While the existence of related parties and transactions between such parties are considered ordinary features of business, the auditor needs to be aware of them because:
- The financial reporting framework may require disclosure in the financial statements of certain related party relationships and transactions, such as those required by IAS 24;
- The existence of related parties or related party transactions may affect the financial statements. For example, the entity’s tax liability and expense may be affected by the tax laws in various jurisdictions which require special consideration when related parties exist;
- The source of audit evidence affects the auditor’s assessment of its reliability. A greater degree of reliance may be placed on audit evidence that is obtained from or created by unrelated third parties; and
- A related party transaction may be motivated by other than ordinary business considerations, for example, profit sharing or even fraud.
Transactions with related parties are important for several reasons:
(a) Several financial scandals involving related parties frequently appear in the headlines;
(b) A true and fair view of the entity's affairs may not be given unless full disclosure is made;
(c) Statutory requirements must be compiled with e.g. loans to directors.
There are basically two types of transactions that arise between a company and a related party:
(a) Those entered into in the ordinary course of business. It is usual for members of a group to trade with each other.
(b) Those not engaged into in the ordinary course of business or which may involve misleading presentation of the accounts or fraud on the company, its members or creditors.
Type (a) generally deserves no special audit attention. The auditor must however ensure that they actually arise in the ordinary course of business at arms length.
Type (b) is where problems may arise and where scandals have occurred.
The Companies Act prohibits loans to directors and where they occur requires full disclosure. The law prohibits the giving of financial assistance for the purchase of or subscription for a company's own shares. The law restricts the rights of directors to acquire non-cash assets from the company or for the company to acquire non-cash assets from its directors. Significant shareholding of more than 5% must be notified to the company within seven days.