Thread: RE: paying expenses on behalf of a related party

Hello everyone

I came across a question during the audit of one of our company's clients.

Company A has 60% of the total shares of Company B.
In exchange for the stocks, Company A pays $10,000(which is only a partial amount of the 60% of stocks) as a contributed capital for Company B, and agrees to contribute capital for the rest of the stocks by agreeing to pay for Company B's all operating expenses for the next 18 months.

So.. is this concept of 'paying expenses on behalf of a related party as a contributed capital'
in compliance with GAAP? If so, where would I be able to find any legal evidence(literature) on this matter?


In addition, here comes the tricky part.
Company B 'forecasts' the amount of operating expenses it expects to incurr for the next 18 month, and sets it up as a 'Accounts Receivable'. Company B will credit the A/R account when it actually receives the money from Company A, and debit Cash account.

Is this method in compliance with GAAP? What we were thinking was that Company B would have to ask for reimbursements to Company A everytime an operating expense incurrs, instead of 'projecting' the estimated amount of expenses to come, and deducting from that account.


Any thoughts would be helpful

Thanks in advance

Strange as described but that is often the case.

If I have this right 1) Co A owns 60% of Co B. 2) Co A is obtaining the other 40% thru this estimated expense funding arrangement.

You ask is this OK? Sure, why not, you have real value transferred in return for stock.

The tricky part, what tricky part? Prepaid or paid in arrears, it doesn't matter. Stock (par value) and paid in capital (contributed capital) can be obtained/recorded either from cash or receivable transactions.

Everything thing gets eliminated in consolidation when statements are prepared for Co A, or not if Co A issues a parent only report that reflects their investment instead.

Dear Pat

Well actually, let me put it this way
1) Company A received some stocks from Company B
2) Company A paid some cash for partial amount of the stocks it received
3) Company A plans to pay off the rest by paying operating expenses on behalf of Company B

Anyways, I don't think it plays a big difference, since what you interpreted is similar in context.
So you call this an 'estimated expense funding arrangement'. Is there any literature or evidence regarding that subject?

Thank you

Originally Posted by Pat

Strange as described but that is often the case.

If I have this right 1) Co A owns 60% of Co B. 2) Co A is obtaining the other 40% thru this estimated expense funding arrangement.

You ask is this OK? Sure, why not, you have real value transferred in return for stock.

The tricky part, what tricky part? Prepaid or paid in arrears, it doesn't matter. Stock (par value) and paid in capital (contributed capital) can be obtained/recorded either from cash or receivable transactions.

Everything thing gets eliminated in consolidation when statements are prepared for Co A, or not if Co A issues a parent only report that reflects their investment instead.

These type transactions are always better if written and specific/well defined. Call it anything you like as it is non standard. Here you're selling/buying stock at a variable cost/price that may or may not have limits. If completed as described there is no issue; if not, the issue is whether there was an enforceable contract and what is the remedy. So the literature you seek may be in the case law not the accounting.

ok, so it definitely would be treated as a 'contributed capital' in either way.

What concerns me is another problem :

1) Company B makes a agreement (contract) with Company A, in which Company A will reimburse all operating expenses of Company B in the next 18 months
2) Company B 'forecasts' the operating expenses that it expects to incurr in the next 18 months

3) Company B sets up an 'Accounts Receivable' based on the 'forecast' from 2), and credits(deducts) the account when an operating expense occurrs and Company A actually pays for it.

So, is this 'forecasting' and seting up an estimated 'Accounts Receivable'
and holding it as an asset account legit? I mean, both companies have the contract setup and everything, but still, wouldn't it be going against the GAAP?

I've never seen the word "exact" used in GAAP literature. Nor have I seen a requirement that any entry must be exact (known precisely) before it can be recorded.

Accounting is full of estimates ranging from the estimated life of an asset to recording pension and health care costs and liabilities. Or how about that reserve for bad debts or in how much deferred revenue to recognize or percentage completion contracts.

Of course there is the obligation to adjust or restate as the literature requires as facts change.