During the accounting year, it is very important to ensure that transactions are carried out, in a proper manner, which is permitted by law and play out in the favor of the parties involved. In this regard, an arm’s length transaction is a concept that is used by accountants in order to ascertain the existing viability of the transaction. Therefore, transactions are supposed to be considered at an arm’s length, for the greater good, for the professionalism, and for the parties involved.
In literal terms, arm’s lengths transactions can be defined as business deals that involve buyers and sellers to act independently with no influence on each other, whatsoever. These types involve companies to act in their personal self-interest, as compared to transactions that are favoring the other party, because of an inherent pressure from one of the party. The main rationale behind this is to ensure that there is no form of collusion between either of the parties. Therefore, by that premise, both the parties are supposed to have equal information relating to the deal.
How to assess if Transactions are conducted at an Arm’s Length?
In the normal course of business, it is important to have independence when it comes to business transactions that might possibly favor one party at the expense of the other. The main reason when this occurs when there are Related Parties involved. These related parties might involve people being in relationships, or in some other manner that might give them a reason to act in other’s person’s interest as opposed to their own self-interest.
Therefore, in order to assess if the transactions are conducted at an arm’s length, the following fundamental features are important to be considered:
- Firstly, it is important to ensure that within the transactions that have taken place, there are no related parties that are involved in the transaction that has taken place. The biggest red flag in this regard is when the transaction within the company is made to a family member, or some close association within the company.
- If there are some things that are different from the norm, and cannot be considered as benchmarked, it is important to look deeper into the transaction itself. For example, if someone has provided an exceptional discount, or an extended favor that is not normal, then such a transaction needs to be looked into.
- In the same manner, if a transaction does not have proper paper work, or does not have sufficient evidence to back the associated transaction, then it is a red flag, which might be needed to be probed further into.
However, the biggest determinant that can be used to assess if transactions are at an arm’s length is the overall nature of the transaction. In the same manner, in case of transactions that take place between related parties, it is imperative to consider if they were actually conducted at an arm’s length or not. Therefore, for this very reason, accountants are supposed to ensure that they disclose all the transactions that take place between related parties.
After subsequent disclosure, the accountants and the officers are then supposed to ensure that these related party transactions have been conducted at an arm’s length or not. This is mostly done by drawing a comparison of these transactions to the general market trend. Benchmarks can be used in order to properly ascertain if these transactions have been conducted in a transparent, or a free and fair manner.
The importance of companies carrying out transactions at an arm’s length can simple be gauged by the fact that it directly impacts the credibility of the company, and helps companies to make sure that they are able to carry out transactions that are free and fair from any favors, or unethical standards. Therefore, they are supposed to be increasingly vigilant about their transactions, as well as their staff dealings, in order to ensure that transactions or business dealings are not ethically violated in any manner whatsoever.
It can be seen that it is highly important for accountants as well as auditors to ensure that they are able to ascertain the viability of all the transactions. This is because it otherwise takes a negative toll on the reputation, and the professionalism of the company, in case they are known for being involved in transactions that are not entirely independent, or transparent.