ISA 550 Related Parties states that the auditor should perform audit procedures designed to obtain sufficient appropriate audit evidence regarding the identification and disclosure by
Management of related parties and the effect of related party transactions that are material to the financial statements. However, an audit cannot be expected to detect all related party transactions.
The Audit Procedures can be summarised as follows:
Step 1: Identifying the related parties.
The auditor should review information provided by the directors and management identifying the names of all known related parties and should perform the following procedures in respect of the completeness of this information:
- Review prior year working papers for names of known related parties;
- Review the entity’s procedures for identification of related parties;Inquire as to the affiliation of directors and officers with other entities;
- Review shareholder records to determine the names of principal shareholders or, if appropriate, obtain a listing of principal shareholders from the share register;
- Review minutes of the meetings of shareholders and the board of directors and other relevant statutory records such as the register of directors’ interests;
- Inquire of other auditors currently involved in the audit, or predecessor auditors, as to their knowledge of additional related parties; and
- Review the entity’s income tax returns and other information supplied to regulatory agencies.
If, in the auditor’s judgment, the risk of significant related parties remaining undetected is low, these procedures may be modified as appropriate.
Where the financial reporting framework requires disclosure of related party relationships (such as IAS 24), the auditor should be satisfied that the disclosure is adequate.
Step 2: Distribute the list to audit staff requesting them to ensure that any transaction with related parties of which they come across should be looked at carefully.
Step 3:Seek out transactions with the related parties. During the course of the audit, the auditor carries out procedures which may identify the existence of transactions with related parties. Examples include the following:
- Performing detailed tests of transactions and balances.
- Reviewing minutes of meetings of shareholders and directors.
- Reviewing accounting records for large or unusual transactions or balances, paying particular attention to transactions recognized at or near the end of the reporting period.
- Reviewing confirmations of loans receivable and payable and confirmations from banks. Such a review may indicate guarantor relationship and other related party transactions.
- Reviewing investment transactions, for example, purchase or sale of an equity interest in a joint venture or other entity.
During the course of the audit, the auditor needs to be alert for transactions which appear unusual in the circumstances and may indicate the existence of previously unidentified related parties. Examples include the following:
- Transactions which have abnormal terms of trade, such as unusual prices, interest rates, guarantees, and repayment terms.
- Transactions which lack an apparent logical business reason for their occurrence.
- Transactions in which substance differs from form.
- Transactions processed in an unusual manner.
- High volume or significant transactions with certain customers or suppliers as compared with others.
- Unrecorded transactions such as the receipt or provision of management services at no charge.
Examining Identified Related Party Transactions
In examining the identified related party transactions, the auditor should obtain sufficient appropriate audit evidence as to whether these transactions have been properly recorded and disclosed.
The auditor should obtain a written representation from management concerning:
- The completeness of information provided regarding the identification of related parties; and
- The adequacy of related party disclosures in the financial statements.