Related-Party Issues Flashcards
After discovering that a related-party transaction exists, the auditor should be aware that the
Substance of the transaction could be significantly different from its form.
Adequacy of disclosure of the transaction is secondary to its legal form.
Transaction is assumed to be outside the ordinary course of business.
Financial statements should recognize the legal form of the transaction rather than its substance.
Substance of the transaction could be significantly different from its form.
This answer is correct because the auditor should be aware that for related-party transactions, the substance of a particular transaction may differ significantly from its form, and that the financial statements should recognize the substance rather than merely its legal form.
An independent auditor finds that a corporation occupies office space, at no charge, in an office building owned by a shareholder. This finding indicates the existence of Management fraud. Related-party transactions. Window dressing. Weak internal control.
Related-party transactions.
This answer is correct because relationships with principal shareholders of this nature are considered related-party transactions.
An auditor searching for related-party transactions should obtain an understanding of each subsidiary’s relationship to the total entity because
This may permit the audit of intercompany account balances to be performed as of concurrent dates.
Intercompany transactions may have been consummated on terms equivalent to arm’s-length transactions.
This may reveal whether particular transactions would have taken place if the parties had not been related.
The business structure may be deliberately designed to obscure related-party transactions.
The business structure may be deliberately designed to obscure related-party transactions.
This Answer is Correct
This answer is correct because experience has shown that business structure and operating style are occasionally deliberately designed to obscure related-party transactions.
Which of the following events least likely would indicate the existence of related-party transactions?
Making a loan with no scheduled date for the funds to be repaid.
Maintaining compensating balance arrangements for the benefit of principal stockholders.
Borrowing funds at an interest rate significantly below prevailing market rates.
Writing off obsolete inventory to net realizable value just before year-end.
Writing off obsolete inventory to net realizable value just before year-end.
This Answer is Correct
This answer is correct since writing off of obsolete inventory in such a manner is an ordinary procedure that is required by GAAP and not directly related to whether related-party transactions exist. Related-party transactions often involve transactions with one or more characteristics that would not exist in “arm’s-length transactions.”
Which of the following procedures most likely could assist an auditor in identifying related-party transactions?
Performing tests of controls concerning the segregation of duties.
Evaluating the reasonableness of management’s accounting estimates.
Reviewing confirmations of compensating balance arrangements.
Scanning the accounting records for recurring transactions.
Reviewing confirmations of compensating balance arrangements.
This answer is correct because auditors review confirmations of compensating balance arrangements for indications that balances are or were maintained for (or by) related parties.
Which of the following auditing procedures most likely would assist an auditor in identifying related-party transactions?
Inspecting correspondence with lawyers for evidence of unreported contingent liabilities.
Vouching accounting records for recurring transactions recorded just after the balance sheet date.
Reviewing confirmations of loans receivable and payable for indications of guarantees.
Performing analytical procedures for indications of possible financial difficulties.
Reviewing confirmations of loans receivable and payable for indications of guarantees.
The requirement is to identify the auditing procedure that would most likely assist an auditor in identifying related-party transactions. Answer (c) is correct because reviewing confirmations of loans receivable and payable for indications of guarantees may reveal unusual transactions that involve related parties. See AU-C 550 for procedures related to identifying transactions with related parties. Answer (a) is incorrect because inspecting the correspondence with lawyers for evidence of unreported contingent liabilities does not generally relate directly to related-party transactions. Answer (b) is incorrect because nonrecurring transactions are more indicative of related-party transactions. Answer (d) is incorrect because analytical procedures performed to identify possible financial difficulties do not relate directly to related-party transactions.
An example of a transaction which may be indicative of the existence of related parties is
Borrowing or lending at a rate of interest which equals the current market rate.
Selling real estate at a price that is comparable to its appraised value.
Making large loans with specified terms as to when or how the funds will be repaid.
Exchanging property for similar property in a nonmonetary transaction.
Exchanging property for similar property in a nonmonetary transaction.
This Answer is Correct
This answer is correct because exchanging property for similar property in a nonmonetary transaction may indicate the existence of related parties (the exchange may or may not approximate what would occur in an arm’s-length transaction).
Which of the following steps should an auditor perform first to determine the existence of related parties?
Examine invoices, contracts, and purchasing orders.
Request a list of all related parties from management.
Review the company’s business structure.
Review proxy and other materials filed with the SEC.
Request a list of all related parties from management.
This answer is correct because the professional standards require that auditors first evaluate the company’s procedures for identifying such transactions and then ask management for a list of related parties.
Which of the following most likely would indicate the existence of related parties?
Writing down obsolete inventory just before year-end.
Failing to correct previously identified internal control deficiencies.
Depending on a single product for the success of the entity.
Borrowing money at an interest rate significantly below the market rate.
Borrowing money at an interest rate significantly below the market rate.
This Answer is Correct
This answer is correct because one would not expect an unrelated entity to loan money at an interest rate significantly below the market rate.
When auditing related-party transactions, an auditor places primary emphasis on
Ascertaining the rights and obligations of the related parties.
Confirming the existence of the related parties.
Verifying the valuation of the related-party transactions.
Evaluating the disclosure of the related-party transactions.
Evaluating the disclosure of the related-party transactions.
This Answer is Correct
The requirement is to identify the correct statement concerning related-party transactions. Answer (d) is correct because AU-C 550 requires that the auditor should place primary emphasis on the adequacy of disclosure. Answer (a) is incorrect because ascertaining rights and obligations is only part of the auditor’s total responsibility and not the primary emphasis. Answer (b) is incorrect because while auditors attempt to determine the existence of related parties, this is not the primary emphasis. Answer (c) is incorrect because verifying the valuation of related-party transactions will often not be possible.
After identifying related-party transactions, an auditor most likely would
Substantiate that the transactions were consummated on terms equivalent to those prevailing in arm’s-length transactions.
Discuss the implications of the transactions with third parties, such as the entity’s attorneys and bankers.
Determine whether the transactions were approved by the board of directors or other appropriate officials.
Ascertain whether the transactions would have occurred if the parties had not been related.
Determine whether the transactions were approved by the board of directors or other appropriate officials.
This answer is correct because the lack of “arm’s length transactions” creates a situation in which an auditor will attempt to determine whether the transactions have been approved by the board of directors or other appropriate officials.
Which of the following events most likely would indicate the existence of related parties?
Granting stock options to key executives at favorable prices.
High turnover of senior management and members of the board of directors.
Failure to correct internal control weaknesses on a timely basis.
Selling real estate at a price significantly different from appraised value.
Selling real estate at a price significantly different from appraised value.
This Answer is Correct
This answer is correct because selling real estate (or, for that matter, other assets) at prices significantly different from appraised values leads one to question why the transaction occurred and whether it was truly “arm’s-length.”
Selling real estate at a price significantly different from appraised value.
This Answer is Correct
This answer is correct because selling real estate (or, for that matter, other assets) at prices significantly different from appraised values leads one to question why the transaction occurred and whether it was truly “arm’s-length.”
Evaluating the disclosure of the related-party transactions.
This answer is correct because the auditor should view related-party transactions within the framework of existing pronouncements, placing primary emphasis on the adequacy of disclosure.
After determining that a related-party transaction has, in fact, occurred, an auditor should
Add a separate paragraph to the auditor’s standard report to explain the transaction.
Perform analytical procedures to verify whether similar transactions occurred, but were not recorded.
Obtain an understanding of the business purpose of the transaction.
Substantiate that the transaction was consummated on terms equivalent to an arm’s-length transaction.
Obtain an understanding of the business purpose of the transaction.
The requirement is to determine an auditor’s responsibility after having determined that a related-party transaction has occurred. Answer (c) is correct because after identifying the existence of such an act, the auditor should obtain an understanding of the business purpose of the transaction. See AU-C 550 for this and other responsibilities. Answer (a) is incorrect because the mere existence of a related-party transaction may or may not lead to audit report modification. Answer (b) is incorrect because the performance of analytical procedures is not required. Answer (d) is incorrect because except for routine transactions, it will generally not be possible to determine whether the transaction would have taken place, or whether it was consummated on terms equivalent to an arm’s-length transaction.
Which of the audit procedures listed below would be least likely to disclose the existence of related-party transactions of a client during the period under audit?
Reading “conflict-of-interest” statements obtained by the client from its management.
Scanning accounting records for large transactions at or just prior to the end of the period under audit.
Inspecting invoices from law firms.
Confirming large purchase and sales transactions with the vendors and/or customers involved.
Confirming large purchase and sales transactions with the vendors and/or customers involved.
This Answer is Correct
This answer is correct because the confirmation of large purchase and sales transactions by itself will generally not disclose related-party transactions.
