How are “related party transactions” treated under GAAP?

• A. They are ignored in financial statements
• B. They need to be disclosed in the financial statements due to their potential impact on the financial position of the company
• C. They are classified as regular transactions
• D. They are exempt from audit review

Answer: (B)

Under Generally Accepted Accounting Principles (GAAP), related party transactions need to be disclosed in the financial statements because they can significantly affect the financial position and results of operations of the reporting entity. These transactions may not reflect market conditions due to the special relationships or arrangements involved, which could lead to potential conflicts of interest or non-arm's length agreements.

The disclosure requirements aim to provide transparency to users of financial statements, such as investors and creditors, so that they can understand the potential implications of these transactions on the company's financial health and performance. By requiring firms to disclose such transactions, GAAP ensures that stakeholders have a fuller picture of the financial arrangements and dealings within the company, which helps in assessing risks and making informed decisions.