Related Parties ISA 550 Audit CAF 9 (ARM+AMK)

Related Parties ISA 550
Audit CAF 9 (ARM+AMK)
Related Parties
Definition Responsibilities Procedures to

Ensure All Related
Parties
Management Auditor
Parties with undue
Ahmed Raza, FCA + Akash Kumar, ACA (ARTT Business School)
influence e.g.
- Associated companies - To identify - To ensure
parties/transactions are  Obtain list
- Majority Shareholder, - To account for identified, accounted for
Key Management, their and disclosed.  Obtain understanding of
family members and - To disclose Procedures and Controls
- To evaluate fraud risk
- Their companies factors, and whether FS  Review working papers of
present True and Fair last year.
view.
Related Party
 Inquire predecessor auditor
Transactions
and component auditor.
 Inquire affiliation of TCWG

and Key Management.
Transaction with related party e.g.
 Inspect records
- Sale and purchase of asset - Third party confirmation.
- Tax Return
- Giving or obtaining loan (or - Register of
repayment) shareholders/directors.
- Published documents.
Artt Business School: F45 PECHS Block 6 Behind Fortune Centre Main shahrah-e-Faisal Karachi. Contact 021-34523175-76
Definition of Related Party:
 A related party that is either

o A related party as defined in the applicable financial reporting framework; or
 Where the applicable financial reporting framework establishes minimal or no related party
requirements:
o A person or other entity that has control or significant influence, directly or indirectly
through one or more intermediaries, over the reporting entity;
o Another entity over which the reporting entity has control or significant influence,
directly or indirectly through one or more intermediaries; or
 Another entity that is under common control with the reporting entity through having:
o Common controlling ownership;

o Owners who are close family members; or
o Common key management.
Definition of 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.
RESPONSIBILITIES OF MANAGEMENT AND AUDITOR REGARDING RELATED PARTY
Responsibilities of Management:
It is the responsibility of the Company’s management to
Responsibility 1
1. Identify 1. Related parties (Names)

2. Record (account for) 2. Relationships with them
3. Report as per FRFW 3. Transactions entered into during the year
Responsibility 2
Implement internal controls to identify RPs and RPTs.
Responsibilities/Objectives of Auditor:
To obtain an understanding of related party relationships and transactions sufficient to be able:
1. To conclude, That he financial statements are presented fairly and are not misleading in so far as
they are affected by the RP relationships and transactions based on the audit evidence obtained
2. To recognize fraud risk factors, if any, arising from related party relationships and transactions
that help in identification and assessment of the risks of material misstatement due to fraud;
Why related party transactions are important for auditor

Many RPTs are in the normal course of business and carry no significant risk of material misstatement
than ordinary transactions.
In some circumstances RPTs may lead to higher risks of MM. For example:
Risk Explanation
1. RPs may operate through complex structures Inherent risk in recording complex transaction
and relationships and the resulting that it might not be correctly recorded and
transactions may therefore also be complex. presented
2. Accounting systems may not be effective at Flagging and changes in RP status may not be
identifying and summarising RPTs and identified (because less sophisticated sys)
balances.
3. RPTs may not be conducted on normal Difficult to distinguish what is arm’s length and
market terms – some may even be conducted what’s not + difficult to disclose appropriately
with nil consideration.
4. Sometimes substance of RP transactions Economics of the transaction in reality may be

differ form resulting in misstatement something else and reporting may be misleading
5. High risk of fraud RPs present greater opportunities for collusion,

concealment, or manipulation by management
Step 1 Obtain an understanding of entity, its environment and its internal controls
The auditor performs the following procedures to understand the entity’s related parties’ relationship
and transactions
1. Make inquiries of management (on obtaining a list of related parties) in respect of:
 The identity of related parties

 The nature of relationships with those related parties
 The nature of any transactions entered into with those parties during the period.
2. Obtain an understanding of the internal controls in operation over:
 the identification of, accounting for and disclosure of related party relationships and
transactions
 the authorization and approval of significant related party transactions
 the authorization and approval of significant transactions outside the normal course of
business
3. Consider the risk of material misstatement due to fraud or error arising from related party
relationships and transactions.
4. Inform all the engagement team members as and when a new related party or a new transaction
with identified related parties are found out.
The above procedures would result in risks of material misstatement resulting for RP transactions. The
auditor shall respond to the identified risks.
Risks and responses in related party transactions
S.r.No Risk Response

1 List of related parties The auditors will perform the following audit
given by the management procedures to ensure that all the related parties are
may not be complete I/A/D in the financial statements
1. Review working papers for previous years, to

look for names of known related parties.
2. Inquire predecessor auditor and component
auditors (if any) about the RPs
3. Inquire about the relationships between
directors and other entities (for example,
investments by directors and their close family
members of significant nature + common
directorship) i.e. obtain a conflict of interest
disclosure by the directors
4. Review shareholder Register for the names of
major shareholders.
5. Review Investment register for major
investments
6. Review minutes of shareholder meetings
(general meetings of the company).
7. Review BOD meeting minutes
8. Inspect Bank Confirmations
9. Inspect lawyers confirmation
10. Inspect 3rd party confirmations (Debtors /
Creditors)
11. Inspect tax returns
12. Inspect invoices (for abnormal discounts,
abnormal credit terms, after sales services)
13. Forms submitted to SECP
Results of the procedures
Result Conclusion
No additional RP/ RPT found Related prarty list is completed
Additional RP / RPT found 1. Revise Risk Assessment
2. Perform Additional Audit
procedures
Further Audit procedures
If auditor identifies related party relationships or transactions not identified by management:
Auditor shall perform following procedures:
 Confirm the existence of related party relationship or transaction from underlying

circumstances.
 Promptly communicate the relevant information to other members of engagement.
 Inquire as to why entity’s process and controls failed to identify or disclose such related party
relationship/transaction.
 Request management to identify all transactions with newly identified related party, and
disclose them accordingly.
 Perform appropriate substantive procedures on newly identified related party, and/or significant
related party transactions.
 Reconsider risk of completeness of related party information because other unidentified related
parties may also exist.
 If non-disclosure appears intentional, reconsider risk of fraud and other implications on audit.

2 Transactions with related Auditor inspect the underlying contract / agreement
parties may be outside the and: shall inquire:
normal course of business 1. inquire the nature of these transactions
and 2. inquired whether related parties are involved
1. may not be 3. inquire business rationale (or lack thereof) of
appropriately these transactions.
approved or 4. Evaluate terms of the transactions are
authorized consistent with management’s explanations.

2. may not be 5. Evaluate whether transactions have been
appropriate appropriately authorized (e.g. by TCWG).
accounted for 6. Evaluate transactions have been appropriately
disclosed accounted for and disclosed.
7. Evaluate transaction is entered to engage in
fraudulent financial reporting or to hide
misappropriation of assets.
For this also review the minutes of meeting of BOD and

Shareholders to identify the fact that these
transactions are appropriate authorized.
Result and Conclusion
Result Conclusion
Transactions ONCOB are appropriately No further audit procedures required
authorized and approved and are
appropriately accounted for and
disclosed as per FRFW
ONCOB transactions either not Inquire the management about the
appropriately approved / authorized or approval and authorization and
accounted for and disclosed as per appropriate accounting and disclosure:
FRFW
Implication on report if not corrected
or subsequently authorized / approved
3 The management may Obtain sufficient appropriate audit evidence by
have asserted that the 1. Comparing the terms of the RP transactions
related party transactions with market
are incurred at arm’s 2. If market rates are not available from other
length which may not be goods / service providers identify rate which are
the case used by the company with other customers
3. Involve expert in case of specialized nature of
transaction
Result and Conclusion

Result Conclusion
Management assertion about the No further audit procedures required
transaction with RP is appropriate w.r.t
arm’s length basis
Management assertion is not Ask the management for appropriate
appropriate disclosure if not implication on report
4 Presence of a Domination over management by a The presence of such parties
single person or small group of persons is a fraud creates a risk on the health of
risk factor. entire financial statements
(rather than a single
Any such party may override the views of entity’s assertion).
management and force entity to enter into a
transaction in which dominant party has an interest. The auditor must:
Indicators of dominant influence exerted by a 1. Exercise professional

related party include: skepticism in case of
 The related party has vetoed significant business reviewing the
decisions taken by management or those transactions involving
charged with governance such parties
 Significant transactions are referred to the 2. Use professional
related party for final approval. judgement wherever
 There is little or no debate among management
circumstances
demand.
and those charged with governance regarding
business proposals initiated by the related party.
 Transactions involving the related party (or a
close family member of the related party) are
rarely independently reviewed and approved.
In the presence of other risk factors, the existence of a related party with dominant influence may indicate
significant risks of material misstatement due to fraud. For example:
 An unusually high turnover of senior management or professional advisors may suggest unethical or
fraudulent business practices that serve the related party’s purposes.
 The use of business intermediaries for significant transactions for which there appears to be no clear
business justification may suggest that the related party could have an interest in such transactions
through control of such intermediaries for fraudulent purposes.
 Evidence of the related party’s excessive participation in or preoccupation with the selection of
accounting policies or the determination of significant estimates may suggest the possibility of
fraudulent financial reporting.
Related Party Risks and Course of

Action
Transactions outside Management’s

If Auditor Identifies
normal course of Assertions of Arm’s
a Related Party
business length basis
1. Confirm from documents.

1. Inspect minutes of 1. Compare with
BOD and shareholders. - Market

2. Communicate to team.
2. Evaluate accounting - Unrelated

3. Inquire client why they
and disclosures. parties
failed.
3. Ensure management’s - Expert

4. Request management to
explanation is
identify all transactions.
consistent with
supporting documents.
5. Perform substantive
procedures.
4. Evaluate existence of
fraud.
6. Increase risk of
completeness.
7. Increase risk of fraud if Related Party with Dominant

non-disclosure appears Influence
intentional.
Implications
Indicators
- Founder and Manager - Fraud risk factor

- Final Approval - Evaluate transactions of
- Veto power party’s interest.
- No Debate on Proposals
- Transactions not independently
reviewed or approved.
MATERIALITY, WRITTEN REPRESENTATION, COMMUNICATION WITH TCWG AND

DOCUMENTATION
Materiality:
Transactions with related parties are usually considered material irrespective of size of transaction. Because in
case of related party, a transaction could be material even if it has nominal amount e.g. sale of company’s assets
to related party at very low price.
Written Representation
Where the applicable financial reporting framework establishes related party requirements, the auditor shall
obtain written representations from management and, where appropriate, those charged with governance that:
 They have disclosed to the auditor the identity of the entity’s related parties and all the related party
relationships and transactions of which they are aware; and
They have appropriately accounted for and disclosed such relationships and transactions in accordance with the
requirements of the framework.
Communication with TCWG:
Unless all of those charged with governance are involved in managing the entity, the auditor shall communicate
with those charged with governance significant matters arising during the audit in connection with the entity’s
related parties.
Communicating significant matters arising during the audit in connection with the entity’s related parties helps
the auditor to establish a common understanding with those charged with governance of the nature and
resolution of these matters. Examples of significant related party matters include:
 Non-disclosure (whether intentional or not) by management to the auditor of related parties or

significant related party transactions, which may alert those charged with governance to significant
related party relationships and transactions of which they may not have been previously aware.
 The identification of significant related party transactions that have not been appropriately
authorized and approved, which may give rise to suspected fraud.
 Disagreement with management regarding the accounting for and disclosure of significant related
party transactions in accordance with the applicable financial reporting framework.
 Non-compliance with applicable law or regulations prohibiting or restricting specific types of related
party transactions.
 Difficulties in identifying the party that ultimately controls the entity.
Documentation:
The auditor shall include in the audit documentation the names of the identified related parties and the nature of
the related party relationships.

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What are the responsibilities of management and auditor regarding related parties?

What are the responsibilities of management and auditor regarding related parties?

What are the procedures to identify related parties?

What are the procedures to identify related parties?

Related Parties ISA 550

Audit CAF 9 (ARM+AMK)

Definition Responsibilities Procedures to

 Inquire affiliation of TCWG

 A related party that is either

o Common controlling ownership;

Definition of Arm’s length transaction:

RESPONSIBILITIES OF MANAGEMENT AND AUDITOR REGARDING RELATED PARTY

It is the responsibility of the Company’s management to

1. Identify 1. Related parties (Names)

Implement internal controls to identify RPs and RPTs.

To obtain an understanding of related party relationships and transactions sufficient to be able:

Why related party transactions are important for auditor

4. Sometimes substance of RP transactions Economics of the transaction in reality may be

5. High risk of fraud RPs present greater opportunities for collusion,

 The identity of related parties

2. Obtain an understanding of the internal controls in operation over:

Risks and responses in related party transactions

S.r.No Risk Response

1. Review working papers for previous years, to

Results of the procedures

Further Audit procedures

If auditor identifies related party relationships or transactions not identified by management:

Auditor shall perform following procedures:

 Confirm the existence of related party relationship or transaction from underlying

S.r.No Risk Response

authorized consistent with management’s explanations.

For this also review the minutes of meeting of BOD and

Result and Conclusion

Result and Conclusion

Indicators of dominant influence exerted by a 1. Exercise professional

Related Party Risks and Course of

Transactions outside Management’s

1. Confirm from documents.

BOD and shareholders. - Market

2. Evaluate accounting - Unrelated

3. Ensure management’s - Expert

7. Increase risk of fraud if Related Party with Dominant

- Founder and Manager - Fraud risk factor

MATERIALITY, WRITTEN REPRESENTATION, COMMUNICATION WITH TCWG AND

Communication with TCWG:

 Non-disclosure (whether intentional or not) by management to the auditor of related parties or

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