Pipara & Co LLP

Related Parties

Introduction

Scope of this SA
  1. This Standard on Auditing (SA) deals with the auditor’s responsibilities regarding related party relationships and transactions when performing an audit of financial statements. Specifically, it expands on how SA 3151, SA 3302 and SA 2403 are to be applied in relation to risks of material misstatement associated with related party relationships and transactions.
Nature of Related Party Relationships and Transactions
  1. Many related party transactions are in the normal course of business. In such circumstances, they may carry no higher risk of material misstatement of the financial statements than similar transactions with unrelated parties. However, the nature of related party relationships and transactions may, in some circumstances, give rise to higher risks of material misstatement of the financial statements than transactions with unrelated parties. For example:
  • Related parties may operate through an extensive and complex range of relationships and structures, with a corresponding increase in the complexity of related party transactions.
  • Information systems may be ineffective at identifying or summarising transactions and outstanding balances between an entity and its related parties.
  • Related party transactions may not be conducted under normal market terms and conditions; for example, some related party transactions may be conducted with no exchange of consideration.
Responsibilities of the Auditor
  1. Because related parties are not independent of each other, many financial reporting frameworks establish specific accounting and disclosure requirements for related party relationships, transactions and balances to enable users of the financial statements to understand their nature and actual or potential effects on the financial statements. Where the applicable financial reporting framework establishes such requirements, the auditor has a responsibility to perform audit procedures to identify, assess and respond to the risks of material misstatement arising from the entity’s failure to appropriately account for or disclose related

1 SA 315, “Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment”.

2 SA 330, “The Auditor’s Responses to Assessed Risks”.

3 SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”.

party relationships, transactions or balances in accordance with the requirements of the framework.

  • Even if the applicable financial reporting framework establishes minimal or no related party requirements, the auditor nevertheless needs to obtain an understanding of the entity’s related party relationships and transactions sufficient to be able to conclude whether the financial statements, insofar as they are affected by those relationships and transactions: (Ref: Para. A1)
  1. Achieve a true and fair presentation (for fair presentation frameworks); or

(Ref: Para. A2)

  • Are not misleading (for compliance frameworks). (Ref: Para. A3)
  1. In addition, an understanding of the entity’s related party relationships and transactions is relevant to the auditor’s evaluation of whether one or more fraud risk factors are present as required by SA 2404 because fraud may be more easily committed through related parties.
  2. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the SAs5. In the context of related parties, the potential effects of inherent limitations on the auditor’s ability to detect material misstatements are greater for such reasons as the following:
  • Management may be unaware of the existence of all related party relationships and transactions, particularly if the applicable financial reporting framework does not establish related party requirements.
  • Related party relationships may present a greater opportunity for collusion, concealment or manipulation by management.

Planning and performing the audit with professional skepticism as required by SA 2006 is therefore particularly important in this context, given the potential for undisclosed related party relationships and transactions. The requirements in this SA are designed to assist the auditor in identifying and assessing the risks of material misstatement associated with related party relationships and transactions, and in designing audit procedures to respond to the assessed risks.

Effective Date

This SA is effective for audits of financial statements for periods beginning on or after April 1, 2010.

Objectives
  1. The objectives of the auditor are:
  1. Irrespective of whether the applicable financial reporting framework establishes related party requirements, to obtain an understanding of related party relationships and transactions sufficient to be able:
    1. To recognise fraud risk factors, if any, arising from related party relationships and transactions that are relevant to the identification and assessment of the risks of material misstatement due to fraud; and
    2. To conclude whether the financial statements, insofar as they are affected by those relationships and transactions:
      1. Achieve a true and fair presentation (for fair presentation frameworks); or
      2. Are not misleading (for compliance frameworks); and
  2. In addition, where the applicable financial reporting framework establishes related party requirements, to obtain sufficient appropriate audit evidence about whether related party relationships and transactions have been appropriately identified, accounted for and disclosed in the financial statements in accordance with the framework.
Definitions
  1. For purposes of the SAs, the following terms have the meanings attributed below:
    1. Arm’s length transaction–A transaction conducted on such terms and conditions as between a willing buyer and a willing seller who are unrelated and are acting independently of each other and pursuing their own best interests.
  • Related party – A party that is either: (Ref: Para. A4-A7)
    1. A related party as defined in the applicable financial reporting framework7; or
    2. Where the applicable financial reporting framework establishes minimal or no related party requirements:
      1. A person or other entity that has control or significant influence,

7 In Indian context, definitions of “Related Party” and “Related Party Transactions” as given in Accounting Standard (AS) 18, “Related Party Disclosures”, issued by the Institute of Chartered Accountants of India, will be applicable for the purposes of this SA, and the said definitions also meet the tests laid down in paragraph 10(b)(ii) of this SA.

directly or indirectly through one or more intermediaries, over the reporting entity;

  1. Another entity over which the reporting entity has control or significant influence, directly or indirectly through one or more intermediaries; or
  2. Another entity that is under common control with the reporting entity through having:
    1. Common controlling ownership;
    2. Owners who are close family members; or
    3. Common key management.

However, entities that are under common control by a state (i.e., a national, regional or local government) are not considered related unless they engage in significant transactions or share resources to a significant extent with one another.

Requirements
Risk Assessment Procedures and Related Activities
  • As part of the risk assessment procedures and related activities that SA 315 and SA 240 require the auditor to perform during the audit,8 the auditor shall perform the audit procedures and related activities set out in paragraphs 12-17 to obtain information relevant to identifying the risks of material misstatement associated with related party relationships and transactions. (Ref: Para. A8)
Understanding the Entity’s Related Party Relationships and Transactions
  • The engagement team discussion that SA 315 and SA 240 require9 shall include specific consideration of the susceptibility of the financial statements to material misstatement due to fraud or error that could result from the entity’s related party relationships and transactions. (Ref: Para. A9-A10)
  1. The auditor shall inquire of management regarding:
  • The identity of the entity’s related parties, including changes from the prior period; (Ref: Para. A11-A14)
  1. The nature of the relationships between the entity and these related parties; and
  2. Whether the entity entered into any transactions with these related parties during the period and, if so, the type and purpose of the transactions.
8 SA 315, paragraph 5; and SA 240, paragraph 16. 9 SA 315, paragraph 10; and SA 240, paragraph 15.
  • The auditor shall inquire of management and others within the entity, and perform other risk assessment procedures considered appropriate, to obtain an understanding of the controls, if any, that management has established to: (Ref: Para. A15-A20)
    1. Identify, account for, and disclose related party relationships and transactions in accordance with the applicable financial reporting framework;
  • Authorise and approve significant transactions and arrangements with related parties; and (Ref: Para. A21)
  1. Authorise and approve significant transactions and arrangements outside the normal course of business.
Maintaining Alertness for Related Party Information When Reviewing Records or Documents
  • During the audit, the auditor shall remain alert, when inspecting records or documents, for arrangements or other information that may indicate the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor. (Ref: Para. A22-A23)
In particular, the auditor shall inspect the following for indications of the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor:
  1. Bank, legal and third party confirmations obtained as part of the auditor’s procedures;
  2. Minutes of meetings of shareholders and of those charged with governance; and
  3. Such other records or documents as the auditor considers necessary in the circumstances of the entity.
  • If the auditor identifies significant transactions outside the entity’s normal course of business when performing the audit procedures required by paragraph 15 or through other audit procedures, the auditor shall inquire of management about: (Ref: Para. A24-A25)
  • The nature of these transactions; and (Ref: Para. A26)
  • Whether related parties could be involved. (Ref: Para. A27)
Sharing Related Party Information with the Engagement Team
The auditor shall share relevant information obtained about the entity’s related parties with the other members of the engagement team. (Ref: Para. A28)
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