Chapter 16 Related parties Flashcards
Define related party.
- Related party:
a) Organization and individual that has control or influence directly or indirectly over the entity.
b) Organization on which entity has control or influence.
c) Organizations under common control and management.
Example: - Companies under same group i.e. holding, subsidiary, and associated.
- Major SHs, directors, and key management, their close relatives and the entities controlled by them.
Define related party transaction.
The transaction b/w client entity and related party.
example:
1. sale or purchase of assets.
2. Providing/receiving services i.e. consultancy, management or accounting services.
3. Giving or obtaining loan or guaranty.
What are the responsibilities of management regarding related parties?
To identify, account for, and disclose all the related party relationships and transactions in A/C with AFRF.
What are the responsibilities/objectives of the auditor regarding related parties?
- To obtain an understanding of all related party relationships and transactions to assess the risk including the risk of fraud.
- To obtain evidence:
a) Whether the related party relationships and transactions are appropriately identified, account for, and disclose in A/C with AFRF.
b) Whether F/S give true and fair view ( if fair representation framework) or F/S are not misleading(if compliance framework )
Why risk is high in related-party transactions?
- There are inherent limitations that management may be unaware of the existence of all the related parties. Further information system may not identify all the related party relationships and transactions
- The related party transactions may operate through complex relationships and structures.
- The related party transactions may not be at arm’s length basis.
- Management may commit fraud through collusion with related parties.
Specify the procedures to ensure the completeness of related parties.
1) Inquiry:
a) Auditor shall inquire from management regarding:
> Identity of related party relationships.
> Nature of relationship with them.
> Type and purpose of transaction with them.
b) Auditor shall inquire from management and others in entity to obtain understand the controls:
> To identity, account for, and disclose related party relationships and transactions.
> To approve significant transactions with related parties and transactions outside the normal course of business.
2) Discussion among the engagement team:
Auditor shall discuss among the engagement team about related parties. e.g.
> Nature and extent of related party relationships and transactions.
> Focus on maintaining professional scepticism.
> Circumstances, documents, and records that indicate risk of related party relationship or transaction.
3) Inspection:
Auditor shall inspect the following documents:
a) Bank and legal confirmation obtained
b) Minutes of meetings of shareholders and TCWG
c) Other documents e.g.
> 3rd party confirmation
> Register of SHs and Directors
> Entity’s income tax return
> Internal audit reports
> Contracts outside of normal course of business or re-negotiated contracts.
4) Other audit procedures to ensure completeness:
a) Inspect working papers of last year
b) Inquire from other audit firms(incase of group audit) about their knowledge of related parties.
c) Inquire from previous auditor about their knowledge of related parties.
d) Inquire about affiliation of directors with other entities.
Write the procedures to verify the assertion made by management “ Related party transactions are conducted on arm’s length basis”
Management may provide evidence to support the assertions e.g.
a) Comparing the terms and conditions of related party transactions with the transactions in open market.
b) Comparing the terms and conditions of related party transactions with the transactions with unrelated parties.
c) Engagement of external expert to confirm terms.
Auditor shall:
a) Evaluate the appropriateness of the evidence provided by management to support the assertion.
b) Verify source of data(Testing accuracy, completeness, and relevance)
c) Evaluate reasonableness of significant assumptions.
What procedures auditor should perform on identifying a related party relationship/transaction?
- Promptly communicate with other members of the engagement to assist them in determining whether the risk should be revised.
- Inquire the management why the controls and process failed to identify the related party.
- Request management to identify all the transactions with the newly identified related party.
- Perform audit procedures on the transactions with newly identified related party.
- Revise the risk of related party information b/c other unidentified related parties may also exist.
- If the non-disclosure appears intentional, consider risk of fraud and evaluate the implications on audit.
What procedures auditor should perform on identifying a transaction outside the normal course of business?
Inquire the management and evaluate the business rationale for the transactions.
If a related party is involved in the transaction outside the normal business course. The auditor shall consider it a significant risk. and perform the following procedures.
1. Inspect the contracts and agreements to evaluate:
a) If it indicates a fraudulent financial reporting or misappropriation of assets.
b) Terms of transaction are consistent with management explanations.
2. Obtain evidence about appropriate authorization of such transactions.
How to evaluate business rationale?
The auditor should consider the followings:
1. Evaluate the transaction whether
a) It is overly complex(involve many related parties)
b) It lacks logical business reasons for its occurrence
c) It involves unusual trade terms(high discounts,Interest rates)
d) It is processed in an unusual manner.
2. Evaluate whether management has communicated with TCWG regarding nature of and account for such transactions.
Give examples of transactions outside the normal course of business.
- Equity transactions
- Transactions with offshore companies.
- Providing services or property without consideration
- Sales with high discounts, an option of return or repurchase.
- Contracts whose terms are revised before expiry.
what are the indicators of a related party having a dominant influence?
- Founder of an entity currently managing the entity
- Significant transactions are referred to the related party for final approval.
- Related party can veto business decisions
- No debates on proposals by related party.
- Transactions involving related party are not reviewed or approved.
What will be the implications on the report if controls are not effective related to related party?
If controls are not effective related to related party, it constitutes a scope limitation.
The auditor shall express a qualified opinion(if the effect is material) or express a disclaimer of opinion(if the effect is pervasive)
What will be the implications on the report if disclosures are not given/not appropriate?
if disclosures are not given/not appropriate it will be a misstatement.
The auditor shall express a qualified opinion(if the effect is material) or express an adverse opinion(if the effect is pervasive).
About what, shall the auditor obtain written representation regarding related parties from management?
The auditor shall obtain a written representation from management that:
1. They have appropriately accounted for and disclosed all the related party relationships and transactions in F/S in A/C with AFRF.
2. They have disclosed the identity of all the related party relationships and transactions to the auditor.
