Related Party Transactions - Risks and Opportunities for Ulterior Purposes - Essay Example

Related party transactions (RPTs) are normal transactions in the business world, but these transactions open a range of opportunities to manipulate financial statements for the ulterior or other motives of the management.

          Risks and opportunities for ulterior purposes  “Related party transaction occur when the firm participates in a transaction with another party or person that is not at arm’s length”(J. Edward Ketz, page 13). Parties are said to be related if one party is able to control the other party, whether directly or indirectly; or one party can exercise significant influence in the other party’s financial and operational decision making. Further management personnel and their close relatives are also called related parties.

Related party transactions (RPTs) are normal in the business world. It is quite easy to affect the financial and operational policies of a subsidiary through RTPs, but RTPs are often used for ulterior motives of the entity. For example, goods may be sold to subsidiaries at favorable prices just to shift the profits of the parent company. “The existence of a related party relationship may expose a reporting entity to risks or provide an opportunity which would not otherwise have existed.

Such a relationship may, therefore, have a material effect on financial position, performance, financing, and investing of an entity.”(RSM Chio Limp, page 34)  In other words, RPTs provide a source whereby financial statements can be misstated at the instance of management. Related party transactions provide a sort of cover to the transactions that are not in the best interests of stakeholders. For example, in order to convert a successful business performance into losses, purchases from related parties may be shown at higher rates.

That is why various disclosures are required for RPTs. Chances of the existence of a fraud increase when RPTs are not disclosed or declared as per statutory or other requirements. Though all RPTs are not abnormal business transactions there exists an opportunity for abnormalities not in favor of stakeholders.