ABC Company purchases a material amount of products from another entity whose operating policies can be controlled by ABC Company's management but does not disclose this situation on its financial statements. What type of improper disclosure scheme is this?

• A. Accounting change
• B. Related-party transaction
• C. Improper asset valuation
• D. Significant event

Answer: (B)

Related-party relationships arise when one party can control or significantly influence the operating policies of another, such as management controlling the other entity from which it buys a large share of its products. GAAP requires clear disclosure of these relationships and the terms of related-party transactions, including the nature of the relationship and the amounts involved. If the company buys a material amount from that other entity and does not disclose the relationship on the financial statements, users can be misled about earnings, leverage, and risk because the transactions may not be at arm’s length. This scenario reflects a related-party transaction with disclosure failure, rather than an accounting change, asset valuation issue, or a significant event.