Audit of related parties

Related party is a party that is either:

1. A related party as defined in the applicable financial reporting framework; or

2. Where the applicable financial reporting framework establishes minimal or no related party requirements:

a. A person or other entity that has control or significant influence, directly or indirectly through one or more intermediaries, over the reporting entity.

b. Another entity over which the reporting entity has control or significant influence, directly or indirectly through one or more intermediaries; or

c. Another entity that is under common control with the reporting entity through having:

· Common controlling ownership.

· Owners who are close family members; or

· Common key management

The objectives of the auditor regarding the audit of related party transactions are:

· To recognize fraud risk factors, if any, arising from related party relationships,

· To conclude whether the financial statements achieve fair presentation and are not misleading and

· To obtain sufficient appropriate audit evidence about whether related party relationships and transactions have been properly identified, accounted for, and disclosed in the financial statements (if required by the applicable financial reporting framework).

The main stages of the audit of related parties

The following stages of the audit of related parties could be distinguished:

(a)   Risk Assessment Procedures and Related Activities.

(b) Identification and Assessment of the Risks of Material Misstatement Associated with Related Party Relationships and Transactions.

(c) Responses to the Risks of Material Misstatement Associated with Related Party Relationships and Transactions.

(d)   Evaluation of the Accounting for and Disclosure of Identified Related Party Relationships and Transactions.

Let's consider each of the stages of the audit of related parties.

Risk Assessment Procedures and Related Activities.

The risk assessment procedures and related activities are performed by auditors to obtain information relevant to identifying the risks of material misstatement associated with related party relationships and transactions. These procedures may include:

(a) Understanding the entity’s related party relationships and transactions.

In understanding the entity relating party relations the auditor inquires of management information regarding:

· The identity of the entity’s related parties.

· The nature of the relationships of related party and the type and purpose of such transactions.

· The controls, if any, that management has established to identify, account for, and disclose related party relationships and transactions, authorize, and approve significant transactions and transactions with related parties outside the normal course of business.

(b) Maintaining alertness for related party information when reviewing records or documents.

When performing the audit, the auditor should remain alert for arrangements or other information that may indicate the existence of related party relationships or transactions that management has not previously identified or disclosed in financial statements.

(c) Sharing related party information with the engagement team.

The entity related parties could be identified in the following ways:

· Inquire of management regarding the identity of the entity’s related parties, the nature of the relationships, the type and purpose of the related party transactions.

· Reading previous year audit working papers.

· Reading the financial reports of the entity.

· Obtaining information regarding the entity’s ownership and governance structures; the types of investments that the entity is making and plans to make; the way the entity is structured and how it is financed.

· Obtaining a list of related parties prepared by group management from the group audit engagement team (in the case of component auditor).

· Inspecting records or documents that may provide information about related party relationships and transactions which were not previously identified and disclosed by entity management.

The following records or documents may provide information about related party relationships and transactions:

• Third-party confirmations obtained by the auditor (in addition to bank and legal confirmations).

• Entity income tax returns.

• Information supplied by the entity to regulatory authorities.

• Shareholder registers to identify the entity’s principal shareholders.

• Statements of conflicts of interest from management and those charged with governance.

• Records of the entity’s investments and those of its pension plans.

• Contracts and agreements with key management or those charged with governance.

• Significant contracts and agreements not in the entity’s ordinary course of business.

• Specific invoices and correspondence from the entity’s professional advisors.

• Significant contracts re-negotiated by the entity during the period.

• Reports of the internal audit function.

• Documents associated with the entity’s filings with a securities regulator (for example, prospectuses).

 

Identification and Assessment of the Risks of Material Misstatement Associated with Related Party Relationships and Transactions.

The auditor shall identify and assess the risks of material misstatement associated with related party relationships and transactions and determine whether any of those risks are significant risks. In doing these procedures the auditor should  treat identified significant related party transactions outside the entity’s normal course of business as giving rise to significant risks.

Examples of transactions outside the entity’s normal course of business may include:

• Complex equity transactions, such as corporate restructurings or acquisitions.

• Transactions with offshore entities in jurisdictions with weak corporate laws.

• The leasing of premises or the rendering of management services by the entity to another party if no consideration is exchanged.

• Sales transactions with unusually large discounts or returns.

• Transactions with circular arrangements, for example, sales with a commitment to repurchase.

• Transactions under contracts whose terms are changed before expiry.

If the auditor identifies significant transactions outside the entity’s normal course of business when performing the audit procedures, the auditor shall inquire of management about:

· The nature of these transactions; and

· Whether related parties could be involved.

Responses to the Risks of Material Misstatement Associated with Related Party Relationships and Transactions.

Responses to the risks of material misstatement are further audit procedures to obtain sufficient appropriate audit evidence about the assessed risks of material misstatement associated with related party relationships and transactions. These procedures include:

Identification of previously unidentified or undisclosed related parties or significant related party transactions

If the auditor identifies related parties or significant related party transactions that management has not previously identified or disclosed to the financial statements, the auditor should:

(a) Communicate the relevant information to the other members of the engagement team.

(b) If the applicable financial reporting framework establishes related party requirements request management to identify all transactions with the newly identified related parties and inquire about the reasons of entity control failure to identify related parties’ relations and transactions.

(c) Confirming or discussing specific aspects of the transactions with intermediaries (bankers, lawyers, guarantors, or agents).

(d) Conducting an analysis of accounting records for transactions with the newly identified related parties.

(e) Verifying the terms and conditions of the newly identified related party transactions, and evaluating whether the transactions have been appropriately accounted for and disclosed.

(f) Reconsider the risk that other related parties or significant related party transactions may exist that management has not previously identified.

(g) If the non-disclosure by management appears intentional evaluate the implications for the audit.

Identification of Significant Related Party Transactions outside the Entity’s Normal Course of Business

If the auditor identified significant related party transactions outside the entity’s normal course of business, the auditor must:

(a) Inspect the underlying contracts or agreements, if any, and evaluate:

o whether the business rationale of the transactions,

o the terms of the transactions are consistent with management’s explanations; and

o the transactions have been appropriately accounted for and disclosed.

(b) Obtain audit evidence that the transactions have been appropriately authorized and approved.

Evaluation of the assertions that related party transactions were conducted on terms equivalent to those prevailing in an arm’s length transaction.

If management has made an assertion in the financial statements that a related party transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction, the auditor shall obtain sufficient appropriate audit evidence about the assertion.

Evaluating management’s support for this assertion may involve one or more of the following:

• Considering the appropriateness of management’s process for supporting the assertion.

• Verifying the source of the internal or external data supporting the assertion, and testing the data to determine their accuracy, completeness, and relevance.

• Evaluating the reasonableness of any significant assumptions on which the assertion is based.

Evaluation of the Accounting for and Disclosure of Identified Related Party Relationships and Transactions.

When evaluating whether the misstatement is material the auditor must consider both the size and the nature of a misstatement. The significance of the transaction to the financial statement users may not depend solely on the recorded amount of the transaction but also on the nature of the related party relationship.

In forming an opinion on the financial statements, the auditor evaluates:

(a) Whether the identified related party relationships and transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework.

(b) Whether the effects of the related party relationships and transactions:

· Prevent the financial statements from achieving fair presentation.

· Cause the financial statements to be misleading.

 Audit documentation related to the audit of related parties.

The auditor shall include in the audit documentation the names of the identified related parties and the nature of the related party relationships.

Also, the auditor must include in the audit documentation:

(a) The nature, timing and extent of the audit procedures performed:

· The identifying characteristics of matters tested.

· Who performed the audit work and the date such work was completed; and

· Who reviewed the audit work performed and the date and extent of such review.

(b) The results of the audit procedures performed, and the audit evidence obtained; and

(c) Significant matters arising during the audit, the conclusions reached thereon, and significant professional judgments made in reaching those conclusions.

(d) Discussions of significant matters with management, those charged with governance.