
Foreign Currency Translation
Why an Indian IT company's US dollar revenue can grow nicely in dollar terms and still show disappointing growth in rupees — or the other way around — without a single extra dollar of business won or lost.