The lease nobody had listed
The company leases its warehouse from an LLC owned by the founder and her brother. At renewal, the rent went up by a fifth, and the founder signed the new lease twice: once for the tenant, once for the landlord. Six months later, three requests arrive in the same month. The auditor wants a list of related parties. The lender's compliance certificate asks the CFO to confirm that all affiliate transactions are on arm's-length terms. And a buyer's diligence team asks for every agreement with an owner. Nobody has a list. (This is an illustrative example, not a real company.)
The lease may have been fair. Nobody can show it, because nobody with no interest in the deal approved it, and nobody compared the rent to the market.
Related parties hide in ordinary invoices
Related-party transactions rarely look unusual in the ledger. They look like rent, payroll, consulting fees and supplier invoices. The common forms:
- A lease of property owned by a founder, owner or director.
- Relatives of owners or executives on payroll or on contract.
- Loans to or from owners, officers or sister companies.
- Purchases from a business owned by a director, a director's spouse or a major donor.
- Shared services, management fees or cost allocations between entities under common ownership.
None of these is wrong in itself. The policy exists to make sure each one is visible, approved by someone without a stake, and priced in a way you can defend.
What the policy must define
Who counts
Use the definitions your reporting already depends on. Under US GAAP (ASC 850), related parties include affiliates, principal owners and their immediate families, management and their immediate families, and parties that can control or significantly influence each other. A principal owner is an owner of record, or a known beneficial owner, of more than 10 percent of the entity's voting interests.
Nonprofits should add the Schedule L categories of "interested persons": current and former officers, directors, trustees and key employees, their family members, creators or founders, substantial contributors, and 35 percent controlled entities.
What must be disclosed and approved
- Disclosure to the log: every transaction with a related party, whatever the amount.
- Prior approval: every new agreement, renewal or change in terms above a threshold the board sets, and every loan, whatever the amount.
- Prohibited outright: anything your lenders, funders or state law forbid, such as loans to directors where that applies.
Who approves, and how
The interested person discloses the interest in writing and leaves the discussion and the vote. Approval comes from people with no interest: the board, an audit committee or a named group of disinterested directors. The approval record states the alternatives considered and the market evidence used, such as competing quotes, a broker's rent comparison or an appraisal. Organizations with federal awards have one more rule to follow: 2 CFR 200.318 bars anyone with a real or apparent conflict of interest from taking part in selecting, awarding or administering a contract paid for with the award.
Three audiences, three disclosure rules
Financial statements under ASC 850
For material related-party transactions, ASC 850 requires disclosure of the nature of the relationship, a description of the transactions (including those recorded at no amount or a nominal amount), the dollar amounts for each period presented, and amounts due to or from related parties with the terms and manner of settlement. Compensation arrangements, expense allowances and similar items in the ordinary course of business are excluded. One rule catches many drafts: a note may not describe a transaction as on arm's-length terms unless that claim can be substantiated.
Form 990 Schedule L for nonprofits
Schedule L follows from the Form 990 Part IV checklist, and each part has its own trigger:
- Part I, excess benefit transactions. Section 501(c)(3), 501(c)(4) and 501(c)(29) organizations only.
- Part II, loans to and from interested persons. Loans outstanding at year end, reported regardless of amount.
- Part III, grants or assistance to interested persons. Reported regardless of amount.
- Part IV, business transactions. Reported if any one test is met: total payments to the interested person for the year exceed $100,000; a single transaction exceeds the greater of $10,000 or 1 percent of the organization's total revenue; compensation to a family member of a current or former officer, director, trustee or key employee exceeds $10,000; or a joint venture in which the organization has invested $10,000 or more and both it and the interested person hold more than 10 percent of the profits or capital at some point in the year.
Form 990 Part VI also asks whether the organization has a written conflict of interest policy, whether covered people must disclose their interests every year, and how compliance is monitored and enforced, which is described on Schedule O. The thresholds above come from the IRS instructions revised in December 2024. Your return preparer makes the filing decisions.
Lender covenants
Credit agreements and bond indentures commonly include a transactions-with-affiliates covenant. It typically requires affiliate deals to be on terms no less favorable to the borrower than an arm's-length deal, approval by disinterested directors above one threshold, and sometimes an independent fairness opinion above a higher one. The definitions and carve-outs vary by agreement. Read your own, map its definition of "affiliate" to your log, and keep the evidence that supports each compliance certificate the CFO signs.
The annual related-party workflow
This workflow assumes a calendar fiscal year. Shift the months to match yours.
| When | Step | Owner | Evidence kept |
|---|---|---|---|
| January | Send annual disclosure questionnaires to directors, officers, key employees and owners above 10 percent | Corporate secretary or general counsel | Signed questionnaires |
| January to February | Update the related-party list and flag each related entity in the vendor and customer master files | Controller | List with version date, master file report |
| Every new deal or renewal | Disclosure, market comparison and approval by people with no interest, before signing | Requester and disinterested approvers | Approval memo, quotes or appraisal, minutes |
| Monthly | Match payments and receipts against the list and post new items to the log | Accounts payable lead | Log entries with amounts |
| Quarterly | Report the log to the board or audit committee, with new items highlighted | CFO | Board pack page, minutes |
| Quarterly, with lender reporting | Check affiliate transactions against the covenant before signing the certificate | CFO | Covenant checklist |
| Year-end close | Confirm balances due to and from related parties, with terms and settlement | Controller | Confirmations, reconciliation |
| Audit fieldwork | Give the auditor the list and the log, and sign the related-party representation | CFO and chief executive | Representation letter |
| Return preparation | Map the log to Form 990 Part IV and Schedule L tests (nonprofits) | Controller and return preparer | Schedule L workpaper |
| Annually | Board reviews the policy, the thresholds and any breaches | Board or audit committee | Minutes, revised policy |
Test the log against the ledger
Questionnaires catch what people remember to declare. The ledger catches what they forget, or prefer not to mention. Once a year, compare the vendor master with employee and director records: shared street addresses, shared bank accounts, shared phone numbers or tax IDs, and vendor names that match a family name on the questionnaires. Look for payments to a new vendor set up by the person who also approves its invoices. Each match is either a related party that belongs in the log, or an explanation worth writing down. Full-population tests of this kind are part of full-ledger analytics.
Where to start
Send the disclosure questionnaire before your next audit, and build the first version of the log from the answers and a vendor-master match. Then ask the board to adopt the approval rule. If you want the policy, the approval workflow and the board reporting reviewed together, that is part of our board and governance review. For the questions a board should put to the CFO about the log each quarter, see twelve questions boards should ask the CFO.