Related Parties

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Related Parties Case Example: ABC Manufacturing Company

Context

ABC Manufacturing Company engages in transactions with entities and individuals that are related parties, including subsidiaries, associates, key management personnel, and their family members. Given the nature of these relationships, transactions may not always be conducted on terms equivalent to those with unrelated parties.

Audit Objective

To identify and evaluate all significant related party transactions, ensuring they are properly identified, measured, disclosed, and accounted for in the financial statements according to applicable standards (e.g., IFRS or US GAAP).

Types of Audit Evidence and Documentation for Related Parties

1. Identification of Related Parties and Transactions

• Case: Obtain an understanding of the company’s process for identifying related parties and related party transactions. Review a list of identified related parties and transactions provided by management.

• Documentation: Document the list of related parties and related party transactions provided by management, including the nature of the relationships and the terms of the transactions.

2. Assessment of Controls Over Related Party Transactions

• Case: Evaluate the effectiveness of the company’s internal controls designed to identify, authorize, and record related party transactions.

• Documentation: Summarize the assessment of internal controls, noting any deficiencies identified and the implications for the audit approach.

3. Substantive Procedures for Related Party Transactions

• Case: Perform substantive audit procedures to verify the accuracy and completeness of related party transactions. This may include confirming terms and balances with related parties, testing the appropriateness of the accounting treatment, and evaluating the sufficiency of disclosures.

• Documentation: Document the substantive procedures performed, including the nature, timing, and extent of testing, as well as the results and conclusions drawn from these tests.

4. Evaluation of Terms and Conditions

• Case: Assess whether the terms and conditions of related party transactions are consistent with those of comparable arm’s length transactions, or if they indicate preferential treatment that could impact the financial statements.

• Documentation: Prepare an analysis of the terms and conditions of significant related party transactions compared to market norms or unrelated transactions, noting any significant deviations and their financial statement implications.

5. Review of Disclosures

• Case: Review the financial statement disclosures related to related parties to ensure they are complete, accurate, and in accordance with the applicable financial reporting framework.

• Documentation: Document the review of related party disclosures, including the adequacy of information provided about the nature, terms, and financial effects of the transactions.

6. Assessment of Fraud Risk

• Case: Consider the risk of fraud associated with related party transactions, such as the understatement or omission of related party transactions or the manipulation of terms to achieve specific financial reporting objectives.

• Documentation: Summarize the considerations and conclusions regarding fraud risk related to related party transactions, including any additional audit procedures performed in response to elevated risk areas.

7. Communication with Those Charged with Governance

• Case: Communicate significant findings related to related party transactions to those charged with governance, including the nature of the relationships, the terms and conditions of significant transactions, and any issues identified with disclosures or controls.

• Documentation: Prepare a summary of communications with those charged with governance regarding related party transactions, highlighting significant discussions, concerns raised, and responses or actions taken by governance.

Conclusion

The audit of related party transactions is a crucial element of the audit process, requiring thorough identification, evaluation, and testing to ensure that these transactions are properly accounted for and disclosed. Through meticulous documentation, auditors provide evidence of their efforts to address the risks associated with related party transactions, ensuring that the financial statements present a true and fair view of the company’s financial position and performance, free from material misstatement.