16. Related Parties

Question 1

Define related parties and give example?

Answer 1

Related party means a related party as defined in the AFRF. Otherwise, the individuals or organizations that have a control over the entity or the organization on which the entity has control or organizations under a common control.
Example:
companies in the same group, majority shareholders and their close relatives, other entities controlled by majority shareholders or close relatives.

Question 2

Define related party transactions?

Answer 2

Related party transactions are transactions between client company and its related party.
Example:
sale of asset
receiving services
giving loan or guarantee

Question 3

Why is risk higher in related party transactions?

Answer 3

1. they may operate through complex relationships
2. management may be unaware of existence of all related parties
3. transactions may not be conducted at arm’s length basis.
4. management may commit fraud through collusion.

Question 4

What is the responsibility of management regarding related parties?

Answer 4

If AFRF prescribes related party requirements, it is the responsibility of management to identify, account for and disclose related party transactions in financial statements.

Question 5

What is the responsibility of auditor regarding related parties?

Answer 5

1. Responsible to obtain understanding of related party relationships and transactions to risk.
2. Responsible to obtain evidence that:
   all relationships and transactions are identified, accounted for and disclosed.
   statements give true and fair view or are not misleading.

Question 6

What are the procedures to ensure completeness of related parties?

Answer 6

1. inspect working papers for previous years for known related parties
2. inquire other audit firms involved in the audit about their knowledge
3. inquire predecessor auditor
4. inquire about affiliation of TCWG and other officers with other entities.

Question 7

How to respond if related party transactions are not properly accounted for?

Answer 7

If management makes the assertion that related party transactions were on arm’s length basis, auditor shall obtain sufficient appropriate evidence about this assertion.
Management may provide the following evidence:
comparing terms in open market
comparing terms with unrelated parties
engaging an external expert.
Auditor shall:
consider the appropriateness of managements process
verify source of data
evaluate reasonableness.

Question 8

What to do when auditor identifies party relation or transactions not identified by management?

Answer 8

1. communicate information to assist them in determining whether risk should be revised or not.
2. If AFRF prescribed transactions; inquire as to why entity failed to identify these transactions and request management to identify all transactions with newly identified transactions.
3. perform substantive procedures on newly identified related party.
4. reconsider risk of completeness

Question 9

Give examples of transactions outside the entity’s normal course of business?

Answer 9

Equity transactions
Transactions with offshore entities
Providing property or services without consideration
Sales with unusual large discounts
Transactions whose terms are changed before expiry

Question 10

If there is a significant transactions outside normal course of business, what should be the response?

Answer 10

Auditor shall inquire the management and evaluate about business rationale and whether related party is involved.
If a related party is involved, auditor shall consider it a significant risk and inspect underlying contracts to evaluate if there is an indication of fraud in financial statement and if terms are consistent with management’s explanations and if the transactions have been properly accounted for and disclosed.

Question 11

How to evaluate business rationale?

Answer 11

See whether the transaction is:
overly complex, has usual terms, lacks a logical business reason, processed in an unusual manner.
See whether management has discussed the nature and accounting of such transaction with TCWG.

Question 12

What to do if there is a related party with a dominant influence?

Answer 12

There is fraud risk factor. Following are the indicators:
Founder of entity is also managing the entity,
Significant transactions are referred for approval,
Little or no debate on proposals.