ASA 550

This Auditing Standard deals with the auditor’s responsibilities relating to related party relationships and transactions in an audit of a financial report.  Specifically, it expands on how ASA 315,^[1] ASA 330,^[2] and ASA 240^[3] are to be applied in relation to risks of material misstatement associated with related party relationships and transactions.

Many related party transactions are in the normal course of business.  In such circumstances, they may carry no higher risk of material misstatement of the financial report than similar transactions with unrelated parties.  However, the nature of related party relationships and transactions may, in some circumstances, give rise to higher risks of material misstatement of the financial report than transactions with unrelated parties.  For example: 

• Related parties may operate through an extensive and complex range of relationships and structures, with a corresponding increase in the complexity of related party transactions.
• Information systems may be ineffective at identifying or summarising transactions and outstanding balances between an entity and its related parties. 
• Related party transactions may not be conducted under normal market terms and conditions; for example, some related party transactions may be conducted with no exchange of consideration. 

Because related parties are not independent of each other, many financial reporting frameworks establish specific accounting and disclosure requirements for related party relationships, transactions and balances to enable users of the financial report to understand their nature and actual or potential effects on the financial report.  Where the applicable financial reporting framework establishes such requirements, the auditor has a responsibility to perform audit procedures to identify, assess and respond to the risks of material misstatement arising from the entity’s failure to appropriately account for or disclose related party relationships, transactions or balances in accordance with the requirements of the framework.

Even if the applicable financial reporting framework establishes minimal or no related party requirements, the auditor nevertheless needs to obtain an understanding of the entity’s related party relationships and transactions sufficient to be able to conclude whether the financial report, insofar as it is affected by those relationships and transactions:  (Ref: Para. A1)

1. Achieves fair presentation (for fair presentation frameworks); or  (Ref: Para. A2)
2. Is not misleading (for compliance frameworks).  (Ref: Para. A3)

In addition, an understanding of the entity’s related party relationships and transactions is relevant to the auditor’s evaluation of whether one or more fraud risk factors are present as required by ASA 240,^[4] because fraud may be more easily committed through related parties. 

Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial report may not be detected, even though the audit is properly planned and performed in accordance with the Australian Auditing Standards.^[5]  In the context of related parties, the potential effects of inherent limitations on the auditor’s ability to detect material misstatements are greater for such reasons as the following:

• Management may be unaware of the existence of all related party relationships and transactions, particularly if the applicable financial reporting framework does not establish related party requirements. 
• Related party relationships may present a greater opportunity for collusion, concealment or manipulation by management.

Planning and performing the audit with professional scepticism as required by ASA 200^[6] is therefore particularly important in this context, given the potential for undisclosed related party relationships and transactions.  The requirements in this Auditing Standard are designed to assist the auditor in identifying and assessing the risks of material misstatement associated with related party relationships and transactions, and in designing audit procedures to respond to the assessed risks.

[Deleted by the AUASB.  Refer Aus 0.3]

As part of the risk assessment procedures and related activities that ASA 315 and ASA 240 require the auditor to perform during the audit,[7] the auditor shall perform the audit procedures and related activities set out in paragraphs 12‑17 of this Auditing Standard, to obtain information relevant to identifying the risks of material misstatement associated with related party relationships and transactions.  (Ref: Para. A8)

Understanding the Entity’s Related Party Relationships and Transactions

The engagement team discussion that ASA 315 and ASA 240 require[8] shall include specific consideration of the susceptibility of the financial report to material misstatement due to fraud or error that could result from the entity’s related party relationships and transactions.  (Ref: Para. A9‑A10)

The auditor shall enquire of management regarding:  

1. The identity of the entity’s related parties, including changes from the prior period; (Ref: Para. A11‑A14)
2. The nature of the relationships between the entity and these related parties; and
3. Whether the entity entered into any transactions with these related parties during the period and, if so, the type and purpose of the transactions.

The auditor shall enquire of management and others within the entity, and perform other risk assessment procedures considered appropriate, to obtain an understanding of the controls, if any, that management has established to:  (Ref: Para. A15‑A20)

1. Identify, account for, and disclose related party relationships and transactions in accordance with the applicable financial reporting framework;
2. Authorise and approve significant transactions and arrangements with related parties; and  (Ref: Para. A21) 
3. Authorise and approve significant transactions and arrangements outside the normal course of business.

Maintaining Alertness for Related Party Information When Reviewing Records or Documents

During the audit, the auditor shall remain alert, when inspecting records or documents, for arrangements or other information that may indicate the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor.  (Ref: Para. A22‑A23)

In particular, the auditor shall inspect the following for indications of the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor:

1. Bank and legal confirmations obtained as part of the auditor’s procedures;
2. Minutes of meetings of shareholders and of those charged with governance; and
3. Such other records or documents as the auditor considers necessary in the circumstances of the entity.

If the auditor identifies significant transactions outside the entity’s normal course of business when performing the audit procedures required by paragraph 15 of this Auditing Standard or through other audit procedures, the auditor shall enquire of management about: (Ref: Para. A24‑A25)

1. The nature of these transactions; and  (Ref: Para. A26)
2. Whether related parties could be involved.  (Ref: Para. A27)  

Sharing Related Party Information with the Engagement Team

The auditor shall share relevant information obtained about the entity’s related parties with the other members of the engagement team.  (Ref: Para. A28)

In meeting the ASA 315 requirement to identify and assess the risks of material misstatement,[9] the auditor shall identify and assess the risks of material misstatement associated with related party relationships and transactions and determine whether any of those risks are significant risks.  In making this determination, the auditor shall treat identified significant related party transactions outside the entity’s normal course of business as giving rise to significant risks. 

If the auditor identifies fraud risk factors (including circumstances relating to the existence of a related party with dominant influence) when performing the risk assessment procedures and related activities in connection with related parties, the auditor shall consider such information when identifying and assessing the risks of material misstatement due to fraud in accordance with ASA 240.  (Ref: Para. A6 and A29‑A30)

As part of the ASA 330 requirement that the auditor respond to assessed risks,[10] the auditor designs and performs further audit procedures to obtain sufficient appropriate audit evidence about the assessed risks of material misstatement associated with related party relationships and transactions.  These audit procedures shall include those required by paragraphs 21‑24 of this Auditing Standard.  (Ref: Para. A31‑A34)

Identification of Previously Unidentified or Undisclosed Related Parties or Significant Related Party Transactions

If the auditor identifies arrangements or information that suggests the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor, the auditor shall determine whether the underlying circumstances confirm the existence of those relationships or transactions.  (Ref: Para. Aus A34.1)

If the auditor identifies related parties or significant related party transactions that management has not previously identified or disclosed to the auditor, the auditor shall:

1. Promptly communicate the relevant information to the other members of the engagement team;  (Ref: Para. A35)
2. Where the applicable financial reporting framework establishes related party requirements:
   1. Request management to identify all transactions with the newly identified related parties for the auditor’s further evaluation; and
   2. Enquire as to why the entity’s controls over related party relationships and transactions failed to enable the identification or disclosure of the related party relationships or transactions;
3. Perform appropriate substantive audit procedures relating to such newly identified related parties or significant related party transactions;  (Ref: Para. A36)
4. Reconsider the risk that other related parties or significant related party transactions may exist that management has not previously identified or disclosed to the auditor, and perform additional audit procedures as necessary; and
5. If the non‑disclosure by management appears intentional (and therefore indicative of a risk of material misstatement due to fraud), evaluate the implications for the audit.  (Ref: Para. A37)

Identified Significant Related Party Transactions outside the Entity’s Normal Course of Business

For identified significant related party transactions outside the entity’s normal course of business, the auditor shall:

1. Inspect the underlying contracts or agreements, if any, and evaluate whether:
   1. The business rationale (or lack thereof) of the transactions suggests that they may have been entered into to engage in fraudulent financial reporting or to conceal misappropriation of assets;[11]  (Ref: Para. A38‑A39)
   2. The terms of the transactions are consistent with management’s explanations; and
   3. The transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework; and
2. Obtain audit evidence that the transactions have been appropriately authorised and approved.  (Ref: Para. A40‑A41) 

Assertions That Related Party Transactions Were Conducted on Terms Equivalent to Those Prevailing in an Arm’s Length Transaction

If management has made an assertion in the financial report to the effect that a related party transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction, the auditor shall obtain sufficient appropriate audit evidence about the assertion.  (Ref: Para. A42‑A45)

In forming an opinion on the financial report in accordance with ASA 700,[12] the auditor shall evaluate:  (Ref: Para. A46)

1. Whether the identified related party relationships and transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework; and  (Ref: Para. A47)
2. Whether the effects of the related party relationships and transactions:
   1. Prevent the financial report from achieving fair presentation (for fair presentation frameworks); or
   2. Cause the financial report to be misleading (for compliance frameworks). 

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:  (Ref: Para. A48‑A49)

1. 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
2. They have appropriately accounted for and disclosed such relationships and transactions in accordance with the requirements of the framework. 

Unless all of those charged with governance are involved in managing the entity,[13] the auditor shall communicate with those charged with governance significant matters arising during the audit in connection with the entity’s related parties.  (Ref: Para. A50)

If the auditor is unable to:

the auditor shall modify the auditor’s opinion in accordance with   ASA 705.*

1. obtain sufficient appropriate audit evidence regarding related parties and related party transactions; or
2. form a conclusion as to the completeness of the disclosure of related party relationships and transactions in accordance with the applicable financial reporting framework;

If the auditor concludes that the related party disclosures in the financial report do not satisfy the requirements of the applicable financial reporting framework, the auditor shall modify the auditor’s opinion in accordance with ASA 705.

The auditor shall include in the audit documentation the names of the identified related parties and the nature of the related party relationships.[14]

Financial Reporting Frameworks That Establish Minimal Related Party Requirements (Ref: Para. 4)

An applicable financial reporting framework that establishes minimal related party requirements is one that defines the meaning of a related party but that definition has a substantially narrower scope than the definition set out in paragraph 10(b)(ii) of this Auditing Standard, so that a requirement in the framework to disclose related party relationships and transactions would apply to substantially fewer related party relationships and transactions.

Fair Presentation Frameworks (Ref: Para. 4(a))

In the context of a fair presentation framework,[15] related party relationships and transactions may cause the financial report to fail to achieve fair presentation if, for example, the economic reality of such relationships and transactions is not appropriately reflected in the financial report.  For instance, fair presentation may not be achieved if the sale of a property by the entity to a controlling shareholder at a price above or below fair market value has been accounted for as a transaction involving a profit or loss for the entity when it may constitute a contribution or return of capital or the payment of a dividend.

Compliance Frameworks (Ref: Para. 4(b))

In the context of a compliance framework, whether related party relationships and transactions cause the financial report to be misleading as discussed in ASA 700 depends upon the particular circumstances of the engagement.  For example, even if non‑disclosure of related party transactions in the financial report is in compliance with the framework and applicable law or regulation, the financial report could be misleading if the entity derives a very substantial portion of its revenue from transactions with related parties, and that fact is not disclosed.  However, it will be extremely rare for the auditor to consider a financial report that is prepared and presented in accordance with a compliance framework to be misleading if in accordance with ASA 210[16] the auditor determined that the framework is acceptable.[17]

(Ref: Para. 10(b))

Many financial reporting frameworks discuss the concepts of control and significant influence.  Although they may discuss these concepts using different terms, they generally explain that:

1. Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities; and
2. Significant influence (which may be gained by share ownership, statute or agreement) is the power to participate in the financial and operating policy decisions of an entity, but is not control over those policies. 

The existence of the following relationships may indicate the presence of control or significant influence:

1. Direct or indirect equity holdings or other financial interests in the entity.
2. The entity’s holdings of direct or indirect equity or other financial interests in other entities. 
3. Being part of those charged with governance or key management (that is, those members of management who have the authority and responsibility for planning, directing and controlling the activities of the entity).
4. Being a close family member of any person referred to in subparagraph (c).
5. Having a significant business relationship with any person referred to in subparagraph (c).

Related Parties with Dominant Influence (Ref: Para. 19)

Related parties, by virtue of their ability to exert control or significant influence, may be in a position to exert dominant influence over the entity or its management.  Consideration of such behaviour is relevant when identifying and assessing the risks of material misstatement due to fraud, as further explained in paragraphs A29‑A30.

Special‑Purpose Entities as Related Parties

In some circumstances, a special‑purpose entity[18] may be a related party of the entity because the entity may in substance control it, even if the entity owns little or none of the special‑purpose entity’s equity.

Risks of Material Misstatement Associated with Related Party Relationships and Transactions (Ref: Para. 11)

Considerations Specific to Public Sector Entities

The public sector auditor’s responsibilities regarding related party relationships and transactions may be affected by the audit mandate, or by obligations on public sector entities arising from law, regulation or other authority.  Consequently, the public sector auditor’s responsibilities may not be limited to addressing the risks of material misstatement associated with related party relationships and transactions, but may also include a broader responsibility to address the risks of non‑compliance with law, regulation and other authority governing public sector bodies that lay down specific requirements in the conduct of business with related parties.  Further, the public sector auditor may need to have regard to public sector financial reporting requirements for related party relationships and transactions that may differ from those in the private sector.

Understanding the Entity’s Related Party Relationships and Transactions

Discussion among the Engagement Team (Ref: Para. 12)

Matters that may be addressed in the discussion among the engagement team include:

• The nature and extent of the entity’s relationships and transactions with related parties (using, for example, the auditor’s record of identified related parties updated after each audit).
• An emphasis on the importance of maintaining professional scepticism throughout the audit regarding the potential for material misstatement associated with related party relationships and transactions.
• The circumstances or conditions of the entity that may indicate the existence of related party relationships or transactions that management has not identified or disclosed to the auditor (for example, a complex organisational structure, use of special‑purpose entities for off‑balance sheet transactions, or an inadequate information system).
• The records or documents that may indicate the existence of related party relationships or transactions.
• The importance that management and those charged with governance attach to the identification, appropriate accounting for, and disclosure of related party relationships and transactions (if the applicable financial reporting framework establishes related party requirements), and the related risk of management override of controls.

In addition, the discussion in the context of fraud may include specific consideration of how related parties may be involved in fraud.  For example:

• How special‑purpose entities controlled by management might be used to facilitate earnings management.
• How transactions between the entity and a known business partner of a key member of management could be arranged to facilitate misappropriation of the entity’s assets.

The Identity of the Entity’s Related Parties (Ref: Para. 13(a))

Where the applicable financial reporting framework establishes related party requirements, information regarding the identity of the entity’s related parties is likely to be readily available to management because the entity’s information systems will need to record, process and summarise related party relationships and transactions to enable the entity to meet the accounting and disclosure requirements of the framework.  Management is therefore likely to have a comprehensive list of related parties and changes from the prior period.  For recurring engagements, making the enquiries provides a basis for comparing the information supplied by management with the auditor’s record of related parties noted in previous audits.

However, where the framework does not establish related party requirements, the entity may not have such information systems in place.  Under such circumstances, it is possible that management may not be aware of the existence of all related parties.  Nevertheless, the requirement to make the enquiries specified by paragraph 13 still applies because management may be aware of parties that meet the related party definition set out in this Auditing Standard.  In such a case, however, the auditor’s enquiries regarding the identity of the entity’s related parties are likely to form part of the auditor’s risk assessment procedures and related activities performed in accordance with ASA 315 to obtain information regarding the entity’s organisational structure, ownership, governance and business model.

In the particular case of common control relationships, as management is more likely to be aware of such relationships if they have economic significance to the entity, the auditor’s enquiries are likely to be more effective if they are focused on whether parties with which the entity engages in significant transactions, or shares resources to a significant degree, are related parties.

In the context of a group audit, ASA 600 requires the group engagement team to provide each component auditor with a list of related parties prepared by group management and any other related parties of which the group engagement team is aware.[19]  Where the entity is a component within a group, this information provides a useful basis for the auditor’s enquiries of management regarding the identity of the entity’s related parties.

The auditor may also obtain some information regarding the identity of the entity’s related parties through enquiries of management during the engagement acceptance or continuance process.

The Entity’s Controls over Related Party Relationships and Transactions (Ref: Para. 14)

Others within the entity are those considered likely to have knowledge of the entity’s related party relationships and transactions, and the entity’s controls over such relationships and transactions.  These may include, to the extent that they do not form part of management:

• Those charged with governance;
• Personnel in a position to initiate, process, or record transactions that are both significant and outside the entity’s normal course of business, and those who supervise or monitor such personnel;
• The internal audit function;
• In‑house legal counsel; and
• The chief ethics officer or equivalent person.

The audit is conducted on the premise that management and, where appropriate, those charged with governance have acknowledged and understand that they have responsibility for the preparation of the financial report in accordance with the applicable financial reporting framework, including where relevant their fair presentation, and for such internal control as management and, where appropriate, those charged with governance determine is necessary to enable the preparation of the financial report that is free from material misstatement, whether due to fraud or error.[20]  Accordingly, where the framework establishes related party requirements, the preparation of the financial report requires management, with oversight from those charged with governance, to design, implement and maintain adequate controls over related party relationships and transactions so that these are identified and appropriately accounted for and disclosed in accordance with the framework.  In their oversight role, those charged with governance monitor how management is discharging its responsibility for such controls.  Regardless of any related party requirements the framework may establish, those charged with governance may, in their oversight role, obtain information from management to enable them to understand the nature and business rationale of the entity’s related party relationships and transactions.

In meeting the ASA 315 requirement to obtain an understanding of the control environment,[21] the auditor may consider features of the control environment relevant to mitigating the risks of material misstatement associated with related party relationships and transactions, such as:

• Internal ethical codes, appropriately communicated to the entity’s personnel and enforced, governing the circumstances in which the entity may enter into specific types of related party transactions.
• Policies and procedures for open and timely disclosure of the interests that management and those charged with governance have in related party transactions.
• The assignment of responsibilities within the entity for identifying, recording, summarising, and disclosing related party transactions.
• Timely disclosure and discussion between management and those charged with governance of significant related party transactions outside the entity’s normal course of business, including whether those charged with governance have appropriately challenged the business rationale of such transactions (for example, by seeking advice from external professional advisors).
• Clear guidelines for the approval of related party transactions involving actual or perceived conflicts of interest, such as approval by a subcommittee of those charged with governance comprising individuals independent of management.
• Periodic reviews by the internal audit function, where applicable.
• Proactive action taken by management to resolve related party disclosure issues, such as by seeking advice from the auditor or external legal counsel.
• The existence of whistle‑blowing policies and procedures, where applicable.

Controls over related party relationships and transactions within some entities may be deficient or non‑existent for a number of reasons, such as:

• The low importance attached by management to identifying and disclosing related party relationships and transactions.
• The lack of appropriate oversight by those charged with governance.
• An intentional disregard for such controls because related party disclosures may reveal information that management considers sensitive, for example, the existence of transactions involving family members of management.
• An insufficient understanding by management of the related party requirements of the applicable financial reporting framework.
• The absence of disclosure requirements under the applicable financial reporting framework. 

Where such controls are ineffective or non‑existent, the auditor may be unable to obtain sufficient appropriate audit evidence about related party relationships and transactions.  If this were the case, the auditor would, in accordance with ASA 705,^[22] consider the implications for the audit, including the opinion in the auditor’s report.

Fraudulent financial reporting often involves management override of controls that otherwise may appear to be operating effectively.[23]  The risk of management override of controls is higher if management has relationships that involve control or significant influence with parties with which the entity does business because these relationships may present management with greater incentives and opportunities to perpetrate fraud.  For example, management’s financial interests in certain related parties may provide incentives for management to override controls by (a) directing the entity, against its interests, to conclude transactions for the benefit of these parties, or (b) colluding with such parties or controlling their actions.  Examples of possible fraud include:

• Creating fictitious terms of transactions with related parties designed to misrepresent the business rationale of these transactions.
• Fraudulently organising the transfer of assets from or to management or others at amounts significantly above or below market value.
• Engaging in complex transactions with related parties, such as special‑purpose entities, that are structured to misrepresent the financial position or financial performance of the entity. 

Considerations specific to smaller entities

Controls in smaller entities are likely to be less formal and smaller entities may have no documented processes for dealing with related party relationships and transactions.  An owner‑manager may mitigate some of the risks arising from related party transactions, or potentially increase those risks, through active involvement in all the main aspects of the transactions.  For such entities, the auditor may obtain an understanding of the related party relationships and transactions, and any controls that may exist over these, through enquiry of management combined with other procedures, such as observation of management’s oversight and review activities, and inspection of available relevant documentation. 

Authorisation and approval of significant transactions and arrangements (Ref: Para. 14(b))

Authorisation involves the granting of permission by a party or parties with the appropriate authority (whether management, those charged with governance or the entity’s shareholders) for the entity to enter into specific transactions in accordance with pre‑determined criteria, whether judgemental or not.  Approval involves those parties’ acceptance of the transactions the entity has entered into as having satisfied the criteria on which authorisation was granted.  Examples of controls the entity may have established to authorise and approve significant transactions and arrangements with related parties or significant transactions and arrangements outside the normal course of business include:

• Monitoring controls to identify such transactions and arrangements for authorisation and approval.
• Approval of the terms and conditions of the transactions and arrangements by management, those charged with governance or, where applicable, shareholders.

Maintaining Alertness for Related Party Information When Reviewing Records or Documents 

Records or Documents That the Auditor May Inspect (Ref: Para. 15)

During the audit, the auditor may inspect records or documents that may provide information about related party relationships and transactions, for example: 

• Third‑party confirmations obtained by the auditor (in addition to bank and legal confirmations).
• Entity income tax returns.
• Information supplied by the entity to regulatory authorities.
• Shareholder registers to identify the entity’s principal shareholders.
• Statements of conflicts of interest from management and those charged with governance.
• Records of the entity’s investments and those of its superannuation plans.
• Contracts and agreements with key management or those charged with governance.
• Significant contracts and agreements not in the entity’s ordinary course of business.
• Specific invoices and correspondence from the entity’s professional advisors.
• Life insurance policies acquired by the entity.
• Significant contracts re‑negotiated by the entity during the period.
• Reports of the internal audit function.
• Documents associated with the entity’s filings with a securities regulator (for example, prospectuses).
• Arrangements that may indicate the existence of previously unidentified or undisclosed related party relationships or transactions.  (Ref: Para. 15)

An arrangement involves a formal or informal agreement between the entity and one or more other parties for such purposes as:

• The establishment of a business relationship through appropriate vehicles or structures.
• The conduct of certain types of transactions under specific terms and conditions.
• The provision of designated services or financial support.

Examples of arrangements that may indicate the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor include:

• Participation in unincorporated partnerships with other parties.
• Agreements for the provision of services to certain parties under terms and conditions that are outside the entity’s normal course of business.
• Guarantees and guarantor relationships.

Identification of Significant Transactions outside the Normal Course of Business (Ref: Para. 16)

Obtaining further information on significant transactions outside the entity’s normal course of business enables the auditor to evaluate whether fraud risk factors, if any, are present and, where the applicable financial reporting framework establishes related party requirements, to identify the risks of material misstatement.

Examples of transactions outside the entity’s normal course of business may include:

• Complex equity transactions, such as corporate restructurings or acquisitions.
• Transactions with offshore entities in jurisdictions with weak corporate laws.
• The leasing of premises or the rendering of management services by the entity to another party if no consideration is exchanged.
• Sales transactions with unusually large discounts or returns.
• Transactions with circular arrangements, for example, sales with a commitment to repurchase.
• Transactions under contracts whose terms are changed before expiry.

Understanding the nature of significant transactions outside the normal course of business (Ref: Para. 16(a))

Enquiring into the nature of the significant transactions outside the entity’s normal course of business involves obtaining an understanding of the business rationale of the transactions, and the terms and conditions under which these have been entered into.

Enquiring into whether related parties could be involved (Ref: Para. 16(b))

A related party could be involved in a significant transaction outside the entity’s normal course of business not only by directly influencing the transaction through being a party to the transaction, but also by indirectly influencing it through an intermediary.  Such influence may indicate the presence of a fraud risk factor. 

Sharing Related Party Information with the Engagement Team (Ref: Para. 17)

Relevant related party information that may be shared among the engagement team members includes, for example:

• The identity of the entity’s related parties.
• The nature of the related party relationships and transactions.
• Significant or complex related party relationships or transactions that may be determined to be significant risks, in particular transactions in which management or those charged with governance are financially involved. 

Fraud Risk Factors Associated with a Related Party with Dominant Influence (Ref: Para. 19)

Domination of management by a single person or small group of persons without compensating controls is a fraud risk factor.[24]  Indicators of dominant influence exerted by a related party include:

• The related party has vetoed significant business decisions taken by management or those charged with governance.
• Significant transactions are referred to the related party for final approval. 
• There is little or no debate among management 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.

Dominant influence may also exist in some cases if the related party has played a leading role in founding the entity and continues to play a leading role in managing the entity. 

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.

(Ref: Para. 20)

The nature, timing and extent of the further audit procedures that the auditor may select to respond to the assessed risks of material misstatement associated with related party relationships and transactions depend upon the nature of those risks and the circumstances of the entity.[25]

Examples of substantive audit procedures that the auditor may perform when the auditor has assessed a significant risk that management has not appropriately accounted for or disclosed specific related party transactions in accordance with the applicable financial reporting framework (whether due to fraud or error) include:

• Confirming or discussing specific aspects of the transactions with intermediaries such as banks, law firms, guarantors, or agents, where practicable and not prohibited by law, regulation or ethical rules.
• Confirming the purposes, specific terms or amounts of the transactions with the related parties (this audit procedure may be less effective where the auditor judges that the entity is likely to influence the related parties in their responses to the auditor).
• Where applicable, reading the financial report(s) or other relevant financial information, if available, of the related parties for evidence of the accounting of the transactions in the related parties’ accounting records.

If the auditor has assessed a significant risk of material misstatement due to fraud as a result of the presence of a related party with dominant influence, the auditor may, in addition to the general requirements of ASA 240, perform audit procedures such as the following to obtain an understanding of the business relationships that such a related party may have established directly or indirectly with the entity and to determine the need for further appropriate substantive audit procedures:

• Enquiries of, and discussion with, management and those charged with governance.
• Enquiries of the related party.
• Inspection of significant contracts with the related party.
• Appropriate background research, such as through the Internet or specific external business information databases.
• Review of employee whistle‑blowing reports where these are retained.

Depending upon the results of the auditor’s risk assessment procedures, the auditor may consider it appropriate to obtain audit evidence without testing the entity’s controls over related party relationships and transactions.  In some circumstances, however, it may not be possible to obtain sufficient appropriate audit evidence from substantive audit procedures alone in relation to the risks of material misstatement associated with related party relationships and transactions.  For example, where intra‑group transactions between the entity and its components are numerous and a significant amount of information regarding these transactions is initiated, recorded, processed or reported electronically in an integrated system, the auditor may determine that it is not possible to design effective substantive audit procedures that by themselves would reduce the risks of material misstatement associated with these transactions to an acceptably low level.  In such a case, in meeting the ASA 330  requirement to obtain sufficient appropriate audit evidence as to the operating effectiveness of controls,[26] the auditor is required to test the entity’s controls over the completeness and accuracy of the recording of the related party relationships and transactions.

Identification of Previously Unidentified or Undisclosed Related Parties or Significant Related Party Transactions

Existence of Related Parties (Ref: Para. 21)

In determining whether underlying circumstances confirm the existence of related party relationships or transactions, the auditor may consider the Australian Accounting Standards,^* including consideration of the substance of the relationship and/or transaction and not merely the legal form.

Communicating Newly Identified Related Party Information to the Engagement Team (Ref: Para. 22(a))

Communicating promptly any newly identified related parties to the other members of the engagement team assists them in determining whether this information affects the results of, and conclusions drawn from, risk assessment procedures already performed, including whether the risks of material misstatement need to be reassessed.

Substantive Procedures Relating to Newly Identified Related Parties or Significant Related Party Transactions (Ref: Para. 22(c))

Examples of substantive audit procedures that the auditor may perform relating to newly identified related parties or significant related party transactions include:

• Making enquiries regarding the nature of the entity’s relationships with the newly identified related parties, including (where appropriate and not prohibited by law, regulation or ethical rules) enquiring of parties outside the entity who are presumed to have significant knowledge of the entity and its business, such as legal counsel, principal agents, major representatives, consultants, guarantors, or other close business partners.
• Conducting an analysis of accounting records for transactions with the newly identified related parties.  Such an analysis may be facilitated using computer‑assisted audit techniques.
• Verifying the terms and conditions of the newly identified related party transactions, and evaluating whether the transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework.

Intentional Non‑Disclosure by Management (Ref: Para. 22(e))

The requirements and guidance in ASA 240 regarding the auditor’s responsibilities relating to fraud in an audit of a financial report are relevant where management appears to have intentionally failed to disclose related parties or significant related party transactions to the auditor.  The auditor may also consider whether it is necessary to re‑evaluate the reliability of management’s responses to the auditor’s enquiries and management’s representations to the auditor.

Identified Significant Related Party Transactions outside the Entity’s Normal Course of Business

Evaluating the Business Rationale of Significant Related Party Transactions (Ref: Para. 23(a))

In evaluating the business rationale of a significant related party transaction outside the entity’s normal course of business, the auditor may consider the following:

• Whether the transaction:
  • Is overly complex (for example, it may involve multiple related parties within a consolidated group).
  • Has unusual terms of trade, such as unusual prices, interest rates, guarantees and repayment terms.
  • Lacks an apparent logical business reason for its occurrence.
  • Involves previously unidentified related parties.
  • Is processed in an unusual manner.
• Whether management has discussed the nature of, and accounting for, such a transaction with those charged with governance. 
• Whether management is placing more emphasis on a particular accounting treatment rather than giving due regard to the underlying economics of the transaction.

If management’s explanations are materially inconsistent with the terms of the related party transaction, the auditor is required, in accordance with ASA 500,[27] to consider the reliability of management’s explanations and representations on other significant matters. 

The auditor may also seek to understand the business rationale of such a transaction from the related party’s perspective, as this may help the auditor to better understand the economic reality of the transaction and why it was carried out.  A business rationale from the related party’s perspective that appears inconsistent with the nature of its business may represent a fraud risk factor.

Authorisation and Approval of Significant Related Party Transactions (Ref: Para. 23(b))

Authorisation and approval by management, those charged with governance, or, where applicable, the shareholders of significant related party transactions outside the entity’s normal course of business may provide audit evidence that these have been duly considered at the appropriate levels within the entity and that their terms and conditions have been appropriately reflected in the financial report.  The existence of transactions of this nature that were not subject to such authorisation and approval, in the absence of rational explanations based on discussion with management or those charged with governance, may indicate risks of material misstatement due to error or fraud.  In these circumstances, the auditor may need to be alert for other transactions of a similar nature.  Authorisation and approval alone, however, may not be sufficient in concluding whether risks of material misstatement due to fraud are absent because authorisation and approval may be ineffective if there has been collusion between the related parties or if the entity is subject to the dominant influence of a related party.

Considerations specific to smaller entities

A smaller entity may not have the same controls provided by different levels of authority and approval that may exist in a larger entity.  Accordingly, when auditing a smaller entity, the auditor may rely to a lesser degree on authorisation and approval for audit evidence regarding the validity of significant related party transactions outside the entity’s normal course of business.  Instead, the auditor may consider performing other audit procedures such as inspecting relevant documents, confirming specific aspects of the transactions with relevant parties, or observing the owner‑manager’s involvement with the transactions. 

Assertions That Related Party Transactions Were Conducted on Terms Equivalent to Those Prevailing in an Arm’s Length Transaction (Ref: Para. 24)

Although audit evidence may be readily available regarding how the price of a related party transaction compares to that of a similar arm’s length transaction, there are ordinarily practical difficulties that limit the auditor’s ability to obtain audit evidence that all other aspects of the transaction are equivalent to those of the arm’s length transaction.  For example, although the auditor may be able to confirm that a related party transaction has been conducted at a market price, it may be impracticable to confirm whether other terms and conditions of the transaction (such as credit terms, contingencies and specific charges) are equivalent to those that would ordinarily be agreed between independent parties.  Accordingly, there may be a risk that management’s assertion that a related party transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction may be materially misstated. 

The preparation of the financial report requires management to substantiate an assertion that a related party transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction.  Management’s support for the assertion may include:

• Comparing the terms of the related party transaction to those of an identical or similar transaction with one or more unrelated parties.
• Engaging an external expert to determine a market value and to confirm market terms and conditions for the transaction.
• Comparing the terms of the transaction to known market terms for broadly similar transactions on an open market.

Evaluating management’s support for this assertion may involve one or more of the following:

• Considering the appropriateness of management’s process for supporting the assertion.
• Verifying the source of the internal or external data supporting the assertion, and testing the data to determine their accuracy, completeness and relevance.
• Evaluating the reasonableness of any significant assumptions on which the assertion is based.

Some financial reporting frameworks require the disclosure of related party transactions not conducted on terms equivalent to those prevailing in arm’s length transactions.  In these circumstances, if management has not disclosed a related party transaction in the financial report, there may be an implicit assertion that the transaction was conducted on terms equivalent to those prevailing in an arm’s length transaction.

Materiality Considerations in Evaluating Misstatements (Ref: Para. 25)

ASA 450 requires the auditor to consider both the size and the nature of a misstatement, and the particular circumstances of its occurrence, when evaluating whether the misstatement is material.[28]  The significance of the transaction to the financial report users may not depend solely on the recorded amount of the transaction but also on other specific relevant factors, such as the nature of the related party relationship. 

Evaluation of Related Party Disclosures (Ref: Para. 25(a))

Evaluating the related party disclosures in the context of the disclosure requirements of the applicable financial reporting framework means considering whether the facts and circumstances of the entity’s related party relationships and transactions have been appropriately summarised and presented so that the disclosures are understandable.  Disclosures of related party transactions may not be understandable if:

1. The business rationale and the effects of the transactions on the financial report are unclear or misstated; or
2. Key terms, conditions, or other important elements of the transactions necessary for understanding them are not appropriately disclosed.

(Ref: Para. 26)

Circumstances in which it may be appropriate to obtain written representations from those charged with governance include:

• When they have approved specific related party transactions that (a) materially affect the financial report, or (b) involve management.
• When they have made specific oral representations to the auditor on details of certain related party transactions.
• When they have financial or other interests in the related parties or the related party transactions.

The auditor may also decide to obtain written representations regarding specific assertions that management may have made, such as a representation that specific related party transactions do not involve undisclosed side agreements.

(Ref: Para. 27)

Communicating significant matters arising during the audit[29] 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 authorised 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 regulation prohibiting or restricting specific types of related party transactions.
• Difficulties in identifying the party that ultimately controls the entity.