UNDERSTANDING RELATED PARTY TRANSACTIONS
Most Corporate institutions will prefer to engage in business deals with entities with whom they are familiar with or have common interest. Although these types of transactions are legal, they potentially could create a conflict of interest or lead to other situations that bring about some form of illegality.
A related-party transaction is an arrangement between two parties that have a preexisting business relationship and thus are conducted with other parties with which an entity has a close association. The most common types of related parties are business affiliates, shareholder groups, subsidiaries, and minority-owned companies. Related-party transactions can include sales, leases, service agreements, and loan agreements
A classic example of a related party transaction is the infamous Enron scandal of 2001, Enron an American Energy Company, used related-party transactions with "special-purpose entities" to help conceal billions of dollars in debt from failed business ventures and investments. The related parties misled the board of directors, their audit committee, employees, and the public. This eventually led to the collapse of the company and the dissolution of accounting firm Arthur Andersen, one of the top five largest accounting firms. The scandal is till this day touted as the biggest audit failure in history and exposes the huge negative potential of related party transactions.
The disclosure of related party information is considered useful to the readers of a company’s financial statements, particularly in regard to the examination of changes in the financial results and financial position over time, and in comparison to the same information for other businesses.
If unchecked, the misuse of related-party transactions could result in fraud and financial ruin for all parties involved.