Meaning of Related Parties
Related Party means :-
1) A related party as defined in the applicable financial reporting framework
For Example :- As per Section 2(76) of The Companies Act 2013, A Related Party is a person or entity that is related to the entity preparing its financial statements like:-
v Director or his relative,
v A key Managerial Personnel (MD/WTD/Manager/Secretary/CEO/CFO) or his relative;
v A firm, in which a director, manager or his relative is a partner,
v A Private Company in which a director or manager is a member or director;
v A public company in which a director or manager is a director or holds along with his relatives, more than 2% of its paid-up-capital;
v A body corporate whose board of directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director, manager;
v Any person on whose advice, directions or instructions of a director or manager is accustomed to act;
v A company which is a holding, subsidiary or an associate company of such company;
v A company which is subsidiary of holding company to which it is also a subsidiary, or
v Such other person as may be prescribed.
Reason for this SA ! Why the Related Party disclosures is important for an entity?
Related-party transactions are close relationships between entities or individuals. They aren’t necessarily wrong, but because of their delicate nature and the risk of abuse or fraud, they must be carefully scrutinized and usually fully disclosed. As an investor, we want corporate disclosures to provide a clear and fair picture of the entity’s net worth, operations, and cash flow. Related party transactions are important because they have the potential for distorting that information. Related party transactions have been highlighted as a feature of a number of financial scandals in recent years. This prompted the financial statements user the importance of adequate attention to information disclosed by companies in their financial statements in this respect.
Even As per AS 18, Related Party Disclosures, All the Related Parties of an enterprise should be disclosed in the financial statements even though there are no transactions between the enterprises.
Concept of Arm’s Length Price
The “arm’s-length principle” basis underlying related party transactions is another area that might be overlooked. It can be understood asthe amount charged by one related party to another for a given product must be the same as if the parties were not related and is therefore what the price of that transaction would be on an open market, determining the arm’s-length price can sometimes be a technically complicated matter, especially when it relates proprietary goods and services or intangibles.
Disclosing Related Party Transaction : Whose Responsibility?
It’s a responsibility of the management to identify & disclose all the related party transactions in the financial statements. In order to do so, the management can establish systems & processes to facilitate the identification & disclosure of the related parties & its transactions such as imposing roles & responsibilities of the audit committee :-
v To monitor all the abusive related parties transactions,
v To reviews of areas such as possible failure to identify related parties and related party transactions, inadequate examination of related party transactions, improper disclosures of related party transactions.
Auditor’s Responsibility
An auditor is required to comply with the provisions of SA 550, Related Parties when auditing Related Party Disclosures. The auditor is required :-
1) To see whether all the financial reporting framework & statutory compliance as far as related to related party, related party transactions accounting & disclosures have been appropriately complied with,
2) To obtain an understanding of the entity’s related party relationships & transactions,
3) To evaluate fraud risk factors in relation to related parties,
4) To have an attitude of professional skepticism.
Auditor’s Duty
| Enquiry with the Management | The auditor shall enquire of management regarding following:-
v The identity of entity’s related parties, including changes from the prior period v The nature of relationships between the entity & those related parties ; & v Whether the entity entered into any transactions with these related parties during the period &, if so, the type & purpose of transactions. |
| Enquiry about Controls | The auditor shall enquire about the internal controls adopted by the management for the following identification, accounting & disclosure as well as authentication approval of related party transactions. |
| Maintaining Alertness | During the audit, the auditor shall maintain professional skepticism that whether any instances are there showing the existence of related party transactions or relationships that management has not previously identified or disclosed to the auditor. |
| Sharing Related Party Information | The auditor shall share relevant information obtained about the entity’s related parties with the other members of the engagement team |
| Designing audit procedures | After applying all of the above procedures if the auditor identifies fraud risk factors then the auditor shall designs & performs further audit procedures to obtain sufficient appropriate audit evidences about the assessed risks of material misstatement associated with the related party transactions & relationships. |
Procedures to Verify the Existence of Related Parties
1) Identifying related party relationships can be a challenging and costly exercise particularly for large organisations. Therefore, unless there is something to doubt, the auditor shall rely on the systems and processes established by management in assessing the identifying and disclosing related party transactions.
2) Other Procedures:- The auditor shall:-
ü Review the working papers for the prior years for names of known related parties;
ü Review the entity’s procedures for identification of related parties;
ü Entity Income Tax Returns & Tax Audit Report;
ü Check the information supplied by the entity to the regulatory authorities;
ü Check records of entity’s investments;
ü Review Internal Audit Report;
ü Review the contracts & agreements with Key Management or TCWG;
ü Check the shareholder registers to identify the entity’s principal shareholder;
ü Check significant contracts & agreements not in the entity’s ordinary course of business
ü Obtain MRL from the management in regards to the disclosures of all related parties to the auditor;
Other Consideration
1) Written Representations
The auditor shall obtain MRL from the management & where appropriate, TCWG that:-
v They have disclosed to the auditor :-
ü Identity of the entity’s related parties,
ü All the related party relationships &
ü Transactions of which they were aware.
v They have appropriately accounted for & disclosed such relationships & transactions in accordance with the requirements of the framework.
2) Communication with the TCWG
The auditor shall communicate with TCWG all the significant matters arising during the audit in relation to related parties.
3) Documentation
The Auditor shall document
ü The names of the identified related parties,
ü The nature of related parties relationships
ü Matters communicated to TCWG, in regards to the related parties
ü Result of Audit Procedures
Auditor’s Reporting
| Cases | Auditor’s Duty | ||||
| When auditor indentified previously unidentified or undisclosed related parties or significant related party transactions | 1) To communicate the same to Management & TCWG,
2) Request the management to disclose the same.
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| Where the contract is of abnormally high amount with related party | 1) The auditor shall apply additional audit procedures in regards to contract terms, pricing, related party relation, transaction, approval, authentication & disclosure.
2) If found unreasonable, the auditor shall modify his audit report in accordance with SA 705 |