Chapter 17: Related Party Transactions

Question 1

What defines a related party under AFRF?

Answer 1

• AFRF defines related parties. If AFRF doesn’t, it includes:
  
  1. Individuals/organizations with control/influence over the entity (directly/indirectly).
  2. Entities under common control/management.
  3. Examples: Parent/subsidiary companies, majority shareholders, directors, key management, their relatives, or entities they control.

Question 2

What are related party transactions? Provide examples.

Answer 2

Transactions between the entity and its related parties. Examples:
1. Sale/purchase of assets.
2. Providing/receiving services (e.g., consultancy, management, accounting).
3. Loans, guarantees, or equity transactions.
4. Transactions may be ordinary or outside the ordinary course of business.

Question 3

Why are related party transactions considered high-risk?

Answer 3

1. Complex structures: Transactions may involve intermediaries or multiple entities.
2. Inherent limitations: Management may not know all related parties, and systems may fail to identify them.
3. Non-arm’s length basis: Transactions may not reflect market terms.
4. Fraud risk: Management may collude with related parties to manipulate financial statements.

Question 4

What are examples of transactions outside the ordinary course of business?

Answer 4

• Equity transactions.
• Transactions with offshore companies.
• Providing property/services without consideration.
• Sales with unusual discounts, credit terms, or repurchase commitments.
• Transactions with terms changed before expiry.

Question 5

What are management’s responsibilities regarding related parties?

Answer 5

Identify, account for, and disclose related party relationships/transactions as per AFRF. Ensure financial statements reflect all related party transactions accurately.

Question 6

What are the auditor’s objectives regarding related parties?

Answer 6

1. Obtain an understanding of related party relationships/transactions to assess fraud risk.
2. Ensure AFRF compliance in identification, accounting, and disclosure.
3. Verify financial statements give a true and fair view (or are not misleading).
4. Detect any undisclosed related parties or transactions.

Question 7

Case Study: The finance director’s wife provided consultancy services. Why should the auditor investigate?

Answer 7

This is a related party transaction (director’s spouse). Auditor must:
1. Ensure it’s properly disclosed in financial statements.
2. Verify it was conducted at arm’s length.
3. Assess the business rationale for the transaction.

Question 8

List risk assessment procedures for related parties.

Answer 8

• Inquiry: Ask management about:
  
  1. Identity of related parties (including changes from prior periods).
  2. Nature of relationships with related parties.
  3. Types and purpose of transactions with related parties.
• Team discussion: Discuss:
  
  1. Nature/extent of related party relationships/transactions.
  2. Professional skepticism.
  3. Circumstances indicating unidentified related parties.
• Inspection: Review:
  
  1. Bank/legal confirmations.
  2. Minutes of meetings.
  3. Shareholder/director registers, tax returns, contracts, etc.

Question 9

How does an auditor ensure completeness of related parties?

Answer 9

1. Review prior-year working papers for known related parties.
2. Inquire with group auditors/predecessor auditors.
3. Check affiliations of TCWG (those charged with governance).
4. Inspect third-party confirmations, regulatory filings, and internal audit reports.

Question 10

What should the auditor do if they identify an undisclosed related party?

Answer 10

1. Communicate the finding to the audit team.
2. Investigate why controls failed to identify the related party.
3. Request management to identify all transactions with the newly identified related party.
4. Perform substantive procedures on the related party/transactions.
5. Reassess the risk of other unidentified related parties.
6. Evaluate implications for fraud risk and management integrity.

Question 11

How should the auditor evaluate a transaction outside the normal course of business?

Answer 11

• Inquire: Assess the business rationale for the transaction.
• Inspect: Review underlying contracts/agreements to verify:
  
  1. Terms are consistent with management’s explanation.
  2. Transaction was properly authorized.
  3. Accounting and disclosure comply with AFRF.
• Evaluate: Look for signs of fraud (e.g., unusual terms, lack of business rationale).

Question 12

What are indicators of a related party with dominant influence?

Answer 12

• Founder managing the entity.
• Significant transactions require related party approval.
• Little debate on related party proposals.
• Transactions involving the related party are not reviewed by others.

Question 13

How should the auditor respond if management asserts that related party transactions were conducted at arm’s length?

Answer 13

• Verify management’s evidence (e.g., comparison with market transactions).
• Assess the appropriateness of management’s process.
• Test the accuracy, completeness, and relevance of data used.
• Evaluate the reasonableness of assumptions.

Question 14

What if controls over related party transactions are ineffective?

Answer 14

Scope limitation: Auditor may issue a qualified opinion or disclaimer of opinion.

Question 15

What if related party disclosures are inadequate (e.g.

Answer 15

omission of a material transaction)?

Question 16

What written representations must the auditor obtain from management?

Answer 16

Management confirms:
1. Compliance with AFRF in accounting/disclosure.
2. Full disclosure of all known related parties/transactions.

Question 17

When should TCWG provide written representations?

Answer 17

• If they approved material transactions involving management.
• If they have a financial interest in related parties.
• If they made specific oral representations about related party transactions.