Related parties are those parties considered to be related if one party has the ability to control or exercise significant influence over the other party in making financial decisions. In the context of above, a related party could be management, owner or any person who is in a position to influence an entity’s operating policies and financial decisions.
Related party transactions refer to the transfer of resources or obligations between related parties irrespective of the value of these transactions.
the following are audit procedures for determining related party transactions:
- Verify and inspect the transactions and documented evidence of the transactions made with related parties. E.g. purchase / sale invoices, executed copies of agreements, contracts and other relevant documents.
- Discuss the business purpose of related party transactions with appropriate person i.e. management or directors.
- Confirm that the terms and conditions of the transactions with related party are at market prices. The auditor should confirm that the terms are the same for similar kinds of transactions with a third party. For example, if a raw material is purchased from a related party, the auditor will verify whether the commercial terms of the transactions are similar to the commercial terms for the same raw material in the open market.
- Carry out the audits of inter-company account balances to cross check the transactions. This will include: (a) Cross checking the related party’s statement of account with the transactions recorded in the entity’s books. (b) Confirmation of other terms such as guarantees and other significant data, with the other party to the transaction.
- Verify whether the transaction has been approved by the board of directors or other appropriate authorities.
- Confirm or verify material information with third parties involved such as banks, guarantors or agents to obtain a clearer understanding of the transaction.
- Confirm that the transaction is authentic. For example, if purchases are made the auditor will verify whether the purchase was a genuine requirement to process a sale order.
- Verify the legality and completeness of the disclosed transactions declared by the directors. For example, if the company has purchased property from a director but the property papers are not transferred to the name of the company.
- The above point leads to important audit evidence, which is the ascertainment of ownership rights of all assets purchased from related parties. This will enable the auditor to make the ‘rights and obligations’ assertion.
- Assess the recoverability of amounts due from directors and other related parties.
- Examine all agreements and contracts involving directors and management personnel and trace the details of those transactions.